DryShips (DRYS) reported its third quarter earnings yesterday. The operator of dry bulk carriers topped the revenue estimates but missed on the earnings estimates. I expected the company to miss on the bottom line estimates given the weak spot charter rates for both tankers and dry bulk vessels. DRYS seems to be challenged by both macro and firm-specific factors. On a macro level, the dry bulk industry profits remain plagued by the overcapacity problem (discussed below), weak global demand for dry bulk commodities and scarce opportunities for funding. On a firm-specific level, DRYS' contract coverage for the next two years is very low. Alongside, the company has decided to reduce and prolong its capital expenditures in the near-term amid a financial crunch. In this situation, DRYS' shareholding in Ocean Rig (ORIG), drilling rigs' operator, is a source of hope for the shareholders.
Before the 3Q earnings of DRYS are discussed in detail, it is important to mention how the overall dry bulk industry is currently performing:Baltic Index Update (BDIY)
The Baltic Dry Index (BDIY) is a good indicator of the dry bulk activity in the world. The index is formed of weighted averages of Baltic Capesize Index (BCI), Panamax Index (BPI), Handymax Index (BHI) and Supramax Index (BSI). Therefore, an upward movement in the index means that there has been a surge in at least any one of the four afore-mentioned indices.
BDIY has recently been showing a peculiar behavior. The index, after falling to 663 points on September 17th, started to rise and crossed the 1100 points mark on 23rd October. Many people started to believe that the global economy is finally turning around, especially the Chinese economy, which is responsible for most of the demand for dry bulk commodities like iron ore, coal and grains. However, I believe the surge was a temporary one, caused primarily by the $156 billion approval by Chinese government for infrastructural development. This is why after crossing the 1100 points mark, the index started falling again and reached 916 points on the 8th of this month.
This week, the index has shot upwards again due to surge in BCI and BPI as shown by the graph below:
According to Bloomberg, the surge in BCI has been caused by increased rate of scrapping for Capesizes, the vessel type used for transporting iron ore. The Bloomberg's article, on iron ore rates, mentions that Bangladeshi beaches are filling with unwanted ships waiting to be scrapped. Also, the global fleet shrank by 0.6 percent last month, its first contraction since November 2008. This news sent bullish signals in the market as overcapacity has been one of the major problems that the dry bulk industry has been facing in last 4 years. The CEO of Global Marketing Systems Inc in Cumberland, Maryland was heard:
"This is the biggest boom for scrapping of Capesizes we have seen in history."
BPI has also been going up due to emergence of fresh Indonesian coal stems. However, the increase in index was not as strong as BCI's rise because it was offset by weakness in the Trans-Atlantic trade. The transportation of coal from Australia to China and India also led to the rise in BPI. However, the Trans-Pacific trade is expected to remain weak this week given the Diwali celebrations in India.DRYS Highlights
DRYS posted revenue of $343.6 million, 7.8% higher on a Y-o-Y basis and almost 4% above the Street's estimates. The loss per share of 9 cents was below the analysts' expectations of 7 cents. This was way lower than the 7 cent profit per share that the company made in the same period a year ago.
Other important highlight was the decrease in the Adjusted EBITDA on a Y-o-Y basis. EBITDA continues to be a key metric for the shipping stocks given that it is used to gauge the financial power of the company to pay-off its debt, which, as already been mentioned, is a big problem for this industry. The Adjusted EBITDA declined from $172.9 million to $141 million. Weak charter rates were considered as the main cause for the decline. People suggest EBITDA per day to be a more appropriate metric for the shipping stock given that EBITDA can also rise/decline given a rise/decline in the fleet size. Following shows the calculation of EBITDA/day:
As shown by the table, the EBITDA/day has considerably deteriorated (down by almost 20%)!
It is also important to discuss what proportion of the company's fleet operates on spot charter rates and what operates on long-term charter rates.
The company has a total of 10 Capesizes, 24 Panamaxes and 2 Supramaxes. All 10 Capesizes operate on long-term charter rates. 18 of the Panamaxes are operated on spot rates (almost 75% of the entire Panamax fleet). Both of the Supramaxes are also operated on spot rates. More exposure to spot rates means more exposure to the Baltic Dry Index. Therefore a recent surge in BPI is expected to benefit DRYS. However, DRYS may not benefit directly from the surge in BCI. Why I use the term "directly" is because in the long-run, all shipping stocks, even those that have majority of their fleets being operated on long-term charter rates, will benefit from improvement in BDIY.
The average age of DRYS' fleet comes out to be six and a half years. The average age of DRYS' Capesize fleet is 6.9 years, Panamax fleet is 8.2 years and Supramax fleet is 9.5 years. The overall average of 6.5 years is less than the industry's average of 10.4 years. Where a lower average age means lesser maintenance costs, it can also mean more years to go before the ships are scrapped.
Another concern for the investors is that DRYS has contract coverage of only 33% and 22% of the total calendar days of 2013 and 2014 respectively.ORIG's shareholding
A 65% shareholding of DRYS in ORIG has been like a carrot on a stick held in front of the DRYS shareholders for the last five years and the luster is wearing thin. Many assume that buying a DRYS share will get an ORIG share for free given the cheap valuation at which DRYS is trading. However, this is not the case. DRYS' CEO George Economou clearly stated his intentions in the press release yesterday that DRYS will keep on selling ORIG's share whenever it needs to do so. Therefore, in case DRYS liquidates, ORIG's share would already have been sold off by the DRYS' management.
However, one can still say that ORIG's shareholding will surely help DRYS to swim through the troubled waters until the global demand recovers and dry bulk industry witnesses a turnaround.
The company, like almost every other company in the dry bulk industry, is facing debt-related problems. The company is bound to pay $750 million in 2013 and $1 billion in 2014. However, it has only $986 million in its cash till (mrq). DRYS is currently making only 12% of its revenues from dry bulk. 85% of the revenues are coming from off-shore drilling while only 3% is coming from the tanker division. The company is relying on its stake in ORIG to get it through the economic recession.
Given the current instability in the dry bulk industry, I will suggest the investors to keep away from this stock until the global economy starts to recover.