6 shipping stocks for commodity boom

By Harry Domash

Prices of corn, iron ore, coal, steel and other commodities are going through the roof. Why? Emerging countries, particularly China and India, are using more of everything, creating supply-versus-demand imbalances that are driving prices to the moon.

China, although a big producer of many commodities, has become a net importer of aluminum, coal, steel, zinc and more. The recent massive earthquake in China only amplified the situation, because the rebuilding effort will increase demand for cement, steel and other materials.

Because all of these products get to China and other destinations by sea, this is a good time to consider shipping stocks. These companies operate oceangoing cargo vessels that they charter out to commodity producers or brokers.

Ship operators typically specialize in one of three shipping categories: oil tankers, containerships and dry-bulk ships.

You already know about oil tankers. Dry-bulk ships carry loose cargo such as coal, grain and steel that is loaded directly into their holds. Containerships carry items that can be packed into large steel containers, including toys, clothing, electronic goods, apples and motorcycles.

Of the three categories, dry-bulk-shipping volumes seem to be growing fastest, so I'm going to focus on that category.

The cost of shipping is key

Dry-bulk-ship operators generally charge by the day. The day rates, subject to the balance of supply and demand, are notoriously volatile. You can see that from this chart showing the Baltic Dry Index, which reflects the average cost to ship a variety of commodities, on ships of a variety of sizes. This index holds the key to these stocks.

The index value per se doesn't mean much, but by viewing current versus historical values, you can see, on a percentage basis, how much dry-bulk rates have moved up or down. The chart shows that day rates have moved up over the years, with plenty of ups and downs along the way.

Because operating costs are relatively fixed, dry-bulk-ship operators' profits skyrocket when rates are high but can turn to losses when rates drop.

On June 19, the Baltic index stood at 9,474, up 7% this year and up 78% from a year ago. However, the index was down 20% from its all-time high on May 20, just four weeks earlier. That points up an interesting aspect to investing in dry-bulk-shipping stocks. Even though day rates fluctuate wildly for all sorts of short-term reasons, the market treats each change in the Baltic index as if it were signaling the start of a long-term, irreversible trend.

Despite the reality that the emerging economies are still emerging, that China still needs to import even more construction materials to repair earthquake damage and that day rates are far above year-ago figures, dry-bulk-shipping stock prices usually dip when the Baltic index drops. The six stocks turned up by the screen I'm going to tell you about in a minute dropped 11%, on average, from May 20 to June 19.

This might make it seem attractive to try to time these stocks, buying when shipping prices are low and selling when they're high. But I've never been able to make that work. With stocks like these, I've found that buying and holding until fundamentals change beats trying to time the market.

Buying and holding also allows you to take advantage of another attractive feature of dry-bulk-shipping stocks: Many of them pay high dividends. Yields (the next 12 months' dividends divided by the current price) range as high as 12%. Those payouts add significantly to returns and tend to cushion share price drops when the Baltic index drops or the overall market heads down.

Finding dry-bulk shippers

I set up a simple screen to locate promising dry-bulk-shipping stocks. For starters, I require stocks in the shipping industry with market capitalizations of at least $250 million. Market capitalization is how much you'd have to pay to buy all of a company's shares. Market caps below $2 billion define small-cap stocks, while stocks with market caps above $10 billion are large caps. Those in between are midcaps.

I usually avoid stocks with market caps below $1 billion because smaller companies are riskier than larger ones. However, most dry-bulk shippers have market caps below $1 billion. So, in this instance, it makes sense to bend that rule.

Screening parameter: Industry Name = Shipping

Screening parameter: Market Capitalization >= 250,000,000

Continued: Dividends

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