As stocks start to wobble after a nine-year bull market, one industry looks like it could break higher over the next few years.

This industry missed out on the spectacular bull market gains because of overbuilding, but last year’s collapse in prices could bring a rebound off multi-decade lows. An ETF tracking the industry plunged 63% to its low last year from a high in 2011, but has since rebounded 20% as early evidence of a recovery becomes clear.

The selloff was so drastic that even the largest players in the space are now small-cap companies. But now industry is clearing its overcapacity issues and demand fundamentals are picking up. This confluence of events could just make it one of the biggest investing themes of the year.

Shakeout In Shipping Helps Fuel A Recovery
The boom in commodity prices just after the Great Recession drove many in the shipping industry to rapidly expand their fleets. Fleet growth exploded from 2009 through 2012, with the industry increasing the number of ships in service by an average of 14% a year.

The oversupply in shipping caused the Baltic Dry Index (BDI), an assessment of the price to move major raw materials by sea, to plunge to a 30-year low of $290 last year from $2,330 in 2014.

That overcapacity may be coming to an end, with the order book on ships at its lowest point since 2002 and new orders accounting for just 9% of the existing fleet. Besides the slower growth in new capacity, companies scrapped older ships at a breakneck annualized pace of 30 million dead-weight tons last year in a race to become more efficient.

The collapse in rates caused a shakeout in shipping and many weaker players collapsed or were acquired by larger companies. The bankruptcy of Hanjin Shipping Ltd in September caused container shipping rates from Asia to the United States to spike 50% on the rush by customers to find other carriers.

#-ad_banner-#The BDI has already recovered to $1,045 from last year’s low and the Guggenheim Shipping ETF (NYSE: SEA) has recovered 18.5% from its 52-week low.

Demand for iron ore shipments, critical for shipping and 30% of total dry bulk shipments, could pick up this year and next with new production projects in Brazil and Australia. The World Trade Organization’s World Trade Outlook Indicator was updated to a reading of 102.0 in February against a prior reading of 100.9 in November, suggesting trade momentum in the first quarter of 2017. Any reading above 100 signals growth and the recent reading came in just under the 103 reading, which denotes above-trend growth.

The World Bank expects the global economy to rebound from a post-recession low of 2.3% last year to 2.7% growth in 2017.

The Strong Survive And Thrive In The Shipping Recovery
The multi-year slump in shipping and the size of the companies means the industry isn’t widely covered by Wall Street analysts anymore. That could mean strong returns for investors positioning ahead of a recovery.

Genco Shipping & Trading Limited (NYSE: GNK) has seen its shares pounded 87% since 2015 and currently has a market cap of just $350 million. Genco is a leading low-cost operator, decreasing its daily vessel operating costs by nearly 12% from 2014. The company completed a $125 million capital raise in January, giving it flexibility as industry fundamentals recover.

The company nearly halved its loss to just $3.85 per share in the fourth quarter from a loss of $7.30 per share in the first quarter and is expected to reduce losses to $0.62 per share when it reports first-quarter 2017 earnings. Genco plans on completing its planned sale of 10 older ships by the end of the quarter to reduce costs further and could surprise on the upside this year. I have a $13.65 price target on the shares for a 28% gain based on an enterprise value of four times sales.

Eagle Bulk Shipping (Nasdaq: EGLE) is only slightly larger at a market cap of $397 million but has recently completed a deal that could see it grow quickly. The company completed a private placement of $100 million in common stock late January to take advantage of low vessel prices to acquire nine new Ultramax ships. The purchase significantly increases the company’s fleet from 40 vessels and could lead to a strong revenue increase this year.

The company halved its loss per share in the four quarters through fiscal third quarter 2017, booking a loss of $0.37 per share versus a loss of $0.87 per share in the preceding period. Only one analyst is following the shares and no earnings estimates are available. That could mean a bump in the shares to my target of $6.75 if the company can produce stronger sales on its new fleet additions.

Risks To Consider: The shipping industry is still in the very early stages of a recovery and companies still face risks to rates and economic growth.

Action To Take: Position in best-of-breed leaders within seaborne shipping as the industry recovers this year and next, looking for companies with relatively better balance sheets that have survived the weakness.

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