Monday, January 25, 2010

Going Fishing In The Baltic

Those interested in finding undervalued stocks among shipping companies, a beaten-down industry (with good reason, as discussed here) will have come across the Baltic Dry Index (BDI), an important measure with which many shipping stocks are somewhat correlated. However, this index operates completely differently than most indexes with which investors are used to working, and therefore an understanding of how it works is imperative in applying its usefulness to making investment decisions.

The BDI has recovered well of late, as shown in the 5-yr chart below:


Though well off its highs of the last couple of years, the BDI has recovered to 2006 levels, suggesting shipping companies should be able to make money, right? For now, perhaps, but the future does not look great. You see, unlike most indexes we're used to working with, the price of the BDI is not set by the supply and demand of investors, which would make it a forward looking index. Instead, the price is based on the spot (current) supply and demand to ship dry raw materials. There is no element of speculation; the index price represents a composite of what it costs to ship these goods right now over a number of important routes.

Why is this distinction important? Because of the nature of the shipping industry. There are long lead times (in the range of several years) for building ships, and so when the economy was strong, the industry appears to have overreacted to the number of new ships that would be required in the coming years. Consider the number of new ships to be delivered in the near future:

As those ships continue to add to the supply of existing ships (and they will until 2012), they will put downward pressure on the BDI.

The BDI can be a very useful tool for analyzing the state of affairs for dry bulk shipping companies. Care must be taken, however, in understanding how the index works so that investors make informed decisions when it comes to purchasing shipping stocks.

Of course, this is only the supply side of the equation. We'll leave the discussion of dry-bulk demand for a future post.

4 comments:

rayhaan said...

yo saj,
Nice article!, u arent discussing individual stocks these days, whats up?
one quick q whats ur advice on investing in companies generating profits yet showing negative cash flow from operating activities
while growing rapidly at the same time?

Saj Karsan said...

Hi Rayhaan,

Yeah there have been a few general ones, but there a couple of individual companies that will be discussed this week.

I would say companies with negative operating cash flow could have problems or could be perfectly fine. You would have to judge each case on its own merits. Does the expansion make sense? Are the right accounts expanding? You could look at days inventory, days receivable, and days payable for example, to see if it's just an expansion or if the company is offering generous terms to its stakeholders, and that's the only way it is able to 'grow' its assets.

SPACED OUT GUY! said...

thx 4 the advice
are their any stocks on this site which match this description?

Saj Karsan said...

Hi SOG,

Not sure what you're referring to. What type of stocks do you mean, the ones discussed in the article or in the comments?

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