Pacific Basin Shipping Limited (2343) Earnings Call Transcript & Summary

Welcome to today's Pacific Basin 2022 Third Quarter Trading Update Call. I'm now pleased to present Chief Executive Officer, Mr. Martin Fruergaard. [Operator Instructions] Mr. Fruergaard, please begin.

Yes. Thank you very much. Welcome, ladies and gentlemen, and thank you for attending Pacific Basin's Third Quarter Trading Update Call. My name is Martin Fruergaard. I'm Chief Executive Officer, and I'm joined by our CFO, Peter Schulz. Please turn to Slide 3. The minor bulk freight market in the third quarter of 2022 softened compared to the first half of the year as increasing inflation and interest rates slowed global growth and weakening construction activity and zero COVID policies drove a slowdown in the Chinese economy. Index spot rates for Handysize and Supermax ships averaged $16,010 and $18,740 net per day, respectively, in the third quarter of 2022, both representing a decrease of 27% compared to the first half of 2022. Significantly lower than normal grain loadings due to the conflict in Ukraine and a slow start to the U.S. grain season impacted demand in the period. Despite this, the average minor bulk freight rates is historically high and the market has remained considerably firmer compared to pre-pandemic levels. We see the market supported by continued overall robust loadings in minor bulk and an increase in the seaborne coal trade due to the high demand in Europe for non-Russian coal, and this despite record domestic Chinese coal production. Currently, we are experiencing improved market conditions, generate increases for both Handysize and Supramax in the Atlantic market due to improving green export out of South America and the continent. Please turn to Slide 4. Global minor bulk and loadings grew approximately 8% in the year to September compared to the same period last year. Growth in minor bulk loadings moderated in the third quarter to 5% year-on-year, and we expect a global macroeconomic outlook and slow Chinese economic recovery to weigh on minor bulk demand for the remainder of 2022 with some upside potentially coming from any loosening of Chinese COVID-related restrictions and the revival of residential construction activity. Weaker container rates also weighed somewhat on the minor bulk market as some cargoes were containerized. Global grain loadings were down 6% year-to-date, partly as a result of the situation in Ukraine but also due to the U.S. grain season experiencing a slow start as low water levels in the upper reaches of the Mississippi River made barging grain for export difficult. We expect Ukrainian volumes to continue to grow, assuming an extension of the Ukraine grain export agreement and as more owners feel increasingly comfortable engaging in this trade and for U.S. grain exports to increase as water levels in the Mississippi River rise. Both of these developments would further support the Atlantic freight market going into fourth quarter. Coal volumes loaded in the year to September increased 2% compared to the same period in 2021. There's a significant increase in European and Indian coal imports due to global energy security concerns and a general displacement of Russian volumes, has been to mitigate the impact of record Chinese domestic thermal coal production and weak coking coal imports. The conflict in Ukraine has also had a positive tonne-mile impact as Europe increasingly source coal from more distant locations such as Australia, United States, Canada and Colombia. Please turn to Slide 5. Our coal business generated average Handysize and Supramax daily TCE earnings of USD 23,620 and USD 26,640 net per day in the third quarter, representing a decrease of 10% and 21% compared to the first half of 2022. So far, 74% and 89% of our contracted Handysize and Supramax days in the fourth quarter of 2022 are covered at USD 18,760 and USD 20,480 net per day, respectively. Our Supramax cover rates, we have provided excludes any scrubber benefit, which is currently about $2,200 per day across our entire core Supermax fleet. We are focused on optimizing our short-term cover to maximize earnings over what is commonly a softer market during the Northern Hemisphere winter and Chinese New Year periods. Please turn to Slide 6. Both our Handysize and Supramax vessels outperformed the average Handysize and Supermax indices by $7,610 and $7,900 per day, respectively. In the third quarter, our operating activity generated a positive margin of $3,860 net per day over 4,780 operating days. This was our strongest quarterly operating activity performance so far in 2022. Our performance continues to benefit from our diverse cargo and customer base and the close customer interaction facilitated by our extensive global office network and is again a testament to the great commercial acumen and operational excellence of our organization, both ashore and at sea. Our performance is also reconfirmed by our external benchmarking, and we are pleased to see that we not only outperformed the spot market rates index but also our peer group. A potentially softer market in the early 2023 will negatively impact our near-term outperformance as well as our operating margins as we have chartered in commitments, particularly in Supermax, taken during the stronger market earlier this year. Please turn to Slide 7. Prior to the IMO 2020 sulphur cap, we invested some $62 million on installing scrubbers on 28 of our Supramax vessels. And we are pleased to report that we have now fully recovered this investment considerably faster than expected. In the third quarter, scrubbers contributed $2,810 per day to our TCE earnings across our entire core Supermax fleet, equivalent to an annualized run rate of approximately $49 million. We have acquired an additional 5 Supramaxes with scrubbers since January 2020 for a total scrubber-fitted owned fleet today of 33 vessels. Along with these, we have 3 scrubber-fitted long-term Supramax chartered-in ships, taking our total core scrubber-fitted fleet to 36 vessels. Please turn to Slide 9. IMF forecasting global GDP growth of 3.2% for 2022 and 2.7% for 2023, reflecting impacts of higher inflation and interest rates, ongoing conflict in Ukraine and a slowdown in the Chinese economy. Expectations are for dry bulk demand to moderate as is typical going into the Northern Hemisphere winter and Chinese New Year periods, with the first quarter typically being the weakest of the year. In the medium to long term, we are optimistic about the prospects of the dry bulk market despite any short-term headwinds. We expect demand will be supported by significant global infrastructure investment, particularly in emerging markets such as India and countries in the ASEAN region. We expect global food and energy security issues to support demand and positive tonne-mile for both grain, coal at a number of minor bulks. And we expect the eventual relaxation of China's COVID mitigation controls next year, giving rise to further government-led infrastructure investment and support of the residential construction sector. Please turn to Slide 10. We see that a long established relationship between dry bulk earnings and new building contracting has been broken. The dry bulk order book is at a record low of 7% and the uncertainty over new environmental regulation and the high cost of new buildings will continue to discourage any significant new ship ordering. We don't expect the ordering of minor bulk zero-emission-ready vessels to be commercially feasible until mid-decade at the earliest. Clarksons Research forecasting just 0.2% fleet growth for Handysize and Supramax in 2023, and we expect this to continue to support the market. Please turn to Slide 11. From next year, ship owners will report individual vessels EEXI and CII data, and many will have to implement engine power limitations with noncompliance beginning to have real associated consequences from 2024. The CII, in particular, is expected to have a material effect on vessel speeds and carry capacity over time as slowing vessel speed is the most effective way to reduce fuel consumption. Based on our current fleet alone and assuming our ambitions of achieving C or better, we estimate a potential reduction in carrying capacity of up to 25% by 2030. In addition, we expect scrapping to increase in coming years as IMO fuel efficiency rules will encourage owners to phase out older and less efficient ships. Please turn to Slide 13. We have, over time, maintained our strategy to grow and renew our fleet while adjusting as the market fluctuates. Our focus has been on minor bulk shipping, operational and cost excellence and all the while organically growing our fleet from 33 owned ships in 2011 to 121 in 2020. Due to strong secondhand prices and in line with our strategy, we have recently been focusing the focus on selling some of our smaller, older Handysize ships, thereby crystallizing value and further optimizing our fleet to meet tightening environmental regulations. We have sold 14 Handysize vessels since the beginning of 2020, the latest 1 being sold in the third quarter of 2022. Vessel values are now softening with the freight market and we have taken advantage of the recent volatility to again consider purchasing high-quality secondhand vessels. And during the first quarter -- sorry, during the third quarter, we agreed to acquire 1 scrubber-fitted Supramax ship, which is our first vessel purchase since December 2021. Going forward, we will continue our organic fleet growth and renewal and we'll invest in zero-emission-ready ships when they become commercially viable for minor bulk trades and the required global bunkering infrastructure is being built out. Please turn to Slide 14. We will continue to trade our ships efficiently for high laden-to-ballast utilization. So we constantly seek, assess and implement energy-efficient operating measures, including looking for collaboration solutions with our customers, tonnage providers, ports and other stakeholders. This will ensure that our existing ships running on conventional fuel oil can maintain sound annual efficiency ratio, ratings and continue to trade for the foreseeable future. We are comparing ourselves for shippings eventually, inclusion in the European Union emission trading system, among other EU initiatives to drive decarbonization shipping. The European Fit for 55 package remains subject to negotiations between the European Council, Parliament and Commission and is now likely to apply to shipping from 2024 onwards. The consequence of these rules will include the progressive slowing of ship speeds and over time, accelerating -- accelerated scrapping of older and less efficient ships. The ships become no longer fit for trading. Please turn to Slide 15. Given the supportive fundamentals of our industry, market rates continue to be historically high and well above our breakeven levels for both Handysize and Supramax vessels. Despite any short-term headwinds, we continue to be excited by the long-term prospects of dry bulk shipping and especially the minor bulk segment. Our large and modern owned fleet of highly versatile Handysize and Supramax ships, combined with our close customer partnerships, enhanced access to cargo opportunities, competitive costs and high vessel utilization makes us well positioned for the future. Ladies and gentlemen, that concludes our trading update presentation. I will now hand over the call to our operator for Q&A.

[Operator Instructions] Our first question is come from Parash Jain with HSBC.

I have 2 questions, if I may. And the first one is probably a bit hypothetical, but can you help us understand if the Russia, Ukraine war ends tomorrow, how would it change some of those trade lanes, the arguments around longer tonne-mile in general demand? And on the same line, what is your expectation in terms of China's appetite for dry bulk if 2023 starts on a clean slate with no COVID-related disruption?

Yes. Good questions. And the first one is, yes, I think it's really hard for me to reply to it because I guess it depends a little -- even if the war ends, I wonder a little bit if the restrictions on Russian export will end. But clearly, if the war ends, I'm sure that we will see export of Ukrainian grain. I think that will be good. All in all, that will increase the volumes, which is down quite a bit here in the third quarter compared to what it usually is. The cost is, of course, as the war ends, doesn't mean that the world will start again to take commodities out of Russia. If the world will do that, I think it would probably be good for the world economy. But I'm a little bit uncertain, Parash, if that's going to happen, but we can only follow that. In respect to China, I think if China opens up early next year, I think that would have a positive impact on the world economy and, of course, on the volumes going in and out of China. And just because China opens up doesn't mean that the world's GDP will grow or demand will grow for goods. But for sure, 1.4 billion people in China coming out of COVID, for sure, that will also mean some extra spending in China and a bigger flow of various commodities. And you have to remember that China actually has been slow for some time now already. And even though we still have a fairly good minor bulk market and I think if China moves up, I think it will have a positive effect on the minor bulk commodities.

[Operator Instructions] Our next question is come from Andrew Lee with Jefferies.

I have a few questions. Maybe the first one is, are you expecting that rates will start rebounding into year-end? I know you mentioned that you expect like first quarter next year before Chinese New Year seasonality means that rates would come down. Does that mean that the rates you expect rates demand to pick up into year-end? The second part of that is that the rates have actually been a little bit weaker than people have been expecting. Is that in line with your expectations, right? Because you previously noted that you expected near term, there would be a little bit pressure. Is it in line or is it worse than expected? Part C of the same question, sorry, is you mentioned that you're more positive on the longer term. How do you define longer term or medium term versus short term, right? So that's the first question. Second question is on the CII regulations, right? You mentioned that you expect 25% of the fleet could actually get scrapped if that goes to B. Is that based on the whole fleet or is that based on Pacific Basin? And does that mean that if I'm looking on Slide 14, right, you have around 32 vessels that are rated B, 7 that are rated E. Does that mean that all 39 need to be scrapped within that -- need to be scrapped? Second question. Final question I have is on -- you mentioned that container rates were low or some volume got shifted. Could you quantify how much volume shifted across?

There were many questions. If we start first with the short, medium and long, that's a good question. I think we think -- actually, we're a little bit positively surprised about how strong the market still is when you're considering all the things that are happening in the world at the moment. I'm actually a bit surprised how good our market actually still continue to be. And I think that also comes a little bit because China is a big player in dry cargo. But for us, it's only 10% of our loading and discharge. And we still see in the ASEAN countries, so the Southeast Asia, still being very active. We see a lot of cement clinkers going into the U.S. and Bauxite. And now we see the grain out of South America and we see coal distribution in Europe. So actually, our markets are holding up quite well. And we would also say that coming into fourth quarter, we do see some grain being postponed and now it's coming to the market. That actually might be part -- that's also why we see the Atlantic market coming up somewhat. Again, when we see short term, which is maybe the next 6 months, the first quarter, we normally see a weaker market. We expect the same to happen this year. And then I think it's down to how deep will the crisis be and how long will it be. That's, for us, very hard to predict. But we, of course, our business is going to be short and not too deep. And therefore, we are actually quite positive about second quarter, third quarter next year already. But we have to follow a little bit how GDP is going in the world and how the world is developing on that side. In respect to the CII, I think first of all, the calculation we have made is not -- doesn't mean that we have to scrap 25% of the ships. And what we try to do is we look at our fleet and say with the rooms we have as coming up, we have to reduce our impact with 2% a year to 2026 and thereafter at least 2% going forward. And what will that mean for us if we have to keep all the ships in C rating? That means we have to reduce speed. And for us, that means that we would have to reduce speed by up to 25%. So the carrying capacity of our -- or the supply, the carrying capacity over the period for our ships will be 25% less. And we feel our fleet is maybe a good picture of how the global minor bulk fleet looks like. So I think what we're trying to say here is that if these rules, if we have -- everybody has to comply with these rules, then supplies will come down between 15% and 25% by 2030 if it has to be done only on speed. So we start to shift [indiscernible] early scrap but we just reduce speed. And therefore, the global supply will be less. So it was an attempt to sort of show you what is the impact actually of these IMO rules when they come into force. I don't know, Peter, if you have anything else to add to that.

No, I agree with that. Just these calculations on carrying capacity is compared using the average speed of the last 5 years of our fleet. So it's compared to a baseline based on last 5 years average to note. At the moment, of course, the fleet is going -- the global dry bulk fleet is going fairly slowly at slightly above 11 knots. Historically, we have been a little bit faster than that but that is the baseline.

And if we just go to Slide 14, then maybe short comment on that. So on Slide 14, this is where -- this is how we are rated on the AER stage. That doesn't mean that if they rate us at E, it doesn't mean that they are bad ships. It is actually more a reflection of how we are trading the ships. So that has a big impact on the rating. So it could be just by trading assume differently than some of the ships would not be an E, but they could actually go in C or even B. When we look at our fleet today, we are prepared for the rules coming into force. And then we will be in compliance with the rules when they come into force. So therefore, some of the ships that are an E, then we have to do something differently in the trading pattern of those and we will do so, or we have to reduce our speed. And then the last question about containers. We -- it's really hard to say how much it is, but it is clear that some of the [indiscernible] cargoes that we were moving in at the height of the market earlier on the deck or something else has been returning -- is slowly returning to the containers and they will put them in containers again. So that impact us, of course. We take a little bit on the top of the market as well in it. But it need to be big as it's very hard to justify and quantify how much it is. But of course, as the container market is coming down, some cargoes will return to containers. And I'm sure there's also some MPPs, multipurpose ships, that will return again to normal dry cargoes instead of containers. I hope that I replied, Andrew.

It does. Maybe just one quick follow-up question. So the 25% speed reduction is from 11 knots. What's the slowest that the vessels can sail?

No, it's not from the 11 knots. It's from the average speed over the last 5 years, which is higher than 11 knots. I can't remember exactly on the top of my head, it is, but it's higher than 11 knots, Andrew.

Just one final question I need to impulse. The vessel that you bought, right, could you give us a little bit of detail how you paid and the size? And also, are you seeing more attractive offers in terms of vessel prices? And are the owners actually being more willing to negotiate a nice price for you guys? What I mean is like more of the discount?