In the 60s film Carry On Up The Khyber, the Brits were at war in Afghanistan (sound familiar?). Unlike our modern lads, the Highland division had a secret weapon, which they kept under their kilts! But when the dastardly enemy captured Scotsman Private Widdle, he was found to be wearing underpants. Armed with this knowledge they set out to discredit the “secret weapon”.

Shipping’s Secret Weapon

The shipping investor’s “secret weapon” is, of course, the market cycle. Since cycles come in all shapes and sizes, “buy low, sell high” makes a great business strategy for investors who “trade ships not cargo”. This philosophy became popular at the end of the 1980s when there were fortunes to be made on trading distressed assets. For example, a VLCC purchased at $3 million in the 1983 was soon worth $20 million. But it’s a tricky business, and investors need to get comfortable with the real dynamics of the “weapon” they are playing with.

It’s Not a Gift, It’s a Loan

The notoriously cyclical VLCC market shows how dangerously dynamic this mechanism can be. The graph estimates the annual “free cash flow” of a VLCC between 1970 and 2013. The cash flow is calculated from spot market earnings less depreciation (not cash, but ships must be paid for some time), interest at LIBOR plus spread, and OPEX.

The approximate “free cash flow” (in $m pa) displays an astonishingly long cycle. Between 1970 and 1973 the VLCC netted $40 million, a fortune on a vessel purchased, for example, for $18 million in 1966. Then between 1974 and 1995 it lost $94 million. Much of this was in the 1980s, but the vessel did not recover full depreciation until the mid-1990s. Then from 1996 to 2010 the money came back again, with investors grossing $90 million over 15 years. Since 2011 the investment is back in the red to the tune of $13 million. It would have been much more if interest rates had not crashed.

Three Lessons

Lesson 1 from this analysis is that the timing of the mega-investment campaigns in 1973 and 2007 could hardly have been worse, requiring deep pockets and patience to survive. Lesson 2 is that spectacular profits are possible but very tricky to achieve. In 1999 a few courageous VLCC investors were on the verge of bankruptcy and sentiment was at rock bottom. However a VLCC ordered for around $70 million, to be delivered in 2000, would by 2008 have earned over $80 million after expenses and the 10 year old ship value peaked at $135 million. Lesson 3 is that investors who didn’t play the cycle made a pittance. The 1974-95 loss of $94 million was eventually recouped by a profit of $89 million in the 2000s. But over the 44 years the net balance was a miserable $23 million.

Cycles Out of Kilter, Captain?

So there you have it. The choice between trading ships and trading cargo is a real one. Investors who opt for trading cargo must, like military leaders, prepare for a long low margin war. And investors who decide to trade ships had better make sure that they’ve got more than just underpants under their kilts. Have a nice day.

SIW1123

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