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Why Investors Should Buy This Sector's Stocks Now

Companies / Investing 2013 May 29, 2013 - 01:54 PM GMT

By: Money_Morning

Companies

Martin Hutchinson writes: In a market that has been heading toward the stratosphere all year, it gets tough continually unearthing undervalued sectors.

But an ever-changing market means new opportunities are always presenting themselves if you know where to look.


And I'm pleased to say I know of one that is looking stronger while still selling at bargain prices. What's more, this sector is kicking off some stellar yields.

And the cherry on top: the sector is in a secular uptrend -- which means, if you're in the right stocks, you're going to see big growth and solid dividends for years to come.

The sector? It's shipping stocks. Whether tankers, LNG carriers or dry cargo, select shipping firms are currently great buys once again.

After an early recovery from the nadir of 2008-09, the Baltic Dry Cargo Index (the index covers "dry" materials like iron ore and coking coal) collapsed in 2011-12, taking much of the shipping sector with it.

While recovery has begun, there are still many companies selling far below net asset value, some of them with very attractive dividend yields.

Jump on This Cyclical Trend

In general, with large fixed asset costs and variable costs that are low, industries like shipping, airlines and railroads are not very attractive places to invest.

Whenever the cycle turns positive, fixed asset investment zooms up, and the lags in the system ensure that heavy investment continues until fixed assets are in a large glut, which takes years to dissipate.

In shipping, that means when things are good, owners spend on building more ships to keep up with demand, borrowing capital to do so. But usually, by the time the new ships are built, the cycle has shifted and demand has waned. And the firms are stuck with too many ships and a scary balance sheet.

During those years, owners must use their fixed assets, so returns decline to a very low level, often with large losses. The overall average return over the cycle is below other industries. The problem is exacerbated by cheap financing, which encourages even more excessive investment booms, since owners dream of growing gigantic and super-rich through leverage (a few of course succeed in doing so.)

The bigger the cycle, the more volatile this dynamic becomes.

Bottom line: You don't want to invest in shipping companies over the whole cycle.

And you certainly don't want to invest in them when the cycle is booming as in 2007-08, because you will buy on the basis of temporary juicy earnings, at prices far above net asset value, and a flood of new building will crush your capital value.

Now, however the big shipbuilding cycle peaked in 2012 and is rapidly winding down, while global trade is showing signs of life.

If you buy shipping companies that can take advantage of this uptrend intelligently, there's some good money to be made.

The Top 4 Shipping Firms Now

LNG carriers are currently in most demand worldwide, because Japan's nuclear power problems have led it to import large amounts of liquefied natural gas. You're therefore not buying at the bottom here, but on the other hand global LNG demand is likely to continue increasing, since it represents a cheap and carbon-efficient fuel for the electric power industry.

In this sector, Teekay LNG Partners (NYSE: TGP) has an attractive 6.2% yield, which is tempting, and its first quarter 2013 income covered its 67.5 cent-quarterly dividend payment. You should note however, that the shares are standing at 2.5 times book value, which makes the share price vulnerable to new building by other companies.

The tanker sector has been under pressure recently; and at the other end of the valuation spectrum from TGP is DHT Holdings (NYSE: DHT), an owner of eight double hull crude tankers, whose shares are currently standing at 23% of book value, indicating substantial upside if the company survives. The company has satisfied its debt maturities until 2016 and has $75 million of cash; its first quarter net loss was $3.1 million. This one's a matter of risk/reward ratio; the shares are very beaten down and look like good value.

In the bulk carrier area, Safe Bulkers (NYSE: SB) operates a fleet of 25 relatively new dry bulk vessels. It is a relatively low-risk operation with most of the ships out on long-term charters. It pays a dividend of 5 cents per quarter and yields 3.8%, yet it is trading on only 4.7 times trailing four-quarter income and just below net asset value. It represents the safety end of the shipping industry, yet with some modest upside potential if rates improve (modest because its ships are on long-term charters).

Finally Capital Product Partners LP (Nasdaq: CPLP) operates a mixed fleet of tankers and bulk carriers. It pays a very juicy 10.3% dividend yield, which was covered by net income in the first quarter but not in 2012, and like SB trades just below net asset value. To a greater extent than SB, it will benefit if bulk shipping rates improve, since around half of its fleet is on spot charter.

For conservative investors, SB looks to be the best bet, while for those seeking high income CPLP is a solid operation. DHT is for the most risk tolerant of you. Avoid TGP here because it's a bit expensive, unless you're very bullish on the global LNG market and think it's currently undergoing a phase of rapid secular expansion (I'm not convinced yet).

Source :http://moneymorning.com/2013/05/29/buy-this-sector-now/

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