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Are the High-Yielding Shipping Stocks Worth the Gamble?

There are some sectors of the market that always seem to have really high yields. For example, MLPs, REITs and business development companies (BDCs) have high yields by structural and tax design. They are pass-through entities and are required to pass much of their cash flows back to investors. Utilities feature steady-eddy cash flows and predictable expenses, so it’s easy for them to offer high dividends to their investors.

Then you have the shippers.

The sector has always been a source for high yields with many offering payouts in excess of 10%. The problem is that these high yields have often come with a hefty dose of risk. And many times in the past, investors in the shippers have been sunk.

But with shipping conditions finally beginning to turn a corner, is the sector and its double-digit yields worth the gamble for today’s investors?

A Long History of Disappointment

If you hop into a time machine and travel back to around 2006, the shippers were riding high. China was hitting its peak GDP expansion and had been consuming all matter of materials. All of that steel, corn and copper came in from all over the place via dry bulk and tanker vessels. Profits were plentiful and the shippers expanded like crazy to meet the demand of the world’s booming economy.

Then the bottom dropped out and the world sank into a recession. Since then, the shippers haven’t been the same.

Excess capacity wreaked havoc on the industry’s profits. Many firms within the container shipping sector haven’t been profitable in over five years, while earnings in the other subsectors have been extremely volatile, moving from hefty profits one quarter to complete washouts in the next. That’s a problem when you have high debts and pay out high dividends.

Historically, the shipping stocks have paid high dividends as many feature large family ownership structures. The best way for a family to extract cash from an investment is through dividends. With conditions in the sector what they are, investors demanded higher payouts to compensate for the risk, meaning they dumped shares to boost yield. High dividends became even higher. And when the lack of profits continued and dividends were cut, investors demanded even higher yields and sold even harder.

The ebb and flow has pretty much persisted since the end of the Great Recession.

What’s Recently Changed for the Shippers

After years of disappointment, some bankruptcies and many dividend cuts, the vast bulk of the shippers are now trading about 60% to 80% below their all-time highs while still yielding in excess of 10%. What’s tantalizing about this is that conditions for the industry may have finally turned a corner.

For starters, the main metric of shipping rates has finally moved higher from its all-time lows. The Baltic Dry Index (BDI) reached an all-time low of 290 back in February of this year. However, recent bullishness coming from China (rising PMI figures) has helped push the metric upwards. Since bottoming out, it has closed pretty much higher every day and now sits at 597 points. That’s still a far cry from the 11,793 point peak, but progress is progress.

Meanwhile, the number of ships on the sea continues to decrease. Bankruptcies have helped reduce global fleet size, while many oil tankers are being used as floating storage tanks to help alleviate the glut of crude oil.

All of this has helped restore profits and cash flows at several shippers. It’s even helped restore suspended dividends at a few. See shipping giant Frontline (FRO ) as an example.

Taking Some Dramamine & Buying the Shippers

So with things getting better for the shippers, should investors take stocks like Nordic American Tankers (NAT ) and its 11% dividend, or Teekay Tankers (TNK) and its 13% yield for a go? The answer is perhaps yes with a big asterisk.

The asterisk points to the potential risk inherent here. While the BDI has improved, any signs that another recession is brewing could seriously drown the sector once again. Not to mention that any rate increase from the Fed could see investors fleeing the exits. Nothing yielding 10% is risk-free. With that in mind, adding a tanker or two could provide some spice to your dividend portfolio.

And there’s plenty to choose from. Costamare (CMRE ), Golar LNG Partners (GMLP ) and Navios Maritime Midstream Partners LP (NAP) all feature strong and improving cash flows and dividend yields in excess of 10%.

A better bet could be the Guggenheim Shipping ETF (SEA). The fund tracks a basket of shipping stocks, which helps on the diversification front and eliminates many of the single-stock risks within the sector. Meanwhile, they still get a high yield. SEA currently pays 11.18%.

The Shippers Are Shipshape

Conditions continue to improve for the shippers. Cash flows and rates are rising, while the number of ships on the water have been decreasing. That’ll lend support to those high yields. For risk-seeking investors, the shipper’s high yields could be worth the gamble.