Shipping companies are awash in cash, and they're passing it on to stockholders in the form of excellent dividends that look to be sustainable for the next three years. By Jeffrey R. Kosnett, Senior Editor January 9, 2006 For years I balked at recommending ocean-shipping stocks despite some terrific returns. I can't say exactly why, except perhaps that the business is a bear to understand and, in the words of one CEO I recently interviewed, it has a volatile, unpredictable image.The publicly traded shipping companies are not well known, the industry is fragmented, and there are no mutual funds that concentrate on this business. Then, too, the newspapers love to tell us every time some cargo ship gets seized in port for unpaid bills. Plus, with REITs and oil-and-gas income trusts available to pay high yields and diversify stock and bond portfolios, I gave shipping a wide berth. Now, it's time to rethink this. First, there's a global economic boom that doesn't seem about to quit. Then, with energy supplies ever tighter in the United States, we are importing not only oceans of crude oil, but also 20% of our refined petroleum products -- gasoline, diesel fuel, jet fuel, etc. Western nations and China and Japan are drastically increasing their investment in liquified natural gas, which is transported from Indonesia and the Persian Gulf in hugely expensive specialized ships. And there's the whole Brazil-China-India-Russia economic thing. These countries are all avid exporters with endless coastlines. Advertisement So I looked to see what's up with shipping stocks. I'm not surprised to discover juicy three-year returns -- upward of 25% for the group -- but what really grabs me is the income side. Look at the list of reasonably new maritime offerings. Many are paying 8%, 9% or even 12% dividend yields. The old names I used to look at and then skip paid little or no dividends and rose or fell due to heavily leveraged earnings. So analysts now separate the industry into yield-oriented and leveraged companies. Because this is a yield column, let's see from where these dividends come. The answer: from cash flow. Maritime companies are run on a cash basis, as follows. (I want to thank Richard Coxall, chief financial officer of Aries Maritime Transport Ltd., for this background). Let's say the ship is chartered for $20,000 a day. Operating costs, which include wages, insurance, maintenance and port fees, are $5,000 a day. Financing is $2,500. The rest is available to the company to use as it wishes. In the old business model, it might go for buying new ships, which eventually traps the company in a downturn should too many boats chase too few loads. Or the company would build cash or investments on its balance sheet, presumably to expand at a better time. High dividends were rare. Advertisement But, about three years ago, a few industry executives (which in this business means guys with a big ownership piece of the action) changed their thinking. They decided to see what would happen if the company would pass 90% or 100% of its net cash flow to the stockholders as dividends -- something that's possible if the boats are never idle but are tied to long-term contracts with escalators or favorable renewal options. So you can scroll through the maritime industry's publicly traded companies and find names like Aries Maritime Transport (RAMS; with a 12% yield) and Arlington (ATB; 9%) -- and then on through the alphabet -- with these high yields and, more important, cash flow to cover them. Then go to the Web sites or read the prospectuses and you'll see this is really what they intend to do for years -- pass on good dividends. It's not far-fetched to compare this to REITs with good long-term leases. Both industries -- real estate and shipping -- are selling time and space, and they own fixed assets that can gain in value as replacement costs rise. Clearly, if a world economic downturn struck, the shipping industry would turn ugly, and the market would question the security of these dividends. Then the stocks would be risky, though no more so than real estate securities. Also, like real estate, shipping has its occasional busts due to overbuilding. But if you can get 9% out of a company like Arlington, whose chief financial officer told me the policy will be to pay 100% of the net cash flow as dividends and that its fleet has good leases until 2008 and in some cases to 2011, it's insulated from any wild building sprees. I still like energy trusts, and the REITs are hanging in there. But shipping looks like another leg on the income stool. Opinions expressed in this column are those of the author.