Asian Drybulk Shipping Sector
SECTOR REVIEW
Who will survive this down-cycle?
■ Freight rates are at loss-making levels with some ships idling at ports. A
weaker China economy is a negative. However, with strong balance
sheets, carriers should be able to survive the down-cycle. We expect a
short-term BDI rebound on pent-up demand, when trade financing
issues are resolved, China-Brazil iron ore talks are settled, seasonal
demand picks-up and/or China steel inventory de-stocking finishes.
■ Carriers like CSD, STX Pan Ocean and Sincere Navigation could see
rising financial leverage, but do not show signs of short-term cash flow
problems, and significant financial distress even if we assume the BDI
falls to a historical low, leading to two years of losses. China Cosco,
STX PO and Pacific Basin have exposures to freight-rated derivatives.
■ Currently shipping customers, faced with trade financing issues, are
unable to ship cargo. For shipping owners, existing contracts may not
be honoured and financing costs are rising. We expect massive new
order cancellations and significant delays in delivery, given ship
financing issues and doubts on shipyards’ execution capabilities.
■ With weaker bulk demand, we still expect industry oversupply in 2009-
10 despite assuming a 30% order cancellation rate. We hence revise
down our 2008-10 BDI average to 6,700, 2,500 and 1,500. We cut sector
earnings by 15-86% in 2009 and expect some to make losses in 2010.
■ We think some stocks are inexpensive plays to a BDI rebound since
they are already below book value, and 14-53% below adjusted NAV. In
our universe, we like China Cosco, China Shipping Dev. and Sincere.
We downgrade Maybulk and U-Ming to Underperform.

Who will survive this down-cycle?
Dire situation – who will survive?
Under our stress test of a historically low BDI of 554 and thus two years of losses, carriers
would not be in significant financial distress if drastic measures like cutting capex and
returning charter-fleets are taken. A reality check on balance sheets also suggests no
carriers are showing short-term cash flow problems. CCH, STXPO and PB have freightrated
derivative exposure (FFA), but the risks to earnings appear bearable. Some vessels
with high capital costs are already operating below cash cost, but we estimate that most
carriers, except for PB and STXPO, could still be profitable in 2009 based on a BDI
average of 1,000, assuming half of their contracts signed earlier are still in place.
Impact of global credit crunch on shipping
Shipping customers are faced with trade financing issues and unable to ship cargoes. For
shipping owners, existing shipping contracts may not be honoured by customers or
charterers (given the collapse in rates), and financing costs are rising. New ship financing
terms are tougher, if they can be arranged at all (the ship financing market has shut
down). Weaker shipbuilders could see cash flow problems, as new orders dry up. We
expect massive new order cancellations and significant delays in delivery (we have
already seen a 30% delay YTD). Even scrapyards face difficulties in obtaining bank
financing to purchase vessels for scrap.
A new supply/demand balance to be established
Considering the weaker China and global trade outlook (CS economists recently revised
down China’s GDP forecast to 5-6% for the next three quarters, the weakest we have
seen in 20 years), we revised down our demand growth forecast accordingly to 2.4-3.6%
in 2009-10E. However, taking into account a 30% order cancellation in our base case, we
still expect to see an industry oversupply in 2009-10E. We estimate that an order
cancellation of 60-70% is required to see supply/demand in balance again in 2009-10E.
That said, we think some weaker ship-owners that entered the market only in the past few
years will be forced to withdraw from the market, as they can never recover their capital
costs, and thus a new equilibrium would be established and break-even profit could be
made by the survivors. We therefore revise down our 2008-10E BDI average to 6,700
(from 8,500), 2,500 (from 7,000) and 1,500 (from 5,000). As a result, we cut sector
earnings by 15-84% in 2009E and expect some firms to make losses in 2010E.
Inexpensive plays on the BDI
While the BDI is expected to stay low throughout the next two years, we think there could
be a short-term rebound on the unleashing of pent-up demand. Trade financing issues
have disrupted or even halted cargo flows, but inventories should eventually run out. Trust
between correspondent banks and their customers are likely to return. Moreover, a pick-up
in seasonal demand and the finishing of China’s steel de-stocking could be short-term
catalysts. We think these stocks have already factored in the current low BDI, as they are
trading below book (reflecting current unprofitable freight rate levels) and adjusted NAV,
which estimates bulk fleet values have fallen some 80% from mid-year levels. Therefore,
we think the dry bulk shipping stocks are call options on the BDI which benefit significantly
should the BDI rebound on the above-mentioned reasons.
Trading at 0.5x forward P/B and 0.6x P/adjusted NAV, CCH is the highest beta play and
could be a key beneficiary from the potential BDI rebound. We expect CSD to remain
profitable and generate decent ROAEs of 15%+, but the stock is at 1.0x F P/B (low end of
historical range) and close to historical low F PE of 6.0x. Sincere has greater earnings
visibility, with 65-89% of FY09 capacity locked in. Even assuming some contract
renegotiations, earnings are still likely to be more defensive relative to sector peers.