What shall we do with the drunken sailor?

At a Glance

The report argues that the long-standing overcapacity in the shipping industry is reversing, with clear signals of supply-side contraction emerging from multiple dimensions. The author uses the metaphor of a "drunken sailor" to describe irrational investment in shipping but believes that "eventually, economic rationality must be restored, the powerful but silent force of mean reversion must assert itself," and this turning point is now underway.

Specific evidence of supply-side contraction includes:

• Shipyard closures: Shipyards in South Korea and China are beginning to close, which the author likens to "sellers of hooch to our drunken sailor."
• Cessation of government subsidies: The bankruptcy of Hanjin Shipping in 2017 is seen as evidence that South Korea has finally abandoned subsidizing the shipping industry, after previously wasting billions of dollars bailing out shipyards like Daewoo.
• Financing drought: European banks are exiting shipping loans, and alternative financing sources like the German KG limited partnership structure have proven that "the tax tail should not be allowed to wag the commercial dog."
• Regulatory pressure: The International Maritime Organization (IMO) requires reducing sulfur oxide emissions from 3.5% to 0.5% by 2020. For dry bulk carriers over 15 years old, future expenditures for retrofitting, dry-docking, and testing could reach twice the vessel's scrap value, making scrapping more attractive. The IMO Ballast Water Management Convention took effect in September 2017. Changes in accounting standards require long-term leases to be capitalized on the balance sheet, increasing difficulties for non-operating owners (NOOs). Higher risk weights on shipping loans reduce the appeal for new entrants to replace European banks.
• Low oil price effect: Low oil prices make the benefits of ordering new, more fuel-efficient vessels unclear. Additionally, if slow steaming ends due to low oil prices, it could risk increasing effective capacity.

Second-hand Vessel Prices and Order Books Decline, Capital is Flowing Out of the Industry

The author emphasizes that supply-side changes have produced observable market signals: second-hand vessel prices are below newbuilding prices, order books are at historic lows, and capital is flowing out of sub-sectors on a net basis. The report notes that in a balanced market, second-hand vessel prices (based on five-year-old vessels) typically follow newbuilding prices; in a bull market, second-hand prices can reach twice the newbuilding price. Current low second-hand prices reduce the appeal of ordering new ships.

Key Data and Comparisons:

Indicator	Current Level	Historical Comparison
Dry bulk orderbook/fleet ratio (July 2017)	7.5%	7.2% in April 2002, the lowest at that time
Container orderbook/fleet ratio	14%	Peaked at 70% in 2007, lowest since 2003
Baltic Dry Index (BDI)	One-tenth of the level ten years ago	—
Shanghai-to-Europe container freight rate	Approximately half of the 2014 level	—

Specific Company Developments:

• Pacific Basin and Diana Shipping have purchased second-hand vessels this year (rather than chartering or ordering new ships), partly funded by existing cash on their balance sheets, leading to a net capital outflow from this sub-sector.
• In the container sub-sector, the bankruptcy of Hanjin Shipping may act as a catalyst for further consolidation: after its receivership filing in August 2016, its vessels were unable to dock for fear of seizure by creditors, ports refused entry due to concerns over unpaid fees, and customers became wary of weaker surviving players.

Maersk: Industry Consolidator with Multiple Moats

The report argues that AP Møller Mærsk (Maersk) is the most advanced player in the capital cycle within the container sub-sector, possessing three attractive characteristics: family control, scale network effects, and counter-cyclical capital allocation. The author points out that the container sub-sector may be the most mature in terms of capital cycle progress among shipping sub-sectors, with the top six players controlling 70% of the market, the largest being Maersk.

Maersk's Specific Advantages and Data:

• Family control: Allows it to "chart a course to a more distant horizon however choppy the waves are in the short term."
• Scale and network effect moat: Enables it to maintain low costs and remain competitive.
• Counter-cyclical capital allocation: Allows it to invest opportunistically and harvest non-core businesses like banking and food retail.
• Captures the entire profit pool: Like Taiwan Semiconductor in the wafer foundry space, Maersk captures over 100% of the industry's profit pool and uses this position to pressure competitors, expand market share, and drive industry consolidation.
• Cost and operational data: Since 2014, Maersk has reduced its core cost per TEU by 20%-25%, but this is only half the decline in revenue per TEU (due to freight rate pressure). Its current cash flow return is only 1.4%. If it could improve this to its cost of capital (just 5.2%), there is 70% upside potential—even though its share price has risen over 60% from its low a year ago, and the fund has increased its position during this period.

Investment Implications

The underlying investment logic of the report is to bet on the mean reversion opportunity brought about by the reversal of the capital cycle in the shipping industry. The author explicitly states that they do not forecast demand (regional GDP, grain exports, coal imports, etc.) but instead judge future returns by observing supply and capacity growth. Current supply-side contraction signals (shipyard closures, financing drought, regulatory pressure, historic low order books) are clear, but progress varies by sub-sector: containers are the most advanced (Maersk dominates the profit pool), followed by dry bulk (order book at its lowest since 2002). Institutional perspective bias note: As a holder of positions (the portfolio contains 7 shipping stocks, totaling 1.25%), the author's discussion inherently includes a defense of the portfolio's rationale. Readers should note that the timing of the supply-side reversal remains uncertain, and demand-side risks (such as a global trade slowdown) are not fully discussed.

Follow-up Analysis: Capital Discipline and Cycle Mismatch in the Dry Bulk Market

1. The Cost of Lacking Capital Discipline: Pacific Basin's "Diworsification Trap"

In stark contrast to Maersk's strict capital discipline in the container sector, capital management in the dry bulk market is generally loose. After perfectly cashing out at the market peak in 2007-2009, Pacific Basin should have returned capital to shareholders through buybacks or dividends but instead chose a path of "diworsification":

• Investment in Chinese real estate: Non-core assets with poor liquidity and high correlation with the Chinese economic cycle.
• Venturing into Ro-Ro vessels and tugs: Weak synergy with the core dry bulk business, increasing management complexity.
• Equity issuance in 2016: To reserve capital for a "late" cyclical upturn. However, the false start of the industry in 2013 proved that a flood of capital (private equity/IPOs) actually delayed the real recovery—a classic example of Soros's "reflexivity": expectations change behavior, and behavior changes outcomes.

Comparative Data: Capital Discipline and Shareholder Returns

Dimension	Maersk (Container)	Pacific Basin (Dry Bulk)
Cycle Top Action	Sold assets + buybacks at 2008 highs	Liquidated fleet in 2007-2009, but did not return capital to shareholders
Capital Allocation Strategy	Focus on core business + cost reduction	Non-core diversification (real estate/Ro-Ro/tugs)
2013 False Industry Start	Did not participate in capital expansion	Peers raised significant capital, prolonging overcapacity
2016 Financing Method	Debt optimization + internal cash flow	Equity issuance (diluting existing shareholders)

2. Survivor's Resilience: Pacific Basin's "Late-Mover Advantage"

Despite strategic missteps, Pacific Basin has managed a "near-death escape" through the following adjustments:

• Cost reduction: Cut administrative expenses by one-third over the past few years, improving operational efficiency.
• Balance sheet repair: After the 2016 equity issuance, the debt ratio fell to a safe range, providing counter-cyclical acquisition capacity.
• Fleet quality: Entirely composed of high-quality substitutable Japanese ships, with low maintenance costs and high resale value.
• Network effect: Its global cargo-gathering network allows it to fill backhaul routes, achieving actual freight rates 10%-20% above market averages.

Recent Actions: Acquiring second-hand vessels at attractive prices, further expanding low-cost capacity.

3. Potential Risks: Lessons from the Airline Industry and Commonalities with Shipping

Our investment experience in the airline industry provides a cautionary tale. Shipping and airlines share the following structural flaws:

• Low barriers to entry, high barriers to exit: High asset specificity (ships/aircraft) makes rapid resale or exit difficult.
• Destructiveness of "visionary" managers: Legendary airline CEOs often pride themselves on "expanding capacity" but leverage up at cycle peaks. The shipping industry has no shortage of such figures (e.g., dry bulk new entrants from 2013 IPOs).
• National strategic intervention: The recent acquisition of Orient Overseas (International) Limited (OOIL) by COSCO is a typical case—state capital tolerates losses for strategic purposes, prolonging the industry's cleansing cycle and acting as a "brake pad" on the capital cycle.

Key Distinction: We are not betting on a single company ("waiting for one ship to come home") but building a "small fleet" through three companies—Diana Shipping, Pacific Basin, and Scorpio Bulkers—to diversify idiosyncratic risk.

4. Current Assessment: Supply-Side Inflection Point Has Arrived, Stock Prices Have Not Fully Reflected It

Despite the risks mentioned above, clear supply-side signals support our current bullish stance:

• Newbuilding order book: At historic lows, with deliveries expected to decline continuously from 2020 to 2023.
• Scrapping volume: Accelerated scrapping of older vessels, especially handymax/supramax vessels over 15 years old.
• Capacity growth: Net dry bulk capacity growth is expected to be below 2% from 2023 to 2025, while demand (iron ore/coal/grain) is projected to grow 3%-4%.

Conclusion: The upturn cycle has begun, but stock prices have not yet fully reflected this. Our long-term horizon (rather than short-term volatility) and diversified holdings (rather than single-point bets) are core advantages in navigating uncertainty.

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Position Moves

Ticker	Direction	Author's One-Sentence View	Key Data
AP Møller Mærsk (Maersk)	Add	Industry consolidator capturing over 100% of the profit pool, with three moats: family control, scale network effects, and counter-cyclical capital allocation	Cash flow return 1.4%; if raised to cost of capital of 5.2%, implies 70% upside; share price up over 60% from lows a year ago
Pacific Basin	Hold & Watch	Strategic missteps (non-core diversification, equity dilution), but resilient through cost cuts and balance sheet repair; recently acquired secondhand vessels at attractive prices	Management costs reduced by one-third; freight rates at a 10%-20% premium to market average
Diana Shipping	Hold & Watch	As part of the dry bulk "small fleet," diversifies individual risk; recently bought secondhand vessels rather than ordering newbuilds	Net capital outflow from the sub-sector
Scorpio Bulkers	Hold & Watch	As part of the dry bulk "small fleet," diversifies individual risk	—
Hanjin Shipping	Liquidate	Bankrupt in 2017, evidence of Korea abandoning shipping subsidies; its bankruptcy may catalyze further industry consolidation	Vessels unable to dock after filing for receivership in August 2016
Orient Overseas (OOIL)	Not explicitly stated	Acquired by COSCO; state capital tolerates losses, prolonging the industry's clearing cycle, acting as a "brake pad" in the capital cycle	—