Ocean Carriers Case - HBR Case Study PDF

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Ocean Carries Case Team: Joey McCall Irina Lioghenchi Rocio Garcia Maryna Smoliana Ocean Carries received a new offer from a potential client. A proposal was a three-year lease of a ship that the company would have to build since no ship in Ocean Carries’ current fleet met the customer’s requirements. Ocean Carries should accept the offer. Based on the data provided, NPV of the investment would be $58.9M. The cost to build a new ship is $39M, and additional $500K would be invested in Net Working Capital, which would increase by 3%, inflation rate, following the next two years. First three years would require an investment to build the ship, which would be $40.5M. The following three years, when the ship would be leased to the customer, the revenue is expected to be $145.5M. Calculating NPV with 9% discount rate, the Net Present Value of the investment is $58.9M.

Based on the company policy Ocean Carriers does not operate ships over 15-year- old. Taking into consideration that the company is known to operate premium ships, the decrease in demand for older ships, and the costs it takes to operate old ships, the company policy of not operating ships over 15 years is correct. Yearly maintenance expense for ships over 15-years-old is $1.25M. Ships over 25-years-old receive 35% discount for daily hire fee. An average daily hire fee is $22,000 which goes down to 14,300. Ships older than 10 years have 16 days of maintenance. With $14,300 daily hire fee, up to $1.2M in maintenance fee, and 16 days in maintenance, one-year profit is $3.7M. The demand for older ships is decreasing as well. Ocean Carriers depreciate the cost of ships on a straight line. Cost of a new ship is $39M. Immediate expense is 10% of the cost, the following year the expense is another 10% of the cost. After 15 years, book value of the ship is $13.5M. The company sells the ships for scraps for $5M. Ocean Carriers records a loss of $8.5M, which provides a depreciation tax shield, and reduces taxes.

Based on the data, the expectation is that daily sport hires to decrease for the next year for the following reasons: 1) Iron Ore Vessel Shipments are anticipated to remain stagnant and slightly decline 2) The Average 3-Yr Charter Rate, which daily spot hires bears a correlation to, is anticipated as slightly declining 3) The Current Order Book for Dry Bulk Capsizes is anticipated to significantly decline Decline in Iron Ore Vessel Shipments - Although Worldwide Iron Ore Vessel shipments and charter rates have been strongly associated with charter rates in the past, and Australian and Indian ore exports would commence in 2003, Iron

Ore Vessel Shipments are expected to remain stagnant. Avg Spot Rate has been positively correlated with increases in Iron Ore Vessel Shipments, and negatively correlated with declines in Iron Vessel Shipments. In 2001, Iron Ore Vessel Shipments are anticipated as experiencing -0.9% growth. This decline, based on historical data, would indicate that we can expect Daily Spot Hires to decrease as well. Decline in the Average 3-Yr Charter Rate - Daily Spot Hires have been observed as fluctuating more widely than time charter rates. The correlation between the two have seen Daily Spot Hires experiencing the greatest increases when Average 3-Yr Charter Rates increases, and the greatest declines when Average 3-Yr Charter Rates decline. Although Daily Spot Hires have a market rate of $22,000 per day, which is considerably more than Average 3-Yr Charter Rates, the correlational relationship between the two would still indicate that Daily Spot Hires are anticipated as decreasing. In 2001, Average 3-Yr Charter Rates are anticipated to decline from $15,344 to $14,747. This -3.9 % growth rate decline, based on historical data, would indicate that we can expect Daily Spot Hires to decrease as well. Significant Anticipated Decline in Current Order Book for Dry Bulk Capsizes - Although 63 new vessels are scheduled for delivery in 2001, and new ships generally earn a premium Daily Spot Rate at 15% versus 35% for older vessels, the current order book does not illustrate a sufficient demand to warrant a need for increased Daily Spot Hires. Generally, production and demand for vessels increased in a strong economy, but following the order of 63 vessels in 2001, the demand for these vessels sharply decline. By 2002, the order book decreases to 33 vessels. By 2003 the order book decreases to 21 vessels. By 2004 the order book decreases to a mere 9 vessels. With a -86% decline in its order book, the long-term optimistic outlook is highly questionable. As a result of this decline, the demand that would lead to an increase in Daily Spot Hires is highly questionable as well. For all of the aforementioned reasons, we can expect within a reasonable degree of certainty, that Daily Sport Hires will undoubtedly decline in 2001. Daily hire rates in capesize dry bulk industry are determined by supply, demand, market conditions, alterations in trade patterns and by the age of the vessels. As for demand, when demand is high, vessels are kept in operation as long as possible. When demand falls, the daily hire rates decrease because owners scrap the vessels. In regards to supply, this factor is affected by the new structure of the vessels. As the vessels increased in size and efficiency the ships became faster, bigger, and more fuel efficient. Thus, fewer ships were needed for the same amount of demand. Daily hire rates are also determined by market conditions. Ocean Carriers specializes in transporting iron ore and in a strong economy, as demand for such products increases, the demand for shipping vessels increases. In a strong economy production of iron ore increases which drives up demand for transportation via vessels. Finally, alterations in trade patterns impact daily hire rates. The locations where vessels are loaded and unloaded effects the demand for capsizes. The further the distance between the two locations, the greater the demand. The age of the vessels also impacted the daily hire rate. Ocean Carriers’ vessels are competitive. The vessels are relatively new and earned a premium to the market. Since older vessels typically receive discounts, Ocean Carriers does not have in its inventory vessels older than 15 years. Overall, the forecast for the long-term prospects of the capesize dry bulk industry appears to be positive, with an expected increase of vessel shipments. Mary Linn, President of FInance at Ocean Carries, is expecting the trading volumes to grow at a rate of 2.0% during 2002 to 2005, and remaining constant at the rate of 1.5% thereafter. The shipping industry is a high risk industry to be a part of. The ship's construction process is time consuming and expensive, which requires a high capital outlay. The demand for dry bulk capesizes is determined by the world’s economy. Over 85% of the capesizes were either iron ore and coal; production and demand for these products tends to increase in a strong economy. According to the data, the Australian and Indian production and exports patterns of iron ore are expected to increase in the upcoming years. This data is further backed up by the Linn consultant expecting a significant increase in trading volumes....