As the shipping channel in the Red Sea has been disrupted by Houthi militants, shipping stocks like ZIM Integrated Shipping Services Ltd. (NYSE:ZIM) flew away. Stocks were crushed in 2023 due to to the low demand for container shipping and the high supply of new vessels entering the market. My investment thesis The stock is now turning bearish after rising to $12 last week after ZIM fell to $6.
Increase in short-term shipments
The market clearly faces a huge unknown regarding the length of the current shipping cycle. Iran-backed Houthi attacks on ships traveling in the Red Sea region are forcing some ships to round Cape Horn in South Africa, adding up to 2 weeks to the travel time for these ships to reach their destinations in Europe.
The Drewry WCI has reached the milestone $1,600 per 40 foot container. The rate is almost stable compared to 3 months ago, but the WCI rate fell below $1,400 in early October.
Of course, the biggest impact on container shipping rates is for those traveling to Europe or the US East Coast from Asia. These trade routes from Shanghai have seen their shipping rates increase significantly, although the one to Los Angeles has remained stable since August, as that route bypasses the Red Sea to cross the Suez Canal.
The world is working together to find a secure transportation solution, including launching U.S. missiles at Iranian sites to combat attacks. Operation Prosperity Guardian, led by the United States and comprising a coalition of 20 countries, aims to stop attacks by the Yemeni Houthis, a relatively unsophisticated militant group, although possessing deadly missiles and drones.
The impact on shipping appears to be nothing more than a short-term incident, although the results certainly cannot be guaranteed.
The market has become too negative
Our view had become more neutral on the stock following the drop in demand for container shipping. ZIM had a more neutral risk/reward scenario and the rebel attacks further highlight why one must be careful about being too negative or too positive on any investment thesis with uncontrollable scenarios always lurking around the corner.
It was only in mid-November that ZIM warned of weaker financial figures for 2023. The shipping company missed third quarter 2023 estimates and had reduced the adjusted EBIT loss for the year to between $600 million and $400 million, compared to an earlier forecast of a loss of $500 million to $100 million.
Management has focused heavily on long-term contracts, but the company has suggested that up to 70% of its business is in the spot market. ZIM is expected to see some financial benefits based on these shipping rate increases.
ZIM has contributed mightily to the industry’s capacity problem by agreeing to take on 46 newbuilds by the end of 2024 while re-delivering existing charters for use by other shippers. On the Conference call on 3rd quarter 2023 resultsCFO Xavier Destriau made the following comment regarding capacity growth:
But you’re right, we will be operating larger ships on average as the ships coming in replace the smaller ships. So today, more or less, we operate a capacity equivalent to 600,000 TEUs for the 129 container ships that we operate. And this should be closer or closer to the 700,000 TEU mark by the end of 2024 when we will have taken delivery of our entire fleet.
Much of the investor focus has been on vessel numbers, with ZIM again delivering vessels while undertaking new builds. The reality is that ZIM will increase its capacity by 100,000 TEUs over the next year, while transportation rates will likely remain low. The increase in TEUs represents nearly 17% growth in capacity and is a key reason the company is striving to be profitable through 2025, even though analysts still generally forecast a loss important.
The main takeaway for investors is that ZIM clearly has greater downside risk now, with the stock trading at $6 during the latest decline and the current situation in the Red Sea not changing the sector’s fortunes. The Houthi militant issue will not last, and investors should prepare for a likely retest of recent lows.