2023-06-13 08:42:51 ET
Summary
- The Panama Canal is facing a severe drought, causing water levels to drop and leading to draft restrictions for vessels.
- This situation could potentially absorb around 2% of global container shipping capacity, impacting companies like ZIM Integrated Shipping.
- ZIM could benefit from temporary rate increases on the Pacific and specific long-haul Latin American trades, causing a price surge and causing short covering.
- So I'm holding ZIM stock for the long term, but see a short-term catalyst for the short term around the Panama Canal.
Quick Intro
I've decided to supplement my recently published piece on ZIM Integrated Shipping Services Ltd. ( ZIM ) with new information that has reached us from Panama. I think that investors in this company will be interested to learn that the critical catalyst for ZIM's growth I'm going to describe today is in place for the foreseeable future.
First of all, I have to thank the analysts at Goldman Sachs who published their take on the situation on June 12 - that's a proprietary source that I can't link to here, but I'll cite and refer to that study for the most part.
What's Going On With Panama Canal?
In a nutshell, the Panama Canal is currently facing a severe drought that has caused water levels in Gatun Lake. This lake feeds the locks in the canal, to drop significantly, Fortune reported . The drought is causing concerns among economists and supply-chain experts as it could potentially revive the chaos experienced in 2021, with shipping cost surges and shortages of goods.
The current water levels are 5% below the five-year average, and the Panama Canal Authority predicts an 8% further drop by August. This has led to draft restrictions in the canal, reducing the maximum draft for vessels from 50ft to 44.5ft, with further reductions expected. As a result, large neo-Panamax vessels may have to cross the canal with significantly reduced cargo capacity. The usual pattern of rising water levels from June to December/January may not occur this year due to the anticipated El Niño event, which historically brings drought and higher temperatures to Panama.
Goldman Sachs [June 12, 2023 - proprietary source]
For the Asia-US East Coast trade, which accounts for a significant portion of cargo crossing the Panama Canal, several alternatives exist to cope with the draft restrictions. The first option is to continue using the canal but deploy more ships to carry the same amount of cargo while optimizing the cargo mix. The second option is to reroute through the Suez Canal on larger vessels, which lowers unit costs but increases voyage time by approximately 15%. The third option is to use US West Coast ports and intermodal transportation, but this option is uncertain due to ongoing labor tensions. So a combination of options 1 and 2 is considered by Goldman Sachs' Transportation team as the most likely scenario.
Considering that around 7% of global container trade crosses the Panama Canal based on GS data, if most of the vessels currently transiting have to load significantly less cargo, it could potentially absorb around 2% of world container shipping capacity. Some of this capacity could be cushioned by shifting services through the Suez Canal, where larger vessels can be utilized, offsetting the added voyage distance with lower unit costs. The potential impact of absorbing 2% of global container shipping capacity due to draft restrictions could be worsened by congestion or labor issues, but these factors are not a concern at the moment.
Goldman Sachs [June 12, 2023 - proprietary source]
The Impact On ZIM
We need to understand one thing I've already written about in my articles - the supply/demand ratio isn't on the side of ZIM and its peers now and in the next few years, as the supply side overweights the demand side. In addition, near-term indicators such as declining spot rates on the U.S. East Coast and fading General Rate Increases [GRIs] suggest weak demand and an oversupplied market. However, the temporary draft restrictions in the Panama Canal could help container lines manage overcapacity in the short term - this is the catalyst my article is dedicated to describing.
Everyone knows the medium-term relationship between supply and demand - the growth of ships exceeds the growth of demand and the market prices that in. While the ZIM share price continues to fall, the reverse is true regarding short interest: according to YCharts, the percent of the shorted float is now close to 20%:
At some point, all the investors with short positions will need to cover their positions. Although the catalyst I previously described is unlikely to have a significant impact on the overall supply-demand balance in shipping, it could lead to temporary rate increases on the Pacific and specific long-haul Latin American trades. In such a scenario, ZIM is expected to benefit and experience a price surge, potentially causing the shorts to accumulate losses as they cover .
And what's so special about ZIM - it is the most direct beneficiary due to its exposure to the Pacific and spot markets.
And based on the EPS downside that I see in the Seeking Alpha Premium's data , the overall risk of significant supply chain disruption and stress that would positively impact the company's earnings doesn't seem to be priced in, in my opinion:
Seeking Alpha Premium
Final Thoughts
For us to see a truly impressive rate hike against the backdrop of such a severely negative supply-demand imbalance, we need to see at least a great recovery in consumer demand in addition to the Panama Canal drought. And as various surveys show, that isn't yet the case. Also, everyone should forget about ZIM's dividends for a while. But I suspect that Goldman Sachs analysts are aware of this - and yet, based on an internal DDM model, they see a price target for ZIM in the region of $16 per share range:
Goldman Sachs [June 12, 2023 - proprietary source], author's notes
If you've read my previous articles, you probably know my take on ZIM - at some point I started looking at this company as a very long-term holding and stopped caring about price. Systematic cost averaging works for me - eventually the cycle will turn and I should be sitting on a pile of cheaply bought ZIM shares, unless the company goes bankrupt, which I don't think will happen. But how soon that will happen, God only knows. So don't think the short-term growth catalyst I described today will be a permanent one. However, if you're a speculator, you can try your luck with ZIM stock based on the information at hand and after doing your own due diligence.
Good luck to all!
For further details see:
ZIM Integrated: Panama Drought Is A Major Catalyst