Has the shipping cycle reversed again?

Which sector of A shares has performed the best so far this year? Undoubtedly, it is the cyclical stocks, from coal and oil to non-ferrous metals to shipping, almost every month has seen outstanding cyclical trends. And recently, the most rapidly rising cyclical sector is undoubtedly shipping. China COSCO Shipping hit a new high after a 3-year adjustment period, and in terms of gains since the epidemic, it once again became the champion of the entire cyclical sector. The shipping sector was the first to rebound after the epidemic, with the most rapid increase in prices, but also the quickest supply-demand adjustment. In 2022-2023, while coal and oil can still maintain relatively high profit margins, shipping profits have started to plummet. However, with the recent recovery in shipping prices this year, people have realized that shipping stocks have long been overlooked in the cyclical sector. With the continuous expansion of expectations, the profit growth and dividend yield expectations of shipping stocks have gradually become the best in the cyclical sector. Therefore, the stock prices that have been adjusting at high levels for a long time are also heading towards historical highs. Shipping stocks are currently seeing astonishing gains, but if this year's dividend yield can reach 20-30%+ like in the past, then there is no doubt about such gains. So, the question is how far the sustainability of shipping stocks can go. Is it still the most attractive in the cyclical sector? 1. Is the Red Sea crisis the main reason? In terms of price increases, the explosive rise since 2020 has now reached the level of Q1 2021. The speed of increase is actually no less. But whether the peak prices can return to 2021 is questionable, and the sustainability of high levels still needs to be observed. The starting point of the rise was the change in supply and demand caused by the Israel-Palestine conflict. Due to attacks by Houthi militants in the Red Sea on commercial ships, major shipping companies had to change routes, resulting in longer distances and insufficient capacity, thus reversing the shipping prices. Therefore, there are also arguments that if the Red Sea crisis disappears, prices will fall back. However, it seems that the situation is not so simple at the moment. After all, in addition to prices to Europe, shipping prices from China to the Americas are also soaring, especially recently, prices from China to the Americas have begun to catch up with those to Europe. On the other hand, in terms of import volumes, the volume of goods imported by the United States is also steadily increasing. The routes to Europe are tense, making it difficult to explain the global rise in shipping prices. The rerouting in the Red Sea has been going on for some time, and the marginal impact of the Red Sea crisis on capacity has approached 0. The current rise in shipping prices is clearly not solely due to the Red Sea issue, but rather a result of the recovery in demand for European and American goods trade, entering a restocking cycle, and coexisting with the Red Sea crisis. After all, global commodity prices are resonating and major industrial metals are also rebounding. Oil, coal, and natural gas prices have been maintained at this level for a long time, which is acceptable. The core logic is that everyone feels that the inflation has dropped to a reasonable level, and the rise in resource prices compared to the prices of services and goods is already modest, causing minimal disruption to the global economy. Compared to other global commodities, last year's maritime logistics costs have returned to pre-rise levels, and current freight rates are not enough to cause significant cost disruptions to global inflation. There is almost no criticism of high freight rates, providing a basis for shipping companies to conspire to raise prices. From a demand perspective, improvements will only lead to a rapid decline in freight rates if the Red Sea route is reopened and the slowdown in demand for replenishing stocks in Europe and the United States occurs. While there are new ships being launched on the supply side, this factor's improvement is slow, and the competitive attitude between shipping companies is the decisive factor in supply. Currently, the intensive, step-by-step price increases among different alliance companies clearly indicate a renewed pursuit of profits. As the shipping industry enters the peak season, long-term contract rates are being renegotiated, with new long-term contract rates for 2024-2025 set to be implemented in the summer based on this year's spot rates. As a result, the comprehensive freight rates combining long and short contracts have a certain basis for increase. Historically, the turning point for comprehensive freight rates to decline is when the difference between spot rate indices (SCFI, WCI) and comprehensive freight rates (CCFI) begins to decrease. Currently, this difference seems to be expanding, making it not so easy for freight rates to fall. Inflation trends are interconnected. One speculation is that global resource prices will experience a phased increase along with economic development. For example, oil stock investors like to say that the central price of oil in the past 10 years was $60, and now, after many years, a central price of $80 is reasonable. Therefore, they no longer expect future oil prices to return to an average of $60. This is also why most investors are willing to give oil stocks a stable long-term profit PE valuation. If that's the case, could the central freight rate also be different from the past decade? II. Who is the big winner Currently, in the entire shipping industry, China COSCO Shipping's stock price has been leading the pack, both in the short term and long term, making it remarkable. It has also become a representative large-cap stock in the A-share market this year. The performance of China COSCO Shipping is mainly due to its outstanding profit performance and a significant amount of net cash in its asset structure. Firstly, with 200 billion in cash on its books, the company has enough valuation safety margin. In Q1 2024, China COSCO Shipping achieved the industry's highest profit margin at the bottom of the freight rates, and its countercyclical and cost advantages have been recognized. Therefore, during the freight rate recovery phase, the company's competitive advantage has been magnified, transforming into a valuation premium. However, there is a causal relationship between China COSCO Shipping's high profit margin and high net cash The reason for the high profit is that there is too much cash, which can generate high interest income in a high interest rate environment. But on the other hand, why is there so much cash? It is precisely because of the past conservative dividend distribution. The market's dissatisfaction with the conservative dividend distribution in the past has turned into a valuation discount at that time. This valuation discount caused China COSCO Shipping to lag behind the industry for several years. However, with the share buybacks since last year, as well as the validation of countercyclical measures and cost advantages this year, the valuation discount has turned into a valuation premium, which is why the stock price has surged. It can be said that China COSCO Shipping has completed a perfect countercyclical operation by expanding at low levels, contracting at high levels to accumulate cash, timely rewarding shareholders, and turning the tables. From the perspective of stock price, it is the biggest winner of the previous shipping industry cycle. However, the rapid rise in freight rates at present has created another situation. Many companies have expanded vigorously in the past two years, such as Evergreen Marine and Mediterranean Shipping. When freight rates are low, capacity is a burden. In 2023, their performance suffered major setbacks, with Evergreen Marine even experiencing a huge loss of $2.7 billion in 2023, almost equivalent to twice its market value in 2023. In 2021, capacity the latest capacity in 2024 If freight rates continue to fall, then the most cautious companies in expansion will continue to benefit from it, after all, aggressive companies continue to incur losses, bankruptcy is imminent. But now that capacity is constantly increasing, capacity has become a money printing machine. The consequence is likely to be that companies with aggressive expansion have won the bet, successfully expanding their share of industry profits, becoming the true winners of the cycle. In this way, companies with insufficient expansion will be bitten back due to insufficient capacity, and their share of industry profits will decrease. Therefore, from a competitive perspective, it is almost impossible for freight rates to return to their peak. As freight rates rise, conservative companies will certainly not want to see their profits surpassed and will choose to lower prices. Taking all these factors into consideration, the current situation in the entire shipping industry is that the inflationary environment is driving the long-term central freight rates upward, just like other resources, so the shipping stocks need to be valued with the new central freight rates. However, the game between conservative and aggressive companies in the entire industry, coupled with the new capacity being released, means that freight rates in this cycle no longer have the potential to reach historical highs. 3. Focus on dividend yield Currently, the logic of the Israeli-Palestinian situation is changing, seemingly on the verge of calming down soon, while the price game within the industry limits the room for price increases, and freight rates may soon be unable to rise, the investment logic is bound to face changes, so the entire industry is also in a phase of correction and hesitation. The safety cushion brought by high dividends remains the key to investing in shipping stocks. Unlike other cyclical stocks that rely on long-term central price increases to create high returns through valuation uplift based on expectations, generating returns through high dividend yields is already sufficient, and the investment return in this mode is more practical and enduring. The key is that what has already happened will not disappear, and the profits that have already been distributed will not be lost Even if freight rates fall, there is still value security margin brought by dividends. For example, when shipping prices returned to the original point last year, most shipping stocks still rose more than 5 times compared to before the epidemic, and this more than 5-fold increase in stock price corresponds to a deeply negative market value, which is all created by profits and dividends. For example, in 2020, the pre-reinvestment adjusted stock price of Orient Overseas was -133 yuan, no matter what happens now, the company can never fall back to that position. The calculation of dividend yield, the numerator looks at profits, the denominator looks at market value, the investment value of shipping stocks depends on the current judgment of the company's profitability and the base of market value. Currently, it appears that the peak of freight rates in 2022 is half, assuming it continues here for a year, it can probably achieve 1/3-1/4 of the profit level in 2022. According to the current commitment distribution ratio, the investment value of related shipping stocks can be distinguished. If freight rates continue to rise, companies with aggressive capacity expansion will undoubtedly have higher profit expectations and higher expected dividend yields to buy in, naturally without any risk. However, correct nonsense is meaningless, the higher the expected dividend yield, the better, but will the market give this opportunity again? Currently, the situation in the market is that the central profit logic of cyclical stocks is gradually rising, oil stocks have risen to a dividend yield of 5% per year, but still attract capital inflows, reaching new highs continuously. The profits of coal and oil stocks have not reached new highs in two years, but the stock prices continue to reach new highs, it is the change in market value that has caused the dividend yield to drop from 10% to 5%. In this context, the performance of shipping stocks has not reached new highs, but the stock prices have reached high levels or even new highs, which is easy to explain. The second reversal of freight rates, touching the level of 2020 and rebounding quickly, precisely indicates that the speculation of the central freight rate rise is happening, just like oil and coal stocks, the long-term stable valuation model is starting to make sense. It is for this reason that the investment in shipping stocks cannot be as pessimistic as in the past. In 2021, there may have been opportunities for shipping stocks with dividend yields of 40%-50%, but that does not mean it will happen again now, just like investors in China Shenhua and CNOOC returning when PB reaches 1x and waiting for historical lows of around 0.4x PB to buy back in. This is a lesson learned from many investors in oil, coal, and utility stocks who sold prematurely in this bull market. Conclusion For the current sharp rise in shipping freight rates, it seems to be a catalytic event, but it also hides the logic of global inflation, the rise in central prices of resources and services. Therefore, it has also joined the ranks of energy stocks: profits have not reached new highs, but stock prices continue to reach new highs. Compared to all these cyclical companies with this logic, shipping, due to its poor business model, high volatility, and low valuation, actually lays the groundwork for a high rebound space, after all, the lower the market value, the higher the dividend yield. We have gradually seen the possibility of some companies having a dividend yield of over 20% for a year, with freight rates still rising, this number can easily expand Of course, short-term freight rates are not the core issue, the central freight rates are. Compared to sharp peaks, it is more meaningful to fluctuate around an intermediate price. For example, the freight rates in Q1 this year represent the long-term average. Although there is a significant gap compared to the peak, at this level, some companies can maintain a dividend yield of over 10%. So, when incorporated into the current investment paradigm of oil and coal stocks, is there still a considerable opportunity for recovery? It must be said that every unexpected opportunity in the market is caused by biases. Until today, there are still some investors who say that holding cyclical stocks for the long term is meaningless. From despising cyclical stocks to embracing them, it is the most authentic portrayal of the market in recent years. Shipping companies have been the most biased type of cyclical companies in the past, and we have all seen the results