The shipping industry is often considered the lifeline of the global economy. This is because it is responsible for transporting a bulk of the goods involved in world trade. Increased demand for commodities from key emerging markets and Europe is a positive for the industry.

However, escalating tensions pertaining to a trade war between the United States and China — the two largest economies — do not bode well for international trade. The dispute shows no signs of relenting. In fact, the tariff exchanges might take a more severe turn in the coming days. It could also trigger a deeper dispute between the two nations. Trade wars are never beneficial as they eat into profit margins of companies, eventually crippling the overall economy.

In the event of a slowdown in global trade, the shipping industry will be hurt badly. In fact, trade war tensions have already hit the dry bulk sector badly. Moreover, the rise in fuel costs is a concern for the companies. This is because expenses associated with oil are considered one of the major input costs for any transportation player. According to a Reuters report, shipping fuel costs will increase by 25% in 2020, following the implementation of rules to check pollution by ships.

Moreover, ratings agency Moody’s has assigned a negative 12-month outlook for the tanker segment in the face of surging supplies. Due to excess supply, charter rates are anticipated to remain low in the next few quarters.

Industry Underperforms on Shareholder Returns

Judging by shareholder returns over the past year, it seems that an improving domestic economy and an upbeat demand scenario from the key emerging markets and Europe weren’t enough for instilling investors’ confidence as far as the industry’s growth prospects are concerned.

Headwinds like high costs, trade war-related tensions and a bleak outlook for the tanker segment have contributed to investors’ pessimism surrounding the space.

The Zacks Transportation Shipping industry, which is a 48-stock group within the broader Zacks Transportation Sector, has underperformed both the S&P 500 and its own sector over the past year.

While the stocks in this industry have collectively gained 3.1%, the Zacks S&P 500 Composite and Zacks Transportation Sector have rallied 15.3% and 7.3%, respectively.

One-Year Price Performance

Shipping Stocks Not Trading Cheap

Despite the industry’s underperformance over the past year, the valuation does not look cheap now. One might get a good sense of the industry’s relative valuation by looking at its EV-to-EBITDA (enterprise value to earnings before interest, tax, depreciation and amortization) ratio, which is often used to value the industry, given their significant debt levels and high depreciation and other expenses.

This valuation metric takes into account not just equity but also the level of debt. For capital-intensive companies, EV/EBITDA is a better valuation metric because it is not influenced by changing capital structures and ignores the effect of noncash expenses. The industry currently has a trailing 12-month EV/EBITDA ratio of 12.46, below the highest level of 12.90 but above the median level of 11.76 over the past year.

The space is also expensive when compared with the market at large, as the trailing 12-month EV/EBITDA ratio for the S&P 500 is 11.99 and the median level is 11.57.

Enterprise Value/EBITDA (TTM)

However, as transportation stocks have unique characteristics, a comparison of the group’s EV/EBITDA ratio with that of its border sector is probably the best approach. Such a comparison shows that the group is trading at a premium. The Zacks Transportation Sector’s trailing 12-month EV/EBITDA ratio of 10.87and the median level of 10.01 for the same period are significantly below the Zacks Transportation Shipping industry’s respective ratios.

Enterprise Value/EBITDA (TTM)

While this might suggest limited scope for an upside, investors should note that the industry has historically traded at a premium to its sector.

Underperformance May Continue Due to Bleak Earnings Outlook

The strong balance sheets of most major companies in the space have enabled them to engage in shareholder-friendly activities. For instance, Golar LNG Limited (GLNG) hiked its quarterly dividend to 12.5 cents per share (50 cents annually) from 5 cents in August. Additionally, the recent uptrend displayed by the Baltic Dry Index (a gauge of the shipping costs of raw materials such as iron ore, coal and grain) is a positive for the industry.

But what really matters to investors is whether this group has the potential to perform better than the broader market in the quarters ahead. While the above ratio analysis shows that there is a solid value-oriented path ahead, one should not really consider the current price levels as good entry points unless there are convincing reasons to predict a rebound in the near term.

One reliable measure that can help investors understand the industry’s prospects for a solid price performance is the earnings outlook for its member companies. Empirical research shows that a company’s earnings outlook significantly influences its stock performance.

The Price & Consensus chart for the industry shows the market's evolving bottom-up earnings expectations for it as well as the industry's aggregate stock market performance. The red line in the chart represents the Zacks measure of consensus earnings expectations for 2019 while the light blue line represents the same for 2018.

Price and Consensus: Zacks Transportation Shipping Industry

This becomes even clearer by focusing on the aggregate bottom-up EPS revisions trend. The chart below shows the evolution of aggregate consensus expectations for 2018.

Please note that the EPS estimate of 1 cent for the industry for 2018 is not the actual bottom-up dollar estimate for every company in the Zacks Transportation Shipping industry, but rather an illustrative aggregate number created by our proprietary analytics model. The key factor to keep in mind is not the earnings per share of the industry for 2018, but how this projected number has evolved recently.

As you can see here, the EPS estimate of a penny for 2018 is down from 38 cents at the end of 2017 and 44 cents this time last year. In other words, the sell-side analysts covering the companies in the industry have been steadily lowering their estimates.

Zacks Industry Rank Indicates Bleak Prospects

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates continued underperformance in the near term.

The Zacks Transportation Shipping industry currently carries a Zacks Industry Rank #165, which places it at the bottom 36% of more than 250 Zacks industries. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

Industry Portrays Lackluster Long-Term Growth

While the near-term prospects look unwelcoming for investors, the long-term (3-5 years) EPS growth estimates for the Zacks Transportation Shipping industry appear unconvincing as well. The group’s mean estimate of long-term EPS growth rate currently reads 7.1%, comparing unfavorably to 9.8% for the Zacks S&P 500 composite.

Mean Estimate of Long-Term EPS Growth Rate

In fact, the basis of this lackluster long-term growth could be the steady downward trend in top line that the shipping industry has been showing since the beginning of 2016.

Bottom Line

In the current scenario, the trade war spat between the United States and China — the two largest economies — shows no signs of ending and is in fact likely to intensify going forward. A highly volatile geopolitical scenario has put pressure on the stability of the business and has affected the operating model.  

Given this bleak backdrop it is of little surprise that shipping stocks are under pressure. What is worse is that the scenario is unlikely to improve as highlighted by the bleak long-term growth projection above. High costs and elevated valuations are further headwinds for the industry.

Given the plethora of headwinds, we believe stocks in the shipping space are not attractive investment options. Investors would be better off if they avoid a few shipping stocks that have a soft earnings outlook.

Safe Bulkers, Inc. (SB) is a provider of marine dry bulk transportation services. The stock has shed 11.6% of its value over the past three months. The Zacks Consensus Estimate for the current-year EPS has been revised 13.6% downward over the last 90 days. The stock carries a Zacks Rank #5 (Strong Sell).

Price and Consensus: SB

Navigator Holdings Ltd. (NVGS) offers international seaborne transportation and regional distribution services of liquefied petroleum gas, petrochemical gases and ammonia for energy companies, industrial users and commodity traders. The stock has shed 7.4% of its value over the past three months.

The Zacks Consensus Estimate for the current-year EPS has been revised more than 100% downward over the last 90 days. The stock carries a Zacks Rank #5.

Price and Consensus: NVGS

Costamare Inc. (CMRE) functions as a containership owner chartering its vessels to liner companies. The stock has shed 26.9% of its value over the past three months. The Zacks Consensus Estimate for the current-year EPS has been revised 4.2% downward over the last 90 days. The stock carries a Zacks Rank #4 (Sell).

Price and Consensus: CMRE

Despite the above headwinds, investors interested in this key industry may consider the following stocks based on their strong growth potential. The stocks have been witnessing positive earnings estimate revisions and carry a Zacks Rank #2 (Buy).

You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Diana Shipping Inc. (DSX) is a global provider of shipping transportation services. The company specializes in transporting dry bulk cargoes. The stock has gained 2.7% of its value on a year-to-date basis. The Zacks Consensus Estimate for the current-year EPS has been revised upward in excess of 100% over the last 90 days.

Price and Consensus: DSX

KNOT Offshore Partners LP (KNOP) is engaged in owning, acquiring and operating shuttle tankers, designed to transport crude oil and condensates from offshore oil field installations to onshore terminals and refineries. The stock has gained 3.7% of its value on a year-to-date basis. The Zacks Consensus Estimate for the current-year EPS has been revised upward to the tune of 5% over the last 90 days.

Price and Consensus: KNOP