Necessary Preconditions for a Sustainable Shipping Recovery: Peter Stokes of Lazard uses IMIF talk to blast short-sighted speculation
Shipping faces an asset bloodbath in the wake of the greed and ignorance of speculators from inside and outside the industry, investment banker Peter Stokes has warned in London.
Mr Stokes, senior advisor and head of shipping at financial advisory and asset management firm Lazard & Co, told a meeting of the International Maritime Industries Forum that the reckoning may not be far off.
What was happening, he said, “in the first place, reflected a misreading of the cycle and, in the second, was symptomatic of one of the worst features of the shipping industry – the prevalence of deals driven by the generation of excessive fees and commissions rather than by genuine considerations of supply and demand.”
He slammed excessive speculation that continued even after 2008 when “low-grade, overpriced deals which should never have been done…. left the German shipping banks with a huge headache.” Since then “we have seen equally egregious examples of deals involving the contracting of extended newbuilding series driven by sale and purchase commissions, management fees, placement and IPO fees and service agreements of various types.”
Mr Stokes said: “In many cases, the capital that has been attracted into these deals has been from the alternative asset management community, but I think the shipping industry cannot simply blame the influx of money from such sources for the damage which has been done to supply/demand fundamentals.
“Yes, in many cases, investors came to shipping thinking they understood it and bringing unrealistic expectations of returns, but were actively encouraged by many industry professionals. Newbuildings should, in my view, be ordered against firm cargo commitments and conservative demand forecasts, or for fundamental fleet renewal requirements. Treating them as a geared bet on the future or as a lucrative generator of fees and commissions is a recipe for the unappetising mess in which the industry repeatedly finds itself.”
Asked if the industry over-hang was leading to a bloodbath of companies and balance sheets, he replied: “It does need to be a bloodbath, but it may be as part of the process that there has to be a write-down of asset values that makes sense in relation to the freight market.”
The core of the presentation by Mr Stokes was a categorisation of what he saw as the necessary preconditions for a sustained shipping market recovery.
First, ship prices needed to establish a floor which reflected economic and financial reality. “That will only happen when banks are prepared to accept that loan-to-value ratios of 150%, 200%, 250% and more will not somehow be brought down to par through a general market recovery.” Writing loans down fully, forcing asset sales and corporate bankruptcies, would not be pleasant, but for both debtors and creditors, there should be proper acceptance of the consequences of past mistakes.”
Secondly, expectations must be reduced. Too many investors have been encouraged to believe that shipping is an industry which can generate 15-25% returns on equity when in reality it barely covers its cost of capital over a full cycle. Investors requiring high double-digit returns should generally give shipping a wide berth, and the industry should stop promising the moon and focus on more structured low-risk deals for which there is a chance of attracting long-term institutional money. To aid recovery, there should be a broad capitulation by investors who committed billions of dollars to the industry on the basis of unrealistic expectations.
Thirdly, we needed a clearer picture of where the demand trends relating to China were heading, and the implications for the bulk and liner trades.
On a macro financial level, we needed interest rates to go up. Zero interest rates meant very low economic growth, and that cannot be consistent with a strong recovery of shipping demand.
Finally, commodity and energy prices needed to establish a new floor. We need to see where the oil price settles and what that means in terms of stimulus for the major consuming countries, financial problems for some of the producing countries and potential shifts in trade patterns. Iron ore and coal prices have also been very weak, and we need to see the extent to which China will continue to substitute cheap imports for domestic supplies at a time when inventories of ore and steel must be increasing.
“Based upon what one can see at the moment, it is hard to be very positive about the outlook for next year, ” said the Lazard executive.
In a market where the shipping industry is finding it very hard to generate operating profits after depreciation, the critical issues become cash flow (which the shipping industry has a habit of confusing with profits) and liquidity.Very weak players cannot survive, but even the best and most efficient operators are not producing an adequate return on their capital.
Although in 2006-08, massive ordering of bulk carriers, container ships and tankers was understandable in the context of the greatest shipping boom in modern history, “it is somewhat harder to be sympathetic about the self-inflicted brain damage which subsequently occurred in 2010 and then again in 2013, as substantial newbuilding ordering took place against a freight market background that was anything but buoyant. “
Those who were persuaded to make those capital commitments did so in many cases because they thought a sustainable recovery was one or two years away, and of course a significant part of this contracting was no doubt the fleet renewal expenditure which every shipowner needs to undertake.
The failure to analyse the cycle accurately went beyond the industry context. Shipping does not exist in its own self-contained universe, and insufficient attention was paid to the economic and financial adjustments in the world since 2008. The ordering of newbuildings for anything other than committed business should at the very least be based on a correct analysis of the shipping cycle and the broader business cycle. What we have been experiencing since 2008 was not a classic recession caused by a temporary demand deficiency, but a so-called balance sheet recession caused by a massive and unsupportable accumulation of debt.
In practical terms, this phenomenon has played out through the survival of “zombie” companies – including many in shipping – because interest can just about be serviced even though there is no prospect of the debt being repaid. Neither past rates of Chinese growth nor the unleashing of a huge debt-driven fiscal stimulus would be repeated.
“My suspicion, therefore, is that we are heading into a period of weaker demand growth in the major shipping trades which, coinciding with a renewed increase in newbuilding deliveries in 2015 and 2016, could lead us into a second leg of the post-2008 shipping down cycle.”
IMIF chairman Jim Davis praised Mr Stokes in that he had “underlined the one feature everyone chose to forget, which is: supply and demand. I wonder if we have learned – it is a bitter experience for everyone to forget that maxim.” Analysis by shipowners of the markets had been very slim over the years, said the chairman.
Mr Stokes reiterated: “The thing we do not understand is the demand side. Everyone talks about supply side which with a bit of self-discipline ought to be controllable. That never really works, because there are no barriers to entry [to the shipping industry]. The problem is that demand is very hard to assess, even in the era of big data. I find it very hard to see why people are expecting demand is going to sort out the problem.”