3 Ways to Play Today's Most Facinating Industry

There are businesses that make sense most of the time, and then there is shipping. A shipping company can own exactly the same vessels it owned six months ago, with the same engines, crews, and roughly the same operating costs, yet those vessels can suddenly start making two or three times as much money.

Nothing magical happened to the ships. What changed was the price somebody was willing to pay to move a ton of iron ore, a barrel of oil, or a load of gasoline from one part of the world to another.

That is what makes shipping such a fascinating business and such a dangerous place for investors who approach it the wrong way. These are not normal industrial companies where we can take last year's earnings, increase them by 7% for the next five years, and congratulate ourselves on building a financial model. Shipping companies are giant collections of floating steel attached to one of the most cyclical markets on earth. When conditions are bad, they can be miserable businesses. When conditions are good, they can generate astonishing amounts of cash.

Conditions are pretty damn good right now.

Clarksons Research's broad measure of shipping earnings reached an all time high during the third quarter. Dry bulk earnings have been running roughly 50% above last year's levels and recently reached their highest point in about four years. Tankers have been even crazier. Weighted tanker earnings surged above $200,000 per day in late September, and at one point VLCC earnings approached $600,000 per day.

Those are extraordinary numbers, but they are not a reason to run out and buy every shipping stock with a ticker symbol. Shipping has a nasty habit of making investors feel like geniuses, then reminding them shortly after that they are not.

Understanding why is the key to making money here.

One of the things I find fascinating about shipping is that demand is more complicated than simply asking how much oil, coal, iron ore, or grain the world is consuming. We also have to know where those commodities are coming from and where they are going.

Distance matters enormously.

Shipping people call this ton-mile demand, and it is one of the most important concepts to understand if you are going to invest in the industry. Suppose China needs a certain amount of oil. If that oil comes from somewhere relatively close to China, a tanker can deliver the cargo and become available for another voyage fairly quickly.

If geopolitical events force that same oil to come from halfway around the world, the tanker remains occupied much longer. China did not consume another barrel of oil, but demand for tanker capacity increased anyway.

Wars, sanctions, and disruptions to traditional shipping routes have rearranged global energy flows and forced vessels to take longer journeys. Every additional day a vessel spends at sea effectively removes some capacity from the market because that ship is not available to carry another cargo.

This matters because ships cannot suddenly appear when demand increases. If the world suddenly needs another 100 very large crude carriers, somebody needs to find a shipyard with available capacity, finance hundreds of millions of dollars of construction, and then wait several years for those vessels to be delivered.

That delay between rising demand and increasing supply is one of the reasons shipping rates can explode.

It is also one of the reasons they eventually collapse.

The shipping cycle is one of the purest examples of human nature at work in financial markets. Freight rates rise, shipowners begin making enormous amounts of money, and cash starts piling up. Suddenly bankers love the industry again. Investors love it. Analysts love it. Everybody reaches the same conclusion: We need more ships.

Shipowners start ordering vessels. Their competitors order some too. Before long, the shipyards are full, but everything still looks wonderful because those ships take years to build. Vessel supply remains tight, freight rates stay elevated, and companies keep making money.

Eventually all that new steel hits the water.

Suddenly, too many ships chase too few cargoes. Freight rates weaken, profits disappear and heavily leveraged owners discover that lenders still expect to be paid even though the economics of operating the ships have deteriorated. Weak companies sell vessels, restructure debt or issue stock at terrible prices.

Older ships get scrapped, new orders dry up, and everybody rediscovers that shipping is a horrible business.

Give it enough time and supply tightens again. Demand improves, rates begin rising and a new generation discovers that shipping is actually a fantastic business.

Here we go again.

This cycle has been going on for generations. I see no reason to believe human nature has improved enough for it to disappear.

That is why I refuse to look at today's extraordinary shipping profits and simply project them several years into the future. That is how investors get slaughtered in cyclical stocks. The question is not whether today's earnings are spectacular. The question is what we are paying for the assets producing those earnings.

That brings us to net asset value.

One of the easiest ways to get into trouble with shipping stocks is to become mesmerized by a low P/E ratio. Imagine a tanker company earning $20 a share during an extraordinary freight market while the stock trades at $60. Three times earnings sounds cheap.

It might be. It might also be incredibly expensive.

If normalized earnings are closer to $5 per share, we are actually paying 12 times normalized earnings. If freight rates collapse and the company starts losing money, our wonderful three times earnings stock suddenly does not have a meaningful P/E ratio at all.

This is why I prefer to begin with the assets. I want to know what the ships are worth today, how much debt is attached to them, how much cash is sitting on the balance sheet and whether there are other claims ahead of common shareholders.

Subtract the obligations from a reasonable estimate of the market value of the assets and we get reasonably close to net asset value, or NAV.

NAV is not perfect. Vessel values can change rapidly, and determining exactly what a particular ship would bring in a sale requires some judgment. It is still a much better starting point for valuing a shipowner than blindly applying a multiple to peak-cycle earnings.

If a company's fleet and other assets are worth $2 billion after subtracting its obligations and I can buy the entire company in the stock market for $1.4 billion, I am effectively buying those assets for roughly 70 cents on the dollar.

You know me well enough to know that gets my attention.

It does not automatically get my money.

Our research into decades of shipping-market history reinforced something that applies to almost every cyclical industry I have studied. The balance sheet is not merely an accounting consideration. In a cyclical business, it is part of the investment thesis.

Consider two companies trading at 60% of estimated NAV. One has a pile of debt, several maturities approaching and very little cash. The other has modest leverage, substantial liquidity and no serious refinancing problems.

They are not remotely the same investment.

If freight rates collapse, the highly leveraged company may have to sell ships into a lousy market or issue shares after the stock has already fallen sharply. The financially stronger company can wait.

Better yet, it may be able to buy vessels from the distressed operator at exactly the moment nobody else wants them.

That is how fortunes get made in cyclical industries. The survivors eventually get an opportunity to buy assets from the desperate.

This is why I am looking for more than a shipping stock trading below NAV. I want a balance sheet capable of surviving the inevitable downturn, adequate liquidity, a competitive fleet and management that understands capital allocation rather than empire building.

I also want the stock moving in the right direction.

That may bother some traditional value investors, but it does not bother me. I have seen enough cheap stocks become considerably cheaper to know that valuation by itself is not a catalyst.

My favorite situation is a company trading below asset value while the business fundamentals and stock price are both improving. That gives us value and momentum working in the same direction.

There is plenty to like about shipping today, but the strength of current conditions is already producing the industry's traditional response.

Shipowners are ordering vessels.

The tanker orderbook has increased sharply. Strong freight rates and rising secondhand vessel values have encouraged owners to return to shipyards and order additional capacity.

That does not mean the current boom ends next Tuesday. Ships ordered today still take years to build, while geopolitical disruptions continue to increase voyage distances and keep existing vessels occupied longer.

Current conditions could remain favorable for quite some time.

I simply do not want to confuse a strong current market with a permanent shortage of ships. Eventually new vessels arrive. Trade patterns change. Freight rates weaken.

That is what shipping does.

The stocks I find most interesting are therefore not necessarily the companies with the highest current earnings. I want companies where profitability is strong but the stock price still leaves us a margin of safety.

Three names stand out.

Scorpio Tankers $STNG ( ▼ 2.0% ) owns product tankers, the ships that transport refined petroleum products such as gasoline, diesel and jet fuel around the world.

The product tanker market has been extremely profitable, but what interests me most about Scorpio is not today's freight rate. It is what management has done with the money.

At the end of July, Scorpio had roughly $2 billion of unrestricted cash against approximately $655 million of gross debt. That left the company with about $1.3 billion of net cash.

Take a minute and appreciate how unusual that sounds for a shipping company.

The traditional shipping model involved stacking debt against vessels during good times and then discovering during bad times that bankers have very little sense of humor. Scorpio has spent the past several years moving aggressively in the opposite direction. During the second quarter alone, the company prepaid roughly $389 million of secured debt.

Management has also been buying back shares and selling older vessels into a strong secondhand market. Scorpio repurchased almost 2 million shares during the quarter at an average price of about $77.72.

This is exactly what I want to see. Sell older ships when vessel prices are attractive, reduce debt, repurchase shares when the stock offers value and resist the urge to spend every dollar generated during a boom ordering more steel.

The current earnings are certainly impressive. Scorpio generated adjusted second-quarter net income of approximately $244 million, or $5.33 per basic share, and declared a quarterly dividend of 45 cents.

I am not going to multiply $5.33 by four and pretend that is normal annual earnings. That would completely miss the point.

What matters is that Scorpio is generating enormous cash flow while entering the next stage of the cycle with an exceptionally strong financial position.

STNG is not dirt cheap anymore. The stock has moved substantially as investors have recognized what is happening. I am comfortable with that. I would rather pay a reasonable price for a high-quality fleet attached to an excellent balance sheet than buy the statistically cheapest shipping stock and spend every morning wondering whether management has hired a restructuring adviser.

Scorpio is the quality choice of these three.

Star Bulk Carriers $SBLK ( ▼ 0.57% ) may be the most interesting combination of value, financial strength and momentum in shipping right now.

Star Bulk owns dry bulk vessels carrying iron ore, coal, grain, bauxite, fertilizer, steel products and all the other wonderfully boring commodities that keep the global economy functioning. I have always liked boring businesses when the numbers become exciting, and the numbers at Star Bulk have become very interesting.

Second-quarter net income was approximately $145 million, while EBITDA approached $195 million. The company's time charter equivalent rate reached $24,486 per vessel per day, its strongest quarterly level since the second quarter of 2022. Daily vessel operating expenses were just $5,265.

That gap between freight revenue and vessel operating costs is where the operating leverage of shipping becomes powerful. Once the basic cost of running the vessel is covered, a large portion of additional freight revenue can find its way into cash flow.

Star Bulk declared a quarterly dividend of 90 cents per share. Since 2021, the company says it has returned more than $2.15 billion to shareholders through dividends and share repurchases.

I pay attention when management talks about returning capital to shareholders. I pay considerably more attention when the money has actually left the corporate bank account and arrived in shareholders' accounts.

The balance sheet is also reasonable. Star Bulk had approximately $532 million of cash in early August against roughly $955 million of borrowings and lease financing.

What makes the story especially interesting is valuation. Star Bulk shares have recently traded below reasonable estimates of the liquidation value of the company's fleet. We therefore have an improving dry bulk market, strong operating results, substantial cash distributions, manageable leverage and a stock still trading below estimated NAV.

Just as important, the stock has been moving higher.

This is what I mean when I talk about combining value and momentum. I do not want to own something merely because it is cheap. I want something that is cheap while the business is improving and the market has begun recognizing that improvement.

Of these three stocks, Star Bulk comes closest to my ideal shipping setup today.

Navios Maritime Partners $NMM ( ▼ 0.66% ) is a different animal, and it is probably the most interesting name here for investors who enjoy rummaging around in the bargain bin.

Navios owns a huge diversified fleet spanning dry bulk, containerships, and tankers. As of August, the company reported 66 dry bulk vessels, 50 containerships and 60 tankers, including vessels under construction.

The company also has a tremendous amount of contracted revenue. Navios reported approximately $4.4 billion extending through 2037. Roughly 77% of available days for the final six months of 2026 had already been fixed, while approximately 51% of 2027 available days were fixed.

The operating results are strong. Second-quarter revenue increased approximately 25% to $410 million. Adjusted EBITDA rose to roughly $242 million, while adjusted net income reached approximately $135 million, more than double the year-earlier figure.

Despite all of that, the market continues to value Navios at a substantial discount to estimates of its underlying assets.

There is a reason.

Investors have long had concerns about governance, capital allocation, related-party transactions, and whether common unitholders will ultimately receive their fair share of the value being created.

Those concerns are legitimate. They are also why the stock is cheap.

The question is whether the market has taken the discount too far.

One potentially important development is management's authorization of a new common-unit repurchase program of up to $200 million. If Navios deploys significant capital buying units while they trade far below NAV, the mathematics become very attractive.

Suppose the underlying assets are worth $100 per unit while the market price is $50. Repurchasing units at $50 allows the remaining owners to increase their claim on assets worth substantially more than the purchase price. Repeatedly doing that with internally generated cash flow can increase NAV per unit significantly even if vessel prices go nowhere.

The key word is "if."

I would watch Navios' capital allocation closely. The discount exists for a reason, and management has to demonstrate that minority shareholders will participate in the value being created.

That makes NMM the highest-risk idea of these three, but potentially the most interesting from a pure deep-value perspective.

I do not think investors need to make this complicated. The shipping business will provide more than enough complications on its own.

Start with the ships. Estimate what the fleet is worth in the secondhand market, subtract debt and other obligations, add cash and figure out what you are actually paying for the assets.

Then examine the balance sheet. Ask what happens if freight rates fall by half. Look at debt maturities and liquidity. Determine whether the company would have to issue stock during a downturn or whether it could become a buyer when weaker competitors are forced to sell.

Next, look at the fleet. Age matters. Efficiency matters. Vessel type matters. Charter coverage matters.

Management matters just as much. I want to know what executives do when shares trade below NAV. Are they repurchasing stock? Are they paying dividends? Are they selling ships when asset values become excessive? Or does every shipping boom inspire management to build an empire?

Finally, I look at the stock price.

I want positive momentum. I do not need to buy at the absolute bottom. I would rather buy after a shipping stock has stopped falling and both the business and the stock price have started improving.

Maybe that means paying 75 cents on the dollar instead of 55 cents. Fine. Think of the difference as an insurance premium against walking directly into a buzz saw.

That is particularly important because NAV itself moves. A fleet worth $2 billion today might be worth considerably less after freight rates collapse and secondhand vessel prices fall.

This is why I like combining valuation with trend.

There is one final rule.

Do not fall in love with shipping stocks.

These are not forever stocks as far as I am concerned. Shipping is a cyclical asset business, and eventually the cycle turns.

Rates rise, cash pours in, vessel values increase and everybody starts ordering ships. Shipping executives appear on financial television explaining why this time the boom is structural. Analysts raise price targets. Investors who would not know a Capesize vessel from a canoe suddenly develop strong opinions about ton mile demand.

Somewhere around that point, I start becoming interested in the exits.

If we buy good assets below NAV with sound balance sheets while freight markets and stock prices are improving, we have several ways to make money. Cash flow can increase, dividends can rise, management can repurchase shares, vessel values can increase and the discount to NAV can narrow.

Eventually that process reverses.

When stocks begin trading at substantial premiums to NAV, vessel orders explode and price trends deteriorate, I am perfectly happy taking the money and finding something else to do.

There will always be another shipping cycle.

The shipping industry is making serious money today. Geopolitical disruptions have made global trade routes less efficient, vessels are traveling farther, tanker earnings have exploded and dry bulk conditions have improved materially.

What makes the current setup interesting is that selected companies are generating enormous amounts of cash while their shares still trade at reasonable prices relative to the value of the fleets underneath them.

Scorpio Tankers gives us a modern product tanker fleet attached to an extraordinarily strong balance sheet. STNG is the quality choice, although investors are no longer getting that quality at a bargain-basement price.

Star Bulk gives us improving dry bulk economics, substantial shareholder returns, manageable leverage and an attractive valuation relative to its assets. Add positive fundamental and price momentum, and SBLK probably gives us the best overall combination of the things I am looking for today.

Navios Maritime Partners is the deep-value wild card. NMM owns a massive collection of assets, generates substantial cash flow and has billions of dollars of contracted revenue, yet investor skepticism about governance and capital allocation continues to keep the units at a significant discount.

I like all three, but for different reasons. If I were looking primarily for quality, I would start with Scorpio Tankers. If I wanted the best combination of value, improving fundamentals and momentum, I would start with Star Bulk. If I wanted the deepest value and was willing to accept additional governance and management risk, I would dig into Navios Maritime Partners.

That is how I want to approach shipping. I do not need to guess exactly where tanker rates will be six months from Tuesday, and I certainly do not need to pretend today's extraordinary earnings will last forever. I want ships worth more than I am paying for them, a balance sheet capable of surviving the inevitable downturn, management that understands the difference between building an empire and creating shareholder value, and improving fundamentals accompanied by a stock price telling me somebody besides me has noticed.

Give me that combination and I am interested.

Shipping will eventually break investors' hearts again. It always does. Our job is to make a lot of money before it gets around to breaking ours.