Source: Zhongjin Dim Sum
Authors: Liu Gangxian, Hang Cheng, etc.

Historical review: Factors influencing stock prices - freight rates and on-hand order levels

Shipping is an industry with strong cyclical characteristics. Demand and supply of ship capacity determine freight rates, and freight rates determine the profitability of current companies. We split the shipping company's stock price into two parts: profit and valuation.Profit is mainly affected by the current freight rate level, and the valuation level is a reflection of the market's judgment on the future supply and demand pattern and profitability of the industry.

We believe that the proportion of the industry's on-hand orders and capacity is an important basis for the market's judgment on future supply and demand patterns, which in turn affects the current valuation level. On the one hand, the ratio of hand orders to capacity reflects the future supply growth rate. In situations where the demand side of the industry is difficult to predict and track immediately, the growth rate on the supply side can reflect the probability of future balance between supply and demand in the industry. On the other hand, the freight rate center level is more influenced by the scale of supply-side capacity, while demand mainly affects the peak level of freight rates. When the supply-side pattern of the industry gradually improves, future freight rate hubs are likely to rise upward.

Looking at the historical stock prices of shipping companies, we see that shipping companies' stock prices are influenced by a combination of freight rates and the ratio of on-hand orders to capacity, and have sorted out four situations according to the different freight rate levels and the ratio of on-hand orders to capacity. In different situations, stock prices are affected by freight prices and on-hand order levels. Furthermore, under different levels of freight rates, there are differences in the flexibility of the company's stock price to the freight rate.

► High freight rates and a high proportion of on-hand orders:When the industry cycle is upward, stock prices rise as freight prices rise. If shipping companies build large-scale ships at this time and the proportion of on-hand orders in hand capacity increases, the future capacity growth rate will be higher, and the market expects future oversupply to be more likely. In turn, industry valuations fall, and stock prices will peak ahead of freight prices.

► Low freight rates and high proportion of on-hand orders:With the increase in supply-side capacity, the industry's supply and demand pattern deteriorated, and freight prices gradually adjusted. At this stage, stock prices fell due to low profits and undervaluations at the same time.

► Low freight rates and a low proportion of in-stock orders:With the gradual digestion of capacity, and shipping companies stopped building large-scale ships at low profit levels, the proportion of on-hand orders in capacity declined, and the future supply and demand pattern of the industry tended to balance. At this time, the valuation system remained relatively stable, and freight rates were waiting to be catalyzed by the demand side, and the correlation between stock prices and freight rates was high.

► Higher freight rates and lower share of on-hand orders:When the industry cycle is upward, stock prices rise as freight rates rise, but if the industry's on-hand orders account for a low level of capacity at this time, the industry's supply and demand pattern is likely to improve in the future. The industry valuation system remains unchanged, and stock prices remain highly correlated with freight rates, and rising freight rates will drive stock prices upward. Furthermore, stock price elasticity is different at different freight rate levels. When freight rates are high, stock prices are more sensitive to freight rates, and further increases in freight rates can bring greater flexibility to stock price increases.

When freight rates are catalyzed upward by demand and supply-side growth is low, the average freight rate gradually rises. Although freight rates fluctuate, the low point of phased fluctuation gradually rises along with the freight rate center. A short-term pullback may be a better time for investment.Looking back at history, we see that when the growth rate of capacity supply is low and demand side growth drives the industry cycle upward, freight rates will still fluctuate in the short term, but the fluctuating low will gradually rise along with the freight center, such as 2003-2004 for oil transportation and 2005-2007 for dry bulk transportation. Since the growth rate of capacity supply is low and the correlation between stock prices and freight rates is high, we think that future stock prices will rise in the same band as freight rates, so a short-term pullback will also be a good investment opportunity.

Oil transportation: the freight center is expected to rise, and the industry cycle is rising

• Historical review: The actual performance of stock prices in the three upward stages of the industry was divided

Looking back at the stock price performance of the oil transportation market, there have been three major upward phases of the industry cycle since 2000. There have been differences in stock price performance over different periods due to differences in future supply-side growth rates.

2003-2008: China's economic growth brought about an increase in the oil transportation cycle.China's economic growth has brought about crude oil consumption and import demand. Demand for oil transportation has increased, oil freight rates have gradually risen, and stock prices have changed at the same time as freight rates. With the sharp improvement in profits, oil transportation companies began to build a large number of new ships in 2006. In 2008, the industry's ship orders accounted for more than 50% of the capacity. In the future, excessive capacity growth rates caused the market to worry that the pattern of supply and demand in the industry would deteriorate, so the valuation of the oil transportation industry declined. The stock prices of some oil transportation companies fell immediately after the first freight rate peaked in early 2008, and the stock prices did not rebound when the subsequent freight rates rose again. A few companies saw their stock prices rise when freight rates rose the second time, but then fell faster than freight rates.

2014-2015: The decline in crude oil prices drives demand for inventory replenishment, leading to an upward cycle in the industry.The increase in OPEC production led to a fall in oil prices, which led to an increase in global demand for crude oil inventory replenishment, thereby increasing demand for oil transportation. From the second half of 2014 to the first half of 2015, oil transportation companies' stock prices rose at the same time as freight prices. However, starting in 2015/6, the ratio of the industry's on-hand orders to capacity increased, so it fell immediately after the stock price peaked in 2015/6, and did not rise with the rebound in freight rates in early 2016.

From 2022 to now: Freight prices have risen due to the lengthening average distance of trade routes and the increase in US exports.As the Russian-Ukrainian conflict broke the original crude oil trade route, lengthened transportation distances, and increased demand for long-route transportation due to the release of strategic US crude oil reserve stocks and increased exports, VLCC freight rates gradually increased in the second half of 2022. However, due to oil transportation companies' historical losses and shipyard production capacity restrictions, the ratio of VLCC on-hand orders to capacity has gradually declined since 2020. As a result, industry valuations have not changed much at this stage, and the correlation between stock prices and freight rates is high.

• Recently, oil freight rates have continued to rise, and the industry cycle is improving

As China's economy recovers, demand for oil transportation still needs to be released.Currently, kerosene is still the main consumption gap for refined oil products in China. The apparent consumption of refined oil products decreased 1.9% year on year in February. Among them, apparent consumption of kerosene decreased 14.2% year on year, a decrease of 310,000 b/d compared to 2019. China's domestic and foreign air travel demand has not yet recovered to pre-epidemic levels. Domestic passenger turnover in February was 93% in the same period of 2019 and 13% of international passenger turnover in the same period of 2019. We estimate that if international passenger turnover returns to 80% of pre-epidemic levels, aviation kerosene demand is expected to increase by nearly 137,000 b/d, an increase of 24% over the current level. If all of this crude oil comes from imports, it corresponds to an import increase of 2.5 million b/d, while crude oil imports in March were 10.14 million b/d. We believe that the resumption of domestic air travel, the restoration of the refinery production side, and the increase in exports of refined oil products are all expected to increase demand for crude oil imports.

The supply-side pattern is optimized, and freight rates are expected to rise further, driven by demand.Since 2023, the resumption of demand in China has led to an increase in oil transportation demand, leading to an increase in freight rates. Currently, oil freight rates have continued to rise after experiencing a correction at the end of 2022, and the current ratio of on-hand orders to capacity is only 2%, which is a historically low level. We don't think there will be much change in the current valuation. The stock price is mainly affected by freight prices. Furthermore, freight rates are currently at a relatively high level, and stock prices are more sensitive to freight rates. When freight rates are catalyzed by demand to rise further, stock prices may have greater upward elasticity.

Dry bulk transportation: The supply pattern is improving, and freight rates have recently rebounded

• Historical review: the stock price performance of the two upward stages of the industry was divided

2005-2008/6: China's infrastructure investment drives an increase in demand for dry bulk shipping, and the industry cycle is improving.Benefiting from the impetus of China's economic growth and accelerated infrastructure investment, demand for dry bulk shipping and freight rates increased. Stock prices rose at the same time as freight prices and peaked in 2007/10. However, as companies in the industry began large-scale shipbuilding, the proportion of on-hand orders in capacity increased rapidly (reaching 57% in 2007/10), the market feared that future demand would be weaker than supply, leading to a decline in industry profits, and the overall valuation of the sector declined. As a result, the stock prices of various companies peaked and fell immediately. Even though freight rates rose rapidly again in the first half of 2008, there was no sharp rebound in stock prices.

2021: China's dry bulk import demand drives the freight index upward.Since 2021, the BDI index has been gradually rising, while stock prices have risen accordingly. Furthermore, after 2018, the proportion of on-hand orders in the dry bulk fleet gradually declined, the industry valuation system stabilized, and stock prices fluctuated with freight prices. There was a slight rebound after the freight rate correction in early 2022, and since the current share of orders in hand is relatively low and the BDI index is above the historical average, the stock price is more sensitive to changes in freight rates at this time. The slight rebound in freight rates also brought about a large increase in stock prices, and then the stock price fell as freight prices fell.

• Freight prices have recently rebounded, and the upward trend in the industry still needs to be catalyzed by demand

The supply of dry bulk cargo fleets continues to be optimized, laying the foundation for market stability and improvement.In January 2023, global hand-held orders for dry bulk goods accounted for 7.24% of the fleet size, a decrease of 0.3 ppt over the previous month, and was at an all-time low. As environmental requirements increase, there is room for further clearance of carrying capacity, and stock capacity still needs to meet the requirements through docking modifications and deceleration navigation, etc., and supply may be further limited.

We believe that in situations where supply-side orders account for relatively low capacity, changes in the company's stock price are mainly affected by freight rates, that is, awaiting catalysis on the demand side.Recently, BDI freight rates have continued to rebound. On April 3, the BDI index was 1,412 points, up 166% from the previous year's low, but it is still down 41.5% from the previous year. We think whether the future freight rate rebound will continue depends mainly on the future demand for dry bulk imports brought about by the commencement of construction on China's infrastructure and real estate production side. Currently, domestic iron ore prices remain at a high level, blast furnace operating rates and steel mill profitability continue to rise. The government work report also proposes speeding up the implementation of infrastructure projects. According to the CICC Macro Group's forecast, the physical infrastructure workload will be further implemented in March and even the second quarter of this year, and the growth rate of infrastructure investment in the first quarter of this year is expected to reach about 10%. We believe that China's economic recovery and accelerated infrastructure investment may drive an increase in industry demand, but we still need to wait for further verification of actual data on the infrastructure and real estate production side.

Transportation: The pressure on the supply side is strong, and freight prices have fallen back to 2019 levels

• Historical review: Two upward cycles in the industry caused stock prices to fall prematurely due to too many orders in hand

Looking back at the stock price performance in the shipping market, there have been two upward cycles in the industry since 2000, and in both upward cycles, stock prices fell prematurely due to the high proportion of on-hand orders in capacity.

2003-2007: Global economic growth led to an increase in freight rates.Driven by China's and global economic growth, freight prices have continued to rise since 2003, and shipping companies' stock prices have continued to rise along with freight rates. However, due to the high volume of on-hand orders in the logistics industry, the stock prices of major companies peaked in October 2007 and fell faster than freight rates.

2020 to 2021: Congestion in the global supply chain led to a decrease in effective capacity, and freight rates rose due to tight supply.In 2020, the stock price of shipping companies rose along with freight rates, but as the proportion of on-hand orders to capacity increased dramatically due to the large-scale shipbuilding of shipping companies, industry valuations declined, peaked in June 2021 and then declined due to a decline in valuation, but industry freight rates only began to fall in early 2022.

• The decline in freight rates stabilized, and the industry entered a period of value observation

Orders for additional capacity have remained stable, and the demand side is still under pressure.In February 2023, container orders on hand accounted for 28.77% of capacity, down 0.28ppt from the previous month. The pressure on capacity delivery will still be strong in the next few years. Considering capacity delivery alone, the supply side will increase 9.0% in 2023. Looking at demand, US retailer inventories were still at a historically high level in January 2023, but the inventory and treasury sales ratio both declined. The Fed raised interest rates by 25 basis points in March. According to the CICC Macro Group, interest rate cuts will not arrive soon. Inflation is still resilient, or there is a pattern of stagflation, which still has an adverse impact on demand.

Considering the large amount of cash flow accumulated by shipping companies, we believe that the consolidation industry has now entered the first strategic observation period for long-term investment value after the epidemic: although the demand side faces problems such as inflation and economic growth concerns, whether major supply-side shipping companies can hedge the pressure of new ship delivery next year through ship scrapping, idle capacity, etc., is a key factor that determines the long-term value of the industry. The observation indicators are the bottom support level of freight rates, the quantity and speed of ship scrapping. We think industry fundamentals may bottom out or occur in the second half of 2023.

Investment risk:

Decline in global economic growth:Shipping is global and highly correlated with global economic development. If the growth rate of the global economy as a whole declines, it may cause demand for containers, crude oil, and dry bulk goods to weaken, leading to a decline in the growth rate of shipping and transportation demand.

Repeated outbreaks:The epidemic will affect travel activities. If the epidemic is repeated on a large scale, the air travel recovery process will slow down somewhat, thereby affecting China's crude oil consumption and crude oil import demand.

China's economic recovery fell short of expectations:China's economic recovery can drive crude oil imports and demand for bulk imports such as iron ore. If China's economic recovery falls short of expectations, it will have an adverse impact on oil transportation and dry bulk transportation.

Editor/Somer