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Why do dividends in this sector sometimes reach up to 70%?

Mart Poom
24. 6. 2023
4 min read

High dividends are tempting. But what if they are so high that a warning light goes off for everyone? Are these staggering numbers even realistic and sustainable anymore?

The shipping sector is perhaps a little more complicated at first glance, so to understand high dividends, we must first look at how the sector itself works.

The shipping sector works on the principle of transporting cargo by sea using ocean-going ships. There are two basic ways in which this activity works:

Carriers - These are companies that own their own fleet of ships. They are in charge of operating, maintaining and managing these ships and arranging the transportation of cargo for their clients. They collect fre ight rates for each cargo shipment. Their profits thus depend directly on the occupancy of their ships.

Shipping companies (shipowners) - They own fleets of ships, but instead of operating them, they provide them 'for hire' through sea charters. The owning company does not provide transport. What is important to them is the sea charter hire they have to collect from cargo carriers. Their profits depend on the demand for sea charter hire rather than on the occupancy of a particular ship.

The main difference is therefore that shipowners indirectly earn profits from chartering ships, while carriers directly earn from transporting cargo by sea on their own vessels.

Both groups thus benefit greatly from the cyclical nature of the market. When the demand for sea freight and charter hire is high, profits rise. Conversely, when demand falls, profits fall or are zero.

Why do they achieve high dividends?

For several reasons.

Low cost of capital: shipping companies generally have easy access to cheap loans and credit because their assets (ships) are considered highly liquid. This allows them to maintain a relatively low cost of capital and leads to high dividends.

The cyclical nature of the market: The ship training market is highly cyclical, with frequent fluctuations. During cyclical peaks, companies build up capital reserves to help them ride out downturns. They then often draw on these reserves in the form of higher dividends during good periods. It's a double-edged sword.

The cyclical nature of shipping means that when conditions are bad, yields can drop quickly or even cancel dividends altogether. The sector has historically suffered from irregularity and volatility.

Now that shipping conditions are finally improving, the numbers are flying up. BUT!

Investors should be cautious. While the returns may be tempting, there remains a hefty risk, especially if economic conditions worsen. Carefully consider whether high returns are worth the risk.

Lower capital expenditure: shipping companies have relatively low capital expenditure compared to other industries because they focus primarily on leasing ships. This allows them to distribute a higher proportion of profits as dividends.

Dividend priority: Some shipping companies have an explicitly high-dividend business model, often targeting a specific group of investors. They may have a high target for dividend payments as a share of profits.

The combination of low interest rate borrowing, the cyclical nature of the market, low capital expenditure and a high dividend focus can lead shipping companies to distribute up to 70% of profits as dividends. However, it very much depends on the specific company and its priorities. And, of course, such a figure is very likely to be totally unsustainable in the long term.

What does history say?

In 2006, things looked promising for shipping companies. China was growing fast and needed to transport raw materials. Transport companies were thriving and expanding. Then the world economy slowed and transport companies deteriorated. Overcapacity led to lower profits. Many companies were not profitable for five years. Profits were extremely volatile.

Historically, transportation companies delivered high dividends. Investors demanded higher yields to compensate for the risk, which meant selling stock. This pushed dividends even higher. Not much has changed. And history repeats itself.

Example

Finally, I'd like to mention 2 companies in this sector for interest. This is by no means a tip or recommendation - rather, I want to give an example of what I've been talking about here.

ZIM
$12.45 -$0.09 -0.72%
1 Day
+0.01%
5 Days
-2.27%
1 Month
-9.28%
6 Months
+1.05%
YTD
+11.8%
1 Year
-45.18%
5 Years
+8.78%
Max.
+8.78%
SBLK
$23.96 $0.52 +2.22%
1 Day
+0.02%
5 Days
+3.51%
1 Month
+8.69%
6 Months
+32.85%
YTD
+10.04%
1 Year
-5.7%
5 Years
+194.62%
Max.
-92.84%

Disclaimer: This is in no way an investment recommendation. This is purely my summary and analysis based on data from the internet and other sources. Investing in the financial markets is risky and everyone should invest based on their own decisions. I am just an amateur sharing my opinions.

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