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Bargain Hunting in the Shipping Industry

Saturday - 4/13/2013, 12:11pm  ET

Investors are not showing any hurry to grab shipping stocks, even as many players in the sector are trading at attractive discounts. Investors’ apathy is understandable, as this cyclical sector is currently undergoing a downtrend.

Industry dynamics mean that these cycles are often very long, running for years. However, there are bright spots within the industry where investors can go long and make profits.

Scorpio Tankers best for now?

Monaco-based Scorpio Tankers  is one such player, which demonstrated an improvement in its operations in its latest quarterly financial performance. In the fourth quarter, Scorpio reported a 32.9% jump in vessel revenue to $30.1 million as a result of an increase in the number of operating vessels, along with an increase in time charter equivalent to $13,392 per day from $11,912 per day.

The increased freight rate is a positive indication for the sector, but what is also working in the company's favor is the energy revolution currently underway in the U.S. The company's operating loss narrowed to $1.8 million from $70 million, while its net loss improved to $4.9 million from $71.7 million from a year ago. The company suffered a major impairment charge of $66 million last year, which was absent this year.

The burgeoning production of light oil from U.S. shale deposits is making the country more and more energy independent. In 2012, the U.S. imported nearly 12% less crude oil from gulf countries. Attractive rates in the global markets provided an incentive for producers to sell their product in overseas markets.

However, age-old laws mean companies cannot export most crude oil varieties. This is forcing producers to circumvent the rules by exporting refined products, which do not attract such restrictions. Exports of refined products from the U.S. are expected to increase nearly 7% this year to 1.07 million barrels a day, according to Department of Energy estimates.

Scorpio Tankers will be benefit from this boom, as it operates 32 product tankers. Analysts expect substantial upside in the stock given its strong market standing and huge potential in revenue growth. Dahlman Rose, which has a Buy rating on the stock, recently increased its price target after the company reported encouraging results.

Recently, Scorpio announced the purchase of four MR tanker re-sales currently under construction at Hyundai Mipo of South Korea ("HMD") for approximately $36.5 million each. 

Diana moving quickly

Apart from Scorpio Tankers, Diana Shipping  i another potential winner. The company operates a  fleet consisting of 23 dry bulk carriers. Since Mar. 1, Diana is up over 26% versus dry bulk peers which are up 18% and 1% for the broader market.  Upside coincided with shipowner optimism expressed at recent industry events, seasonal grain trade demand, and positive views on Diana mentioned by some well-known investment pundits.

Recently, management stated belief that spot rates in 2013 will be about the same as in 2012. Motivated from the low asset prices, management also stated that it aims to buy more tonnage, but as there are limited number of quality second-hand vessels to pick from it is open to order newbuilds as well.

However, management reiterated its growth strategy with targeted, ongoing fleet expansion with reliance on debt of up to 50% for the next two years while chartering vessels in a staggered manner to reduce re-charter risk over the medium-term. With the stock soaring in the past few weeks and management plans to take on more debt, investors should proceed with caution.

Teekay may be best long-term pick

Investors can also buy shares of Teekay  to get a slice of action. The company provides crude oil and gas marine transportation services and has been the subject of favorable analyst recommendations following strong quarterly earnings.

The company reported an almost flat top line at $515 million, but it was seen as a positive as analysts were expecting revenue to drop to $466 million. Teekay also managed to narrow its full-year loss to $160 million from $358 million. Deutsche Bank has a Buy rating on the stock with a price target of $41, while analysts at Barclays have a price target of $35.

Foolish bottom line

Overall, the expected growth in petroleum is a shot in the arm for shipping companies that are otherwise faced with tough market conditions. While Scorpio Tankers could be the better near term opportunity given its relatively small size and high exposure to oil transportation, the gains in Teekay may be higher in the long run. At the end of the day, an increase in oil demand could boost the stock price of all three companies, both in the short and long term.

This article was originally published as Bargain Hunting in the Shipping Industryon Fool.com

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