The BDI rally over the past month has narrowly focused on capesizes, driven by robust Chinese restocking of iron ore. Capesize rates should rise for a couple more weeks, supported by good steel demand in China, though the action may not spread to the smaller vessels.
We stay Neutral on the sector, with Pacific Basin and Maybulk as top picks as they are fundamentally strong and trading below their SOP. Stock catalysts include a gradual but broad recovery in dry bulk rates from 2014. We have an Underperform call on PSL on valuation grounds, and particularly highlight STXPO as our top sell as it is technically insolvent. We lower our target for STXPO to W295 (from W1,380) in this report.
" Freight rates and ship values have bottomed out, but there is no tangible evidence to support a sustained recovery soon."
? Pacific Basin Interim Report 2013
Broad or narrow recovery?
The average BDI has risen 52% so far this quarter from its 2Q13 average, driven almost entirely by a 142% qoq rise in capesize rates. Iron ore stocks in China are low, crude-steel production in 2013 has recovered very nicely from a lacklustre 2012, and apparent steel consumption has remained robust. The numbers coming out of China for real-estate investment, floor space under construction, and auto and white-goods production look good.
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For the moment, only iron ore demand has picked up, and only capesizes are feeling the tide. While there is a small hint of recent activity on the panamax side, the supramax and handysize segments remain lacklustre. We believe this is due to a 30% ship overcapacity, 3x more than that in past cyclical troughs, which limits onward rate transmissions when only one commodity is seeing a short-term demand increase.
How long will it last?
We expect capesize rates to stay high as long as Chinese iron ore restocking continues. Once that process is done, capesize rates may drop as quickly as they had risen, going by several examples in the recent past. An interesting point is, what would happen to share prices if capesize rates correct. After all, Pacific Basin?s share price has risen 18% over the past three months, and it does not even own a single capesize vessel.
The long view
As a result of the exceptionally high surplus rate, we should not expect dry-bulk freight rates to recover by very much or very quickly. Rates should bottom out this year, then rise slowly into 2014-15, assuming there is no major ordering binge. This gives us the confidence in our Outperform calls on the best-quality companies in the sector, even if there might be some short-term volatility. (Read Report)
