DryShips (NASDAQ: DRYS) stock has made and lost its share of fortunes. In 2007 the DryShips stock exploded from under $20 a share to over $120 a share in just a few months. Now, DRYS stock is down -30% year-to-date and about the same amount in the last 52 weeks. This shipping stock is just one example of the volatility we see in the sector.
There has been a sharp drop in shipping rates lately — as indicated by the Baltic Dry index that measures the cost to transport metals, grains and fossil fuels — generally dry goods. The index peaked at 4209 on May 26 and declined to 1700 on July 15; as of this writing it is at 2712. But, last year at this time we had a similar drop. The index peaked at a hair above 4291 on June 3, 2009, and declined to 2163 as of Sept. 24, 2009.
This is not an isolated phenomenon to dry bulk shippers. Oil tankers have the same issue. In fact, at the end of July rental income after fuel costs to ship Saudi Arabian crude oil to Japan on the industry’s benchmark route fell to $11,585 a day, lower than the $11,601 owners need to pay operating costs. Basically, this is like just paying the crew and leasing the empty tanker for nothing.
You would think that oil and dry bulk commodities would be weak if shipping rates are plummeting, but nothing could be further from the truth. Since the Baltic Dry Index topped out on May 26, the equally weighted CRB index is up 11.7%, copper is up 11.4% while crude oil is up 18.4%. It appears that this is not an issue of too little demand for commodities, but too much supply of ships, be it for oil or dry bulk commodities.
Since China is the biggest consumer of many dry bulk commodities and it just surpassed the U.S. as the world’s largest energy consumer in 2009, more and more commodity demand, prices and shipping rates will be set by the mainland. The Chinese central bank has been tightening aggressively since April, which has already shown in Chinese economic numbers. Since the goal here is to produce a soft landing, when the central banks stops, the shipping markets will recover — and they already have some.
DryShips Inc. used to be particularly exposed to the Baltic Dry Index. And even though the stock continues to trade in tandem with spot pricing, it should not. The company’s dry bulk carriers are almost 100% insulated from spot pricing for 2010 and nearly 82% insulated for 2011. The change in the strategy came in early 2009 due to the huge decline in spot prices from 2008.
The company actually made money in the quarter to the tune of 30 cents a share — this is only a $4 or so stock — but managed to mess things spectacularly with interest rate swaps. It had to take a huge 25 cent charge to its operating earnings for financial losses from the swaps that have nothing to do with the business of shipping. The moral: operating companies should not speculate in interest rate derivatives.
The company also has some exposure to offshore drilling due to the acquisition of drilling rigs in 2008. Given the mess in the Gulf, investors are overreacting as the rigs are under three-year contract with Petrobras, so there is no direct exposure. The company trades at four times forward earnings, so if this is only a China/Gulf generated scare, the stock should recover into the end of 2010. Enterprise value is $3.7 billion on a market cap $1.3 billion, which shows that management has too much debt and not enough equity in the business, but a stronger global economy can bail out the shippers. DryShips is a good speculation stock.
Another good shipping stock may be case Excel Maritime Carriers (NYSE: EXM). Whenever I see a P/E of 1.7 I begin to investigate. Usually the market does not believe the earnings and forecasts a decline in profitability. In this case Excel Maritime trades at 1.7 trailing earnings but forward estimates give a P/E of 10.2; the stock still trades at only 30% of book value. As with DryShips, the enterprise value — which adds the debt load to the market value of equity — is $1.6 billion on equity value of less than $500 million. The issue is that Excel is 65% exposed to the charter market — or fixed rates — while the rest of the ships operate on spot pricing. As such it is a more leveraged and volatile play on the Baltic Dry index than DryShips, hence the low valuation.
Another two low-multiple companies are Genco (NYSE: GNK) and Eagle Bulk Shipping (NASDAQ: EGLE), which both trade around 50% of book value and have enterprise value about triple the equity value. As I looked though many shipping companies’ financials, I saw the same problem. The more exposed to spot pricing a company was, the lower the valuation on a price-to-book or/and price-to-earnings basis. I also saw much higher enterprise values as the examples above indicate. In effect, the market is saying that the debt holders are in control. Most dry bulk shippers are risky stocks as they tried to increase exposure to the spot market when the rates were sky-high in 2008 — and then in 2009 they were scrambling to reduce that exposure.
On the opposite end of the spectrum is Teekay LNG Partners (NYSE: TGP), which ships liquefied natural gas and oil. The company does not have single ship operating on spot rates — contracts go up to 15 years — which bring the necessary stability for planning of the business. This is a master limited partnership yielding 7% and trading at 2.2 book value.
The book value valuation tells you how much more the market is willing to pay for the predictability of cash flows and dividends when comparing it with spot shippers. This clearly is the better way to operate a shipping company.
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