Why shippers hate recessions but love crises
Global shippers are enjoying a sudden boom in rates, especially in moving raw commodities like iron ore and crude oil. Any improvement would be welcome news for a fleet that has been suffering since Covid-19 receded and demand returned to pre-pandemic levels. History suggests that no turnaround is near — it is likely these latest spikes are merely the result of short-term shocks and cannot be sustained.
Indices that track the cost of moving oil and bulk goods have posted big gains over the past few weeks. The Baltic Dry Index, the most-widely followed gauge of prices to ship dry goods like coal and iron ore, has almost doubled since the start of September. The Baltic Dirty Tanker Index, its crude oil counterpart, is up 50% this month.
The global economy and the outlook for next year have not greatly improved in that time. Instead, a series of localized crises boosted demand for transportation. Indications in August that Beijing may ease up on the property sector gave the impression that iron ore may rebound, which boosted dry bulk shipping, but those hopes did not last and rates should have fallen. Instead the Baltic Dry Index continued to rise because of a series of bad news.
Droughts across the world have been a major factor. “The low rainy season has benefited the seaborne trade of iron ore,” Athens-based Xclusive Shipbrokers wrote earlier this month. That’s because rain makes iron ore, a dry commodity, absorb water, which becomes heavier and more dangerous to ship. Dry weather has the opposite effect. Compounding the problem, low water levels in the Mississippi River and the Panama Canal have reduced traffic through both waterways, cutting transportation capacity and raising prices. Long waits at the Central American waterway might continue through both Christmas and Lunar New Year, the Panama Canal Administrator forecast last month.
Then there is this month’s surprise Hamas attack in Israel, and the ensuing bombardment of Gaza. Renewed conflict in the Middle East stoked concerns over the supply of energy, chiefly oil, forcing shippers to adjust their routes. Buyers are stocking up, and they’re urgently booking oil tankers. The Baltic Dirty Tanker Index shot up.
Tracking and predicting transportation rates is a science as old as shipping itself. Knowing when prices will fall gives manufacturers and traders an edge in booking capacity, while being able to predict a rebound in trade is crucial for shipowners deciding whether to buy new vessels or lay up their existing fleet. The past five years have compressed decades of boom-bust shipping cycles, offering a glimpse of the industry’s volatility. Rates across all types of shipping, including container, bulk and oil, were weakening well before Covid-19 threw the world into disarray. Yet economic indicators before the pandemic struck remained relatively strong.
This sounds counterintuitive. A strong global economy and increased trade ought to boost demand for transport, and drive prices up. It does not. Sung Man Jung, who analysed data for his Master’s thesis at the World Maritime University, looked at the periods before, during, and after the 2008 financial crisis to isolate the factors affecting the Baltic Dry Index. He found that it was the supply of vessels, not a drop in gross domestic product or trade, that impacted BDI following the meltdown. A strong economy leading up to that one-time shock spurred ship owners to keep buying vessels.
More capacity to move dry bulk loads, measured in deadweight tons, was added than retired. As a result, supply climbed 34% between 2007 and 2010, according to a
analysis of data compiled by the US Department of Agriculture. The subsequent decade, driven by chronically low interest rates and a booming Chinese economy, boosted trade, but the BDI remained lacklustre. Commodity prices, the most direct indicator of demand, has very little impact on shipping rates, Jung found.
What drives prices upward is short-term unsustainable shocks, and recent history has shown this to be true. Russia’s invasion of Ukraine last year caused the BDI to jump. Ukraine is a major grain producer and that war raised concerns about supply. Most other increases in shipping indices have been due to short-term factors. In late 2019, the maritime industry laid up large swathes of its fleet in order to fit air scrubbers to meet new rules on sulfur oxide emissions. Indices spiked, and then plummeted when those vessels went back into service.
With the global economic outlook worsening, as evidenced by the International Monetary Fund’s recent downgrade, there is no reason to hope for a rebound in trade and shipping prices. But this may not matter. Capacity is a bigger factor, and prolonged economic weakness coupled with an aging fleet and new environmental rules, will likely to spur ship owners to scuttle more vessels. Those betting on a sustained recovery in marine transport rates need to hold on a while longer.
Higher funding costs
Analysts are mostly negative on Suntec REIT after the REIT reported a 14% y-o-y drop in its distribution per unit (DPU) for the 3QFY2023 ended Sept 30.
DBS Group Research and Maybank Securities kept their “hold” calls with lowered target prices while Citi Research kept its “sell” call. Its target price also remained unchanged at $1.13.
PhillipCapital was the only brokerage to keep its “buy” call and target price of $1.47, the highest among the four brokerages featured here.
To PhillipCapital’s Liu Miaomiao, Suntec REIT’s 3QFY2023 results came in within her expectations.
The REIT’s 3QFY2023 gross revenue grew by 15% y-o-y to $123.4 million, at 79.7% of her FY2023 forecast while its net property income (NPI), which rose by 9.7% y-o-y to $84.6 million, stood at 77.9% of her full-year estimates.
The REIT’s DPU for the 9MFY2023 also stood at 76.3% of Liu’s full-year forecast.
In her report dated Oct 24, Liu noted the REIT’s positive rental reversions. She also liked
Price target:
Lim & Tan ‘buy’ 88 cents that the REIT’s current divestment plan is on track so far.
“Suntec is committed to its current divestment plan, aiming to sell strata units at Suntec Office Tower 1–3 worth $100 million by the end of FY2023. Selling prices are supported by strong demand from end-users and limited supply due to the Urban Redevelopment Authority’s (URA) restrictions on new developments. By 3QFY2023, approximately 40% of the divestment plan was completed, with prices 20% above book value. This is likely to reduce gearing by 100 basis points (bps), providing a buffer against potential yearend valuation declines,” Liu writes.
“The management expresses confidence in the Singapore market and foresees no change in cap rates. While gearing improvement from divestment may be offset by overseas asset devaluation, it is expected to remain below the 45% threshold,” she adds.
However, the REIT’s cost of debt, which increased by 37 percentage points y-o-y and 0.14% percentage points q-o-q to 3.78% as at Sept 30, remains a concern.
“[Suntec REIT’s] adjusted interest coverage ratio (ICR) deteriorated to 2x [from 2.1x in 2QFY2023], capping the regulatory gearing limit at 45%,” she points out.
On this, the analyst expects Suntec REIT’s all-in interest cost in FY2024 to reach 4.25%.
“There is no commitment to top-up the distributional income using excess cash yet in FY2024,” she notes.
The REIT’s overseas markets have also displayed weaker metrics. In the UK, the REIT’s overall occupancy rate fell by 6.5 percentage points q-o-q to 93.5% while its Australian portfolio occupancy rate fell by 1.2 percentage points q-o-q to 95.54%.
“Leasing movement in UK and Australia markets were crippled by the cautious economic outlook with hampered expansionary drivers. 55 Currie Street is expected to have a reduction in occupancy rate of 40%. Management has allocated 12 months to backfill the space and anticipates rental reversion to be flattish but in line with the market rate,” says Liu.
Looking ahead, the analyst expects Suntec REIT’s Singapore market to be its key revenue driver double-digit rental reversion for the retail side to continue and high single-digit for the office sector in FY2024.
“We have also observed a decreasing trend in occupancy costs, which supports the potential for higher rental reversion,” she notes.
“In the UK office market, it seems to have reached its bottom, and we do not foresee any further drops in occupancy rates in FY2023. However, the transaction market in Australia remains subdued, characterized by a widened price gap between buyers and sellers, which is currently hindering the divestment of 177 Pacific Highway in the near term,” she adds.
Based on Suntec REIT’s last-closed price of $1.10 as at Oct 23, the REIT implies DPU yields of 6.08% or 7.16% for the FY2023 and FY2024 respectively, based on Liu’s estimates.
“We believe much of the downside risk including larger-than-expected expansion in cap rate and slower-than-expected divestment have been factored into the current share price. As such, our dividend discount model (DDM)-based target price remains at $1.47 with FY2023–FY2024 DPUs of 6.68 cents to 7.87 cents,” she says.
DBS Group Research’s Rachel Tan and Derek Tan have lowered their target price to $1.10 from $1.48 previously, which is the lowest among the brokerages within this article.
They have lowered their FY2024 DPU estimates by 2% to factor in higher vacancies from the REIT’s UK and Australia portfolios and higher financing costs.
Nonetheless, they acknowledge positive aspects such as its strong double-digit reversions at Suntec City and in Australia and the divestment of its strata units to maintain its gearing.
However, the REIT’s higher interest costs remain a concern.
“Despite Suntec’s underlying portfolio, especially its Singapore assets, seeing improved performance, higher interest costs have been eroding its income as its debt was only [around] 50% hedged previously. Despite the payout of its remaining capital distributions in FY2023, we estimate that its two-year DPU CAGR will decline by 15%,” say the DBS analysts.
Other key data to watch are the REIT’s vacancies in Australia and the UK, higher refinancing costs in FY2024 and valuation risks.
“Suntec REIT will be the key beneficiary should interest rates decline at an accelerated rate,” the analysts add.
Similarly, Maybank Securities’ Krishna Guha has also lowered his target price to $1.15 from $1.30 due to a continued risk of lower asset values and higher funding costs. “Top-line growth was anchored by accelerated recovery of the convention business. However, higher interest costs and lower margins moderated distribution,” says Guha.
“While Suntec’s valuation (6.9% FY2023 dividend yield, 0.5x P/B) is attractive in a historical context, downside risk remains from elevated gearing, potentially lower asset values and continued repricing of interest costs,” he continues.
Citi’s Brandon Lee has kept his target price unchanged as he sees “no respite” for the REIT on its high gearing. Despite the REIT’s efforts in divesting $100 million of Suntec City Office strata units, the move, which should reduce Suntec REIT’s gearing by 100 bps, will be offset by softening y-o-y valuations in Australia and the the UK. The softening valuations in Australia and UK would bring the REIT’s gearing up by 100 bps, which would mean that its FY2023 gearing should be relatively unchanged at 42.7%, note Lee.
Furthermore, the Singapore office sector is also softer. “While Suntec REIT is facing some resistance during rent increases, it will likely notch positive rent reversions (albeit not doubledigit) and high occupancy of 98%,” says Lee of its Singapore office portfolio. —