Every corner of the ocean shipping world is completely distinct from the others. What fuels the tanker business is almost entirely different than what steers dry bulkers or container ships.
Stark differences exist even within each segment. Take container ships. On one end of the spectrum are the large and ultra-large vessels that have the capacity to carry over 10,000 twenty-foot-equivalent units (TEU) or more – in many cases over 20,000 TEU. On the other end is the ‘feeder’ class, ships that have a capacity under 3,000 TEU, cater to small ports and are often ‘geared’ – with cranes onboard to service terminals that are too small to have their own equipment.
The larger container ships are dedicated to the high-volume ‘mainline trades,’ led by Asia-Europe and Asia-U.S. The feeders serve local business in low-volume ports.
The feeder market offers a niche opportunity for investors that has been hyped repeatedly at ship-finance conferences over the past two years. Just because they’re small doesn’t mean their returns will be, claim proponents.
The investment pitch is that most container ships on order or recently delivered are in the large and ultra-large categories, while a much higher percentage of feeder vessels are old and nearing retirement. As average container-ship size escalates, global networks will move more towards a ‘hub and spoke’ model, with mainline vessels dropping boxes off at transshipment hubs, where they are transferred to the feeder ships that will bring the cargo to the world’s myriad ports. Higher demand and lower vessel supply will boost feeder charter rates, to the benefit of investors.
There is a counter-argument to this thesis, however. It says that there are now so many large and mid-sized ships on the water that there will be more direct calls to ports, not less, and ports will upgrade their terminal facilities to handle larger ships. These direct calls will avert the more costly transshipment concept, and to the extent the hub-and-spoke system does expand, it will feature more transfers from very large ships to medium-sized ships, and not to small feeders.
One company that offers a window of visibility on container-ship feeder market prospects is Euroseas (NASDAQ: ESEA). On May 29, it reported a net loss from continuing operations of $16,032 in the first quarter of 2019, compared to a net loss from its container shipping fleet (excluding its dry bulk fleet, which it spun off May 2018) of $1.4 million in the same period last year.
“It’s difficult to say [which way rates will go], because of uncertainties stemming mainly from the trade talks. The trade talks will affect demand either positively or negatively, depending on the outcome. ”Aristidis Pittas, CEO, Euroseas
The company, which is led by Greek ship owner Aristides Pittas, earns revenues by chartering its owned ships to vessel operators. It achieved an average daily charter rate of $9,088 per day in the first quarter of this year, up 8 percent year-on-year.
Euroseas owns 11 container ships with aggregate capacity of 25,483 TEU. Ten are in the feeder category – defined as box ships under 3,000 TEU in size (Euroseas’ feeders range from 1,169 to 2,788 TEU). Its final ship is a 5,610 TEU Panamax-class vessel.
On a conference call with analysts, Pittas described Euroseas as “the only publicly listed company focused on the container-ship feeder sector.” That is true in the U.S. public market, but not globally. MPC Container Ships (Oslo: MPCC), which has a much larger fleet of feeders, is currently listed in Norway and has aspirations to list in the U.S. And if Euroseas’ stock price is any indication – it closed at just $0.62 per share on May 29 – investors have yet to be swayed by the feeder-ship pitch.
Euroseas had previously announced intentions to merge with another company and create a larger listed entity. In October 2017, it signed a letter of intent to explore a combination with Greece’s Poseidon Containers. That deal never went forward, and Poseidon ultimately merged with Global Ship Lease (NYSE: GSL) instead.
Pittas maintained that Euroseas continues to seek acquisition opportunities. “We are looking at the possibility of using the shares of the company as currency to buy further ships,” he explained, referring to the ‘ships-for-shares’ merger-and-acquisition model that has been widely used by public shipping companies in 2018-19.
He continued, “The biggest problem we have in these discussions is that some participants want to value our company based on its market capitalization rather than its net asset value [NAV]. That creates some difficulty in attracting players to contribute their ships into the listed company.”
Shares of many shipping companies, including Euroseas, are currently trading at a steep discount to NAV, which is defined as assets (based on the current value of the ships in the second-hand market, plus cash and other assets) minus debt and other liabilities. If the shares trade at a large discount to NAV, a buyer (such as Euroseas) would have to hand over too much of its own equity in an acquisition, effectively paying a higher price for the ships than it would have if it simply bought them in the second-hand physical market.
Commenting on the current rate environment for feeders – which is not strong – Pittas voiced optimism on a moderate recovery ahead. He noted that 1,700 TEU geared ships had obtained average rates of $8,250 per day in the fourth quarter of 2018, $7,000 per day in the first quarter of this year, and are now up to $7,750 per day. Rates for 2,500 TEU geared ships fell from $9,800 per day in the fourth quarter to $9,100 per day in the first quarter and are now at $9,300 per day.
The relatively poor charter rates in the feeder class stand in stark contrast to rising rates for larger vessel categories.
Analysts have speculated that rates for larger container ships are rising because liner companies need to pull their vessels out of service to install exhaust gas scrubbers to comply with the IMO 2020 rules, which limit fuel and exhaust sulfur content starting January 1, 2020. In order to keep their schedules, liner companies need to charter-in replacement ships, buoying rates for those vessels.
The best candidate for a scrubber installation is a ship with room to spare onboard to fit the scrubber, and one that spends most of its time at sea. Feeder container ships have limited space onboard to add a scrubber, and they spend much less time at sea and more time in port than larger container ships on long-haul mainline routes.
Asked on the conference call about the prospects for feeder rates in the third quarter, Pittas replied, “It’s difficult to say, because of uncertainties stemming mainly from the trade talks. The trade talks will affect demand either positively or negatively, depending on the outcome. If demand holds, we do expect an improvement in charter rates, although not a dramatic one like the very significant improvements seen for the 5,000-8,000 TEU ships.”