How to Invest in Shipping Stocks

The international maritime shipping industry is crucial to the global economy. Shipping vessels transport essential energy commodities like crude oil and diesel, dry bulk goods such as iron ore and grains, and finished manufactured products like autos and electronics. Overall, the maritime shipping industry carries out a staggering 90% of world trade flows, according to the International Chamber of Shipping.

Despite its vital role in moving the global economy forward, the shipping sector can be quite challenging for investors. Even a slight economic slowdown can have an outsized impact on sector profitability. This guide will help you navigate the industry, gain a better understanding of its ups and downs, and learn how to invest in shipping the right way.

What are shipping stocks?

The global freight transportation and logistics industry includes four methods of transportation:

  1. Marine: the transportation of cargo on waterborne vessels.
  2. Air: moving commercial goods on dedicated air freighters.
  3. Rail: the transportation of freight via the rail industry.
  4. Freight: moving goods via the trucking industry.

While many use the term shipping industry to refer to the entire freight transportation and logistics sector, it more specifically refers to companies that operate maritime vessels (i.e., ships). Thus shipping stocks are publicly traded companies that operate maritime vessels that transport commercial goods such as cargo, oil, and coal. Thus, this guide will focus on the maritime shipping industry.

What drives the shipping industry?

The maritime shipping industry has been called the lifeblood of the global economy. Each day, more than 50,000 merchant ships travel the seas carrying an estimated $4 trillion of goods each year. Without it, the intercontinental trade of bulk raw materials, food, and manufactured goods would not be possible. As such, it's a vital cog in moving the global economy forward.

Given the shipping industry's importance, it can often be a leading indicator of the direction of the global economy. It does this by providing critical data points that can suggest a slowdown or acceleration is coming. One way it does this is through the Baltic Dry Index (BDI), which assesses nearly two dozen major shipping routes to measure the change in rates charged by ships carrying dry commodity goods like iron ore and grain. If the index starts falling, it implies demand for shipping capacity is in decline, which hints that troubling seas could be ahead for the global economy. Meanwhile, a rising BDI infers that demand is on the upswing, which can mean smooth sailing ahead for the economy.

Economic growth typically benefits shipping companies. It allows them to charge higher shipping rates, enabling them to make boatloads of money. They can use that cash to expand their fleets and reward investors with dividends or repurchase shares. Those initiatives have the potential to enrich shareholders. A slowdown, on the other hand, can significantly affect sector profitability. An economic contraction, for example, will dampen demand for shipping capacity, which can cause dayrates to plunge. Conditions can get so challenging that shippers operate at a loss. That can cause a wave of bankruptcies to hit the sector, wiping out shareholders in the process.

What are the types of shipping vessels?

The maritime shipping industry transports four main types of product, which each requires specialized marine vessels. Because of that, many companies focus on operating one of the four major maritime shipping vessels.

1. Dry bulk carriers

The shipping industry uses specialized ships to transport dry commodities such as grains, metals like iron ore and copper, and other unpackaged cargo like coal and cement. These dry bulk carriers store goods in the hull of the ship, which is the watertight body of the vessel. Dry bulk ships come in a range of sizes. Mini-bulk carriers can move between 500 to 2,000 tons of goods upriver. Meanwhile, massive Capesize ships -- which typically transport coal and iron ore -- are so big they can't go through the Panama Canal. Instead, they must pass around Cape Horn in southern Chile to go between the Atlantic and Pacific oceans.

2. Oil and refined products tankers

These specialized ships transport crude oil and refined products like gasoline from production centers to end users. They're vital to the oil industry since more than 60% of global oil supplies move via maritime transportation. The sector employs several vessel classes to move these fuels based on carrying capacity. General Purpose (GP) tankers can carry between 70,000 to 190,000 barrels of gasoline from a refinery to a port. Meanwhile, supertankers like Very Large Crude Carriers (VLCCs) and Ultra-Large Crude Carriers (ULCCs) can transport between 2 million and 3.7 million barrels of crude oil. ULCCs are so large that only one U.S. port can handle a fully loaded vessel.

3. Liquified gas and chemical carrying ships

These specialized vessels transport liquified natural gas (LNG), liquified petroleum gas (LPG), and petrochemicals such as ethylene from export terminals to market centers. LNG carriers, for example, are heavily insulated to keep the fuel cool, since it needs to stay at negative 260 degrees Fahrenheit to remain in liquid form. Meanwhile, LPG carriers -- which transport natural gas liquids (NGLs) such as propane and butane -- and chemical tankers have specialized hulls designed to carry these flammable liquids overseas safely.

4. Container ships

These vessels transport shipping containers filled with non-bulk cargo such as packaged manufactured goods. About 90% of global non-bulk cargo moves via container ships. The industry measures container capacity in twenty-foot equivalent units (TEU). As a result, the sector tends to class ships by the TEUs they can carry. Small feeder vessels can transport up to 1,000 TEUs, while Ultra-Large Container Vessels (VLCVs) can hold more than 14,500 TEUs.

Key terms for the shipping sector

Investors interested in the shipping sector need to know several important terms used by the industry. The following five are crucial in understanding how shipping companies make money:

  • Dayrates: Shipping companies typically lease their vessels to customers on a per-day basis, charging what are known as dayrates. They can be the going market price or set as part of a long-term agreement.
  • The spot market: Some segments of the shipping industry, mainly dry bulk vessels and oil tankers, lease their ships to customers at the going market rate, known as the spot market. This price tends to fluctuate with conditions in the shipping market. If the global economy is expanding, then worldwide trade should be on the upswing, which tends to drive up demand for shipping vessels and spot market dayrates. On the other hand, if market conditions start deteriorating, these dayrates can plunge.
  • Time charters: Shipping companies lease their vessels to customers under agreements known as time charters. These contracts lock in the dayrate for the length of the deal, which can range from less than a year to more than a decade.
  • Contract backlog: Shippers that lease their vessels under long-term time charters create a backlog of predictable future revenue. That gives their investors better visibility into what they'll likely make in the future compared to companies that lease mainly on the spot market.
  • Utilization rates: Shipping companies need customers to utilize their vessels to make money. That's why the sector focuses on utilization rates, which is the percentage of their fleet currently working on behalf of a customer.

One fundamental factor that investors need to know about a shipping company is whether it primarily leases its vessels to customers on the spot market or under long-term time charters. That's because spot market rates can be very volatile. That cuts both ways. Surging prices due to strong demand for shipping capacity can enable shippers to haul in a boatload of profits. Meanwhile, plunging prices during a market downturn can sink earnings. On the other hand, companies that ink long-term time charters have much more predictable revenue since those agreements lock in dayrates. While that helps insulate earnings during rough seas, it limits their upside during strong market conditions.

Risks of investing in shipping stocks

The shipping industry has been much riskier than most other sectors over the years. Four issues in particular tend to have the most impact on investment returns in the industry:

  • Changes in global trade: When the global economy slows down, it has an outsized effect on the shipping sector. In 2016, for example, global containerized trade growth slowed down. That weighed heavily on spot market dayrates for mid-sized containerships. Rates -- which had averaged roughly $8,800 per day in the previous five years -- collapsed by more than 50%. They plunged below the cash breakeven level of most ships, meaning they were losing money.
  • Overcapacity: The management teams of shipping companies tend to be overly optimistic during good times. That leads them to order new ships to meet anticipated future demand growth. However, more often than not, an unexpected speed bump occurs right as shippers take delivery of several new vessels. That floods the market with too many ships, which tends to weigh on utilization rates as well as dayrates.
  • Leverage: Ships costs lots of money (large, high-tech vessels are more than $200 million apiece). Because of that, shippers borrow heavily to fund vessel acquisitions. While they can easily manage their debt levels during strong shipping markets, leverage often acts as a lead weight during rough seas.
  • Dilution: In addition to borrowing money to fund fleet expansion, shippers also sell more stock to finance new vessels. That adds a boatload of new shares to the market. This dilution can weigh on the stock price, especially when industry conditions deteriorate.

Given the risks of the sector, investors interested in shipping stocks should focus on companies with healthy financial profiles and large contract backlogs. Those two factors put them in a stronger position to navigate the sector's rough seas.

Top shipping stocks

Privately held entities, governments, and companies that trade on foreign exchanges own many of the world's largest shipping fleets. However, several large ship owners trade on U.S. exchanges, giving investors plenty of options.

The following table contains 10 of the top shipping companies listed on major U.S. stock markets.

To give investors some more insight into the shipping sector, we'll take a deeper dive into a few of these top shippers. First, we'll look at three shipping stocks -- Seaspan, Gaslog, and Teekay -- that have taken several notable steps to position themselves to navigate the sector's many risks. Then we'll look at DryShips, which is one of several cautionary tales in the shipping sector.

Seaspan: The containership leasing king

Seaspan is the world's largest containership leasing company. It leases its vessels under fixed-rate time charters to shipping liners that move cargo around the world. While most shipping liners own significant fleets, they charter with lessors like Seaspan to reduce capital costs since ships are expensive to buy.

Seaspan focuses on owning large, modern containerships of 10,000 TEUs or more. As of early 2019, nearly 70% of its fleet consisted of these larger vessels, which shipping companies use to move goods across long-haul global trade routes. Liners tend to sign long-term, fixed-rate charters for these vessels, which provides Seaspan with predictable revenue. Seaspan, for example, entered 2019 with $4.8 billion of contracted revenue in its backlog, with an average remaining length of 4.5 years at the time, including some charters that won't expire until 2035.

The containership owner's decision to focus on larger ships that it charters under fixed-price agreements enables the company to generate predictable revenue. Only about 10% of its leases typically expire in a given year, which leaves it much less exposed to volatile shipping rates. That puts the company in a stronger position to navigate the ups and downs of the shipping sector. It also gives it a competitive advantage over rivals that operate vessels mainly leased on the spot market.

Gaslog: Focused on the fastest-growing shipping segment

Gaslog is one of the leading owners and operators of LNG carriers. In mid-2019, the company had 26 vessels on the water -- including those operated by its master limited partnership (MLP) Gaslog Partners -- and eight on order.

Much like Seaspan, Gaslog primarily charters its vessels under long-term, fixed-rate contracts with major LNG shippers like Royal Dutch Shell. That allows the company to collect relatively predictable revenue since it reduces its exposure to the volatile spot market.

Gaslog has increased the size of its fleet over the years by ordering new ships so that it can support the rapidly growing LNG shipping market. This trend should continue in the future. That's because LNG demand is on track to rise at a 6% compound annual growth rate through 2025, according to industry estimates. That should drive the need for additional LNG carriers, which should open the door for Gaslog to order more gas carrying vessels.

Gaslog made two smart decisions, which could benefit its investors in the coming years. First, it's focused on the rapidly expanding LNG market, which provides it with more growth opportunities than most other shipping segments. Second, it typically charters its vessels under long-term contracts, which helps insulate it from the volatility of the spot market. Those two factors put the company in a strong position to potentially enrich its shareholders.

Teekay: A diversified way to play the shipping sector

Teekay is one of the world's largest marine energy transportation, storage, and production companies. Teekay itself, though, typically owns very few vessels. In early 2019, for example, the company's fleet consisted of three FPSOs, which are offshore production facilities that it leases to oil companies to support their fields. Instead, Teekay is a holding company since the bulk of its assets are its interest in three MLPs that own a variety of vessels:

  • Teekay LNG Partners (NYSE: TGP) is one of the largest LNG carriers in the world. These vessels act like floating pipelines to move LNG and LPG from export terminals to global markets. The company primarily leases these vessels under long-term charters to major LNG marketers like Royal Dutch Shell.
  • Teekay Offshore Partners (NYSE: TOO) is one of the largest operators of leased FPSOs. It's also the largest operator of shuttle tankers, which move oil produced from the FPSOs to oil terminals on the coast. The company primarily charters both its FPSOs and shuttle tankers under long-term, fixed-rate charters to oil producers.
  • Teekay Tankers (NYSE: TNK) is one of the largest operators of mid-sized oil and petroleum product tankers. The company primarily leases these vessels to oil shippers at spot market rates.

Teekay's MLPs focus mainly on owning vessels chartered under long-term contracts, which provides the company with significant revenue visibility. In early 2019, Teekay's MLPs had an $18 billion revenue backlog with an average remaining duration of nine years. That helps insulate the company from market volatility, giving it a competitive advantage over rivals with high exposure to short-term spot market rates. Because of that, it's a better option for investors seeking a lower-risk shipping stock that could potentially benefit from the continued growth of global energy trade.

DryShips: A cautionary tale for prospective shipping investors

DryShips is a fascinating story for investors. It was the first dry bulk-focused company to go public on a U.S. exchange in 2005. It used those funds to help finance the expansion of its fleet. By 2008, the company owned 38 vessels and had diversified into offshore drilling rigs. The financial crisis slowed down the growth of its dry bulk fleet. Because of that, the company quickly pivoted to the oil market by expanding its offshore drilling business into one of the largest focused on ultra-deepwater rigs. It also diversified into oil tankers. By 2014, the company owned 56 ships, leased primarily at spot market rates.

In 2014, though, oil prices collapsed, which created shockwaves in not only the oil market, but in dry bulk as well. That forced the company to jettison several vessels to stay afloat, including selling more than 30 to its founder to help pay back its debt. By the end of 2016, the company's fleet was down to just 13 dry bulk carriers and six offshore support vessels.

DryShips started rebuilding its fleet in 2017. It bought 17 vessels that year, including dry bulk and gas carriers as well as oil tankers. However, instead of relying on debt to fund growth, which burned it in the past, DryShips sold boatloads of stock. These new shares significantly diluted existing investors, causing the company's stock price to crash 99% that year.

DryShips has incinerated shareholder value throughout its history. That's due to two overarching factors. First, the company primarily leases its vessels at spot market rates, which leaves it highly exposed to market volatility. While rising dayrates during the boom years from 2005 through 2008 enabled the company to haul in boatloads of cash, sinking rates during the downturns in 2008 and 2014 nearly sank DryShips. Making matters worse is that DryShips relied on outside financing to help fund growth instead of internally generated cash flow. When those markets dried up, the company was forced to sell ships and stock at fire-sale prices to stay afloat, which further eroded shareholder value.

The shipping industry isn't for most investors

Shipping stocks have historically been nauseatingly volatile. While they can make investors boatloads of cash during strong market conditions, shipping stocks tend to plunge when storms start brewing. Because of that, investors need to carefully weigh the risks against the reward potential before venturing into shipping stocks. Their best bet is to focus on companies with top-notch balance sheets and healthy contract backlogs, since those two factors should help keep those stocks afloat during the next inevitable downturn.

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Matthew DiLallo owns shares of Seaspan. The Motley Fool recommends Seaspan. The Motley Fool has a disclosure policy.