A Contrarian Play on Global Shipping
A year ago, I posed the question: “Is Global Shipping Poised to Capsize?” At that time, Russia had just invaded Ukraine and the Fed was about to start jacking up interest rates.
The financial sanctions imposed on Russia drove up the price of oil. At the same time, rising interest rates increase the cost of servicing debt.
In addition, the global supply chain was sagging under the weight of lockdowns in China. Just when we thought we’d seen the last of COVID-19, it once again reared its ugly head.
You don’t have to be a financial genius to foresee the implications of those factors. Things were about to get a lot tougher for most businesses.
I said then, “If I were compiling a list of undesirable traits of companies to invest in during the current economic environment, it would include:
- Consumes a lot of energy.
- Highly leveraged (borrows a lot of money).
- Dependent on the global supply chain to function.”
In particular, I opined that “global shippers find themselves in the crosshairs of several macroeconomic megatrends that could all soon move against them.” And move against them, they did.
Last week, the U.S. Global Sea to Sky Cargo ETF (SEA) was 31% below where it was on the day that article was published. Over the same span, the SPDR S&P 500 ETF Trust (SPY) was down less than 5%.
That degree of underperformance usually means one of two things is likely to happen next. Either SEA will throw in the towel and liquidate its assets, or it will rally strongly as those same macroeconomic factors reverse direction.
I’m not so sure this fund will be around much longer. It has less than $5 million in net assets. The fund’s manager has agreed to waive or reduce its management fee so it does not exceed 0.60% for the first $100 million of the fund’s average daily net assets.
It may be a long time until the fund’s assets exceed $100 million. But as long as SEA remains in business, it could be one the best ways to play a rebound in the shipping industry.
Although the fund is small, the average market cap of its holdings is $17 billion. Its top holdings comprise all the major international shipping companies.
Despite its name, not a single U.S. based company is among the fund’s top 10 holdings. The only American companies in the fund’s top twenty holdings are FedEx Corp. (NYSE: FDX) and United Parcel Service (NYSE: UPS).
According to the fund’s sponsor, the reasons it is bullish on shipping, cargo and logistics companies include:
- Leading indicator for economic trade and growth
- Favorable pricing power
- High barriers to additional capacity.
In addition, the sponsor claims, “The ETF provides access to companies that have exhibited a favorable ability to increase prices, a key driver of revenue growth.” In the shipping industry, scalability is a function of pricing and not output.
The same macroeconomic factors that hurt pricing last year should start to ease up this year. Oil prices are much lower now than they were a year ago. Shippers have restructured their balance sheets to reduce debt. And the Global Supply Chain Pressure Index is at its lowest level in more than two years.
The simplest way to play a rebound in shippers is to buy shares of SEA. A return to the $20 share price it was trading at last summer would represent a 33% gain on its current share price near $15.
A more aggressive strategy is to buy a call option on SEA. A call option increases in value when the price of the underlying security goes up.
Last week while SEA was trading near $15, the call option at the $13 strike price that expires on October 20 could be bought for $4.
For that trade to be profitable, SEA must appreciate by at least 13% within the next seven months. If it makes it back to $20 by then, the gain on this option would be at least 75%.
This trade is not without risk. If SEA falls below $13 by the time this option expires, it will have no value at all.
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