"AFTERMATH OF HURRICANE SANDY”
Hedgeye Internal Dialogue
ENERGY: Refined Product Shortage Will Not Last Long
Takeaway: The refining, distribution, and marketing of refined product in the greater NYC metro area is clearly the segment of the energy industry most impacted by Sandy. We suspect that this “shortage” will not last much longer.
The area was ill-prepared for such a disaster. Gasoline and distillate inventories in the Atlantic Districts and New England were at the lowest level in five years heading into the storm. There are a few key reasons for this:
- Refined product demand remains weak across the entire U.S. When demand is weak, there is less chance of a “demand shock,” therefore less need to hold product in inventory.
- Futures curves are backwardated (higher prices today than in the future), dis-incentivizing storage.
- Refined product production is low in the Northeast because of poor refining margins (high Brent price, weak demand for products, excess capacity). Indeed, several Northeast refineries have closed or are running at reduced rates due to profitability issues over the last two years.
The pre-Sandy inventory figures were 48MM bbls of gasoline and 39MM bbls of diesel in the Northeast. Compare this to 3.1 MM bbls/d of demand for gasoline (15.5 days of supply) and 1.2 MM bbls/d of demand for diesel (32.5 days of supply).
The waive of the Jones Act (only U.S. flagged ships can move refined product from U.S. port to U.S. port) allows ships to take product inventory from the U.S. Gulf Coast and move it up to the New York area. At least two companies are in the process of doing that.
There is little risk of a gasoline shortage, in our view. With 15 days of inventory, refineries already coming back online and increased shipments from the Gulf via pipeline and tanker, there will be enough gasoline to support demand in the Northeast market.
The issue is that so many gas stations were without power last week (more than 50%), that the ones that had power were jammed and ran out of fuel. Now, nearly 100% of stations have power, and the ones that never lost power are waiting on the new supplies. That should come quickly. We suspect that this “shortage” will not last much longer.
INDUSTRIALS: Airfreight/Express & Courier Services Entry Point
Takeaway: We believe we are looking at a really good entry point for airfreight/express & courier services – particularly FDX.
There have been 4 huge headwinds:
- Inventories have been building
- Global trade has fallen over the past couple of quarters
- Capacity in airfreight has just started to tighten after years of slack
- Containership prices have increased relative to airfreight since 1Q after years of lost pricing.
Those have depressed margins and understated profitability and may be turning. A port disruption would be icing on that last point’s cake on relative pricing.
An estimate shows that each day of transit costs 0.6% - 2.3% of the cargo’s value in what is essentially a transport tax (lost selling days, spoilage, lost design time etc). This is an interesting data point, even if it’s only a few days of lost cargo activity, it still matters. Therefore, weeks of disruption could matter significantly. Since air cargo is basically always only at +/-50% capacity utilization, there could be some switching of more critical cargo into that transport channel. It certainly has the capacity and reliability.
People claim that improved service levels have driven air cargo to boats, we think it’s mostly that the price differential blew out. The opposite was true around 2004, when everyone figured air cargo was a huge growth business. That was relative pricing, too and largely unrelated to service. The price swings are huge over time. See the chart below from our pending Express & Courier Services Black Book (for access to this call email ).
RETAIL: Sandy Destruction; Longer Term Impact
Takeaway: Reality is going to be more discounted goods, lower earnings and less cash flow. We particularly don't like the department stores in this context (M, KSS, JCP, and we'd throw GPS in there as well).
If anyone out there thinks that Sandy will not have a meaningful impact beyond a couple of weeks worth of disruption in consumer purchasing behavior, then think again. The chart below shows the absolute containerized imports into the US for apparel and footwear products over the past two years.
Number of Twenty-Foot Equivalent Units (TEUs) Imported Into The U.S.
The data is through November 2, and the drop is startling.
The reality is that we cannot simply expect the ships to dock, unload their wares, and then the retailers are off to the races.
- The Longshoremen (already near the full capacity their strict work rules allow) will have to unload the excess containers, and then the (largely unionized) drayage drivers will need to take to either the railyard or to the hub and spoke system for an LTL trucking company (also likely unionized)
- Then the goods get unpacked, repackaged, and shipped off around the country
- It wouldn't be a problem if we were operating previously at less than 50% productivity, because then all we'd need to do is get people to work harder
- But productivity is closer to 80%, which leaves little room catching up on lost work
A simple one or two week delay in shipment could snowball into a 3-4 week delay in when product hits the shelves. This is an extremely critical period logistically for the holiday shopping season. Sandy had very bad timing.
This is when 'just in time' inventory management comes back to bite U.S. businesses. Retailers will do a great job of playing the blame game on the storm. But the reality is going to be more discounted goods, lower earnings and less cash flow. We particularly don't like the department stores in this context (M, KSS, JCP, and we'd throw GPS in there as well).