The valuation of shipping companies: A stochastic freight rate valuation model

Anders Dyrup Rasmussen

Student thesis: Master thesis


The valuation of companies which operate in highly volatile industries possesses significant challenges to standard financial valuation theory. Shipping companies which engage in the transportation of dry and wet bulk in the global shipping industry are one such example. The shipping freight rates have exhibited extreme volatility in the past two years as a direct result of the financial and economic crisis that engulfed the world economy. This jeopardizes the revenue stability of the shipping companies, making it difficult to project their free cash flows and value the company using traditional valuation techniques. The discounted cash flow model which is often used to value companies relies on a few key input parameters to obtain a single valuation for the company. Even though sensitivity analysis is commonly used to assess the input parameters, there remains great uncertainty surrounding those inputs. Projecting the revenue generation of the company in a straight line using a fixed growth rate seems too simple to capture the complex relation driving freight rates and thus the revenue of shipping companies. Increased correlation between the different vessel classes and increased volatility in the freight rates calls for a review of the methods used to value shipping companies operating in highly volatile industries. This paper develops a new approach to discount cash flow valuation using an Ornstein-Uhlenbeck one-factor stochastic freight rate model to drive the revenue generation of shipping companies. The model considers both dry and wet bulk vessel operators through modelling eight different freight rate indices (Capesize, Panamax, Supramax and Handysize dry bulk vessels, as well as MR, LR1, LR2 and VLCC wet bulk vessels) and relies on Gaussian copulas to capture the stochastic correlation between the freight rates. The paper seeks to establish a probability distribution around the valuation estimate and to describe the relationship between freight rate volatility and valuation distributions. Through more advanced quantitative methods and standard financial theory, the paper aims to improve on current valuation of companies operating in volatile industries. Using the Danish listed company, D/S Norden, the project has shown that the distribution of the company‚Äüs share price is relatively narrow, implying that the most probable share price of D/S Norden is USD 47 given the assumptions outlined. The project further concludes that the share price distribution is highly sensitive to changing the freight rate volatility, freight rate correlation, the speed of mean-reversion and the net exposure of D/S Norden to the stochastic freight rates. Any small change to or estimation of one of these parameters and the resulting valuation distribution can change considerably

EducationsMSc in Applied Economics and Finance, (Graduate Programme) Final Thesis
Publication date2010
Number of pages94