Date: Wednesday, March 17th, 2021
The U.S. import boom has already shattered the forecasts and pushed the global supply chain to the brink. The guessing game now is: When will it end?
Amit Mehrotra, head transportation analyst at Deutsche Bank, believes the bull run for imports will persist for a lot longer than most people think.
In a wide-ranging interview with American Shipper on Monday, Mehrotra argued that the U.S. inventory restocking cycle is nowhere close to over and import demand is certainly not about to fall off a cliff.
Mehrotra’s views on U.S. consumption imply there’s more room to run for container-shipping stocks. Meanwhile, the bigger picture on the post-COVID recovery is global and extends beyond containerized goods, pointing to upside potential for dry bulk and tanker shipping, as well.
Early innings for restocking
American Shipper: This wave of U.S. imports has been massive. There’s a big focus on inventory restocking. And when you see the huge pileup of container ships at anchor off the ports, it raises the question: How have port delays affected the restocking cycle?
Mehrotra: “There’s definitely a supply-side effect on imports from the congestion you’re seeing. But I don’t think people are giving enough credit to the demand side of this thing. The inventory restocking cycle is still only in the third or fourth inning.
“We look at sell-through rates of major retailers and compare them to how inventory per store is tracking. If you look at Dollar Tree [NYSE: DLTR] for the most recent quarter, same-store comp growth was 4.9% but inventory per store was down 5.1%. That’s a 1,000-basis-point spread between sales and inventory. The spread for Walmart [NYSE: WMT] was over 700. At Target [NYSE: TGT], it was almost 400. At Tractor Supply [NASDAQ: TSCO], it was a whopping 2,000 basis points. These are big numbers. It’s a critical sign.
“Six months ago, it was, ‘Oh my God, we’re stocked out of everything, we need to replenish, the supply chains are slow, we need to get these imports as soon as possible.’
“But the nuance has changed. Now, if you look at inventory dollars per store, they’re actually up year-over-year. What has changed is that sell-through rates are way faster. Inventories are flying off the shelves faster than companies can replenish them. That is why the inventory restocking cycle is still in the early innings.”
How COVID could change inventories
How would you weigh the inventory effect from higher demand versus the effect from lower supply due to the congestion in the global container shipping system?
“Six months ago, I would say it was 75-80% supply-chain kinks, 20-25% demand. Now, I would say it’s actually 60-70% demand, 30-40% supply-chain kinks. There’s definitely congestion. There were definitely big impacts from the weather in February. But let’s be clear: Demand is very, very strong and inventories are still very lean.”
I would think U.S. importers facing today’s port delays and record-high ocean freight costs would opt to hedge their transport risk by storing more goods in warehouses, which would bring import demand forward and put even more pressure on the ocean-transport system for the rest of this year. In other words, importers would increase their inventory-to-sales ratio versus pre-pandemic levels.
“You’re asking whether there’s a structural change in how much inventory someone needs to hold. I think that makes complete sense. But I think it’s not just about COVID impact [disruptions to container shipping imports], which is more transitory. The biggest driving force structurally is that a knock-on effect of COVID is the acceleration in e-commerce and omnichannel retailing. When you order something online and get it in one day, not five days, that’s not magic. That’s because the darn thing is sitting closer to you to begin with. To do that, the supply chains have to get a lot more complex and a lot more fragmented. And when you have more nodes and more predictive tools, you have to hold more inventory to effect those one- or two-day delivery commitments.”
Consumer demand’s next phase
This implies inventory-to-sales ratios are going to be higher than pre-COVID, while in fact, inventory-to-sales ratios are still below where they were pre-COVID because demand is so strong. That’s inherently bullish for forward import demand. The next big question is what happens to demand in the weeks and months ahead.
On one end of the spectrum, there’s the theory that the surge in import demand over the past six months was due to consumers spending more on goods when they were prevented by COVID from spending on services. Going forward, vaccines will allow more spending on services, thus less on goods, so the import pace will decline. On the other end of the spectrum, there’s the idea that the vaccines will give people confidence to draw down accumulated savings, plus they’ll have their next stimulus check — and there will be even more spending on goods and thus continued strong imports.
“I think, in terms of where demand could go, what’s the saying? ‘You ain’t seen nothing yet.’
“We haven’t seen the stimulus checks yet. If you have a family of four earning less than $150,000, you’re getting over $5,000 in the mail. That’s huge. If you don’t live in the cities, your home is probably worth $50,000-$100,000 more than it was before. People’s 401Ks are at all-time highs. This is an incredibly weird recession because the balance sheets of consumers have actually improved.
“Here at Deutsche Bank, we tracked data very closely after the first reopening [following the initial 2020 lockdowns]. There was a big surge. Same-store comps were through the roof. I would not underestimate the pent-up demand release you’ll get when people can actually go out without wearing masks and shop in stores.
“As for where consumers spend their money [goods versus services], I’m completely agnostic. If you’re telling me people are going to stop buying resistance bands because they’re going to Italian restaurants instead, how does the restaurant get all of the beverages and raw materials and ingredients? They come on a truck. And most of that stuff is imported on container ships. The idea that we’re going to see this cliff where nobody’s going to buy anything [when Americans can spend more on services] is a little bit ridiculous, to be honest.
“What I’m more focused on is the overall fiscal position of the consumers and their ability to spend money. And I think we’re seeing very, very strong signals on that front.”
More upside for box-shipping stocks
Let’s turn to ocean shipping stocks. What you’re saying on imports sounds very positive for the container-ship leasing companies.
“The biggest point of differentiation that I have, and Deutsche Bank has, versus others, is our view on the strength of demand and the length and sustainability of that demand. We believe demand is going to be a lot stronger than people appreciate, led by the industrial economy but also the consumer economy. I think some people are just starting to wake up to the upside opportunity.
“The intrinsic value of these [container-ship leasing] companies can continue to move higher so long as the demand environment stays quite good. If it goes through the end of this year and into 2022, the intrinsic values of these companies are going to be significantly ahead of where they are today.”
Fewer landmines for shipping stocks
It’s not just container-shipping stocks that are rising. Stocks of ocean shipping companies across all sectors are seeing more interest. That said, there have been many disappointments over the years for these equities. Has anything changed?
“I think, in general, when you look at the maritime equity landscape, whether it’s dry bulk or tankers, there are just a lot fewer landmines out there. You’re unlikely to get blown up owning a shipping stock. Because most of the balance sheets have so much equity in them now. That’s not to say there isn’t going to be volatility. But I feel incredibly confident saying that the equity values of the companies we recommend — the Euronavs [NYSE: EURN] and Star Bulks [NASDAQ: SBLK] of the world — will never be impaired. These companies’ balance sheets are in such a strong position that they’ll never have to issue equity from a position of weakness. That allows you to really be comfortable owning them. You’re not buying a shipping stock hoping that rates turn before the company runs out of cash, which, over the last 10 years, was really how you invested in shipping.”
Valuing shipping stocks
Speaking of the past decade, shipping stocks usually were valued at a discount to net asset value (NAV; the market-adjusted value of the ships and other assets, minus liabilities) and NAVs were higher than implied by charter rates. Now, in containers and dry bulk, we have a very different dynamic. Charter rates are high and imply that ship values should be higher than they are. Do investors get to a point where they’re comfortable enough with the sustainability of rates that they stop valuing stocks based on the value of fleets — NAV — and switch to valuing stocks on cash flow?
“Listen, cash flows are still incredibly volatile. I think NAV is a flawed metric, but it’s the best metric you have. If you were to value these companies on a multiple of cash flow, the higher the rates would go, the lower your multiple would have to be. Just as an example, when all those tankers were printing money early last year earning $200,000 a day, when you look back, they were basically being valued at a zero multiple. And the reason is because they gave it all back. They’re currently giving it all back. The market was efficient. It was saying, ‘I’m not going to capitalize these earnings because you’re giving it all back nine to 12 months from now.’
“I think the reasons stocks didn’t move was because NAVs didn’t move up, and the reason NAVs didn’t move up was because there weren’t buyers coming out of the woodwork to buy secondhand [tanker] tonnage at big premiums, which is what you would have needed for the equities to start moving.”
More secondhand ship sales
And that’s another difference in 2021. We are starting to see a lot of secondhand ship transactions.
“So much of the shipping market is psychology. Every day now you wake up and see another dry bulk ship that has traded hands. There seems to be this confidence on the buy side to acquire these ships. Ship values are up probably up 15-20% over the last six months. That’s why you see the equity value of a company like Star Bulk shooting up.
“Star Bulk is trading above NAV today. Its NAV is around $14 per share and it’s trading at around $16. That’s a big deal.”
When’s the last time we were talking about shipping stocks trading at a premium to NAV?
“It’s a really positive sign. The dry bulk story is great. It doesn’t get as much attention as tankers do because you have interest from the energy side in the tanker stocks.
“And even tankers seem to be positioned well. As we all go back to work and drive more and fly more, we’re going to be using the end products these companies ship on their tankers. There’s also a really positive story emerging on the supply side. Dry bulk ships are basically like floating tugs. But the value of the cargoes in tankers is incredibly high. As a result, you have oil majors that are really, really inherently looking for good quality ships — and age is a big determining factor in that.”
The newbuilding threat
This goes to the whole thesis of the low orderbook. That owners are concerned about future decarbonization rules, so they’re not ordering enough vessels to replace older ships because they’re worried about premature obsolescence. Given that it takes two years from order to delivery, the supply side is obviously looking good in the near term across most shipping sectors. But I wonder whether these decarbonization regulation concerns will hold. We just had 10 orders for LNG-fueled VLCC newbuilds, and there were 25 very large container ships ordered in Q4 2020, many that won’t even use LNG as fuel. Maybe if people get more comfortable with the idea of a global economic rebound, they’ll start ordering in earnest again?
“As much as I’m an optimist, I’m also a realist. To say ‘this time it’s different’ in a market like shipping is incredibly naive. I don’t think it’s different this time. It’s never different this time.
“But that being said, for what you say to happen over the next couple of years, the psychology of the market would have to change. What you’re really talking about is speculative orders. And before you can get those, the economics are going to have to be clear, so two things are going to have to happen.
“First, rates would need to be much stronger for much longer than people think today. Second, secondhand asset values would need to be a lot higher. With steel prices going up, the cost of newbuildings is also going up, and the gap between secondhand values and the newbuilding price would really have to shrink before you get a rush of newbuilding orders.
“And once we’re actually facing that threat, the equities would have to be significantly higher, so it’s a moot point from where we stand today. Although it’s definitely a risk if you’re putting new money to work two years from now.”
In other words, for today’s shipping stock investors, it would ultimately be a good problem to have.
Investor interest can change quickly
“The last thing I’d like to say is that investor interest can come back very quickly. It wasn’t that long ago, maybe a little over a year ago, last January, when I was getting more calls about the product-tanker sector and tankers in general than I was about railroads.
“I would say investor interest in shipping today is still probably a 2 or 3 out of 10. It’s still very low, but it was zero six months ago. It could go to a 5 or a 6 in three or four months. I’m spending more time on shipping today than I have in the last 11 months. I suspect more institutional investors are poking around the space, because the stocks are working. Star Bulk has gone from $8 to $16 in four months and I think it’s on its way to significantly higher than that. The interest level is definitely on the upswing.”