Archives for posts with tag: cash flow

In the classic movie The Seven-Year Itch, hero Richard Sherman is left sweltering in his Manhattan flat as wife and kids head for the beach. A daunting prospect, until Marilyn Monroe turns up in the flat below. That’s where the fantasy starts as Richard exercises his “seven-year itch” in an amusingly unlikely relationship with the charismatic Monroe.

Shipping’s Seven-Year Fantasy

2014 has been a hot summer in Europe and shipping investors have been getting the seven-year itch themselves. Although the Lehman Brothers collapse in September 2008 triggered the meltdown in rates, the seeds of the crash were sown exactly seven years ago on 10th August 2007. On that date the European banks became so suspicious of each other that the interbank market seized up. To celebrate, seven years later shipping investors are busy indulging their seven year itch with the residents of the flat below – not Monroe, but the equally attractive Asian shipyard representatives. 174m dwt of orders in 2013 and 66m in 1H 2014 show what a good time they’ve been having.

Cashing In At The Top

But how did the investors’ last big fling in August 2007 (273m dwt of orders were placed in full year 2007) turn out? Surely this was a bit of a disaster? Actually things did not turn out quite as badly as seemed likely when the market crashed. For example, a Suezmax resale costing $105m in August 2007 would have made around $57m trading since then, after OPEX (see chart). If this cash was used to pay down the vessel, the balance in August 2014 is $48m, compared with a market value of around $41m. Of course this does not take account of waiting, slow steaming and mishaps. But even allowing for these, it’s not the disastrous story veterans of the 1980s expected.

Off To A Good Start

Getting an investment off to a good start is vital and that’s what helped the 2007 investments shown in the chart. The accumulated cash flow of six August 2007 resale purchases shows that 50% of the cash was generated in the first year; 25-30% over the next 18 months; and very little in the last 4 years. For example the Cape generated only $6m between Dec 2010 and August 2014.

But the good news is that thanks to financial easing and near zero interest rates, residual values have remained firm. In 1985 a Panamax bulker delivered at a cost of $25m had a market value of around $8m. Today a Panamax bulk carrier ordered a couple of years ago at a cost of $29m has a resale value of $31m – it’s actually made money. So although the cashflow has been reminiscent of the 1980s, asset values this time round are a very different story.

7 Years On – Is the Cycle Over?

So there you have it. What looked like a disastrous shipping recession has turned out to be surprisingly benevolent, at least compared with the traumas of the 1980s. With shipyard credit available on a grand scale and not much in the secondhand market it’s a no-brainer – head east and you’ll find Marilyn standing over a subway ventilator. But don’t forget this is only a summer fantasy – the wife and kids will be back soon. Have a nice day.

SIW1134

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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