Dryships: Looks Fairly Attractive With Major Risks Attached

| About: DryShips Inc. (DRYS)

By: Ahmed Ishtiaq

DryShips Inc. (NASDAQ:DRYS) specializes in carrying drybulk commodities and drilling rigs. The company's drybulk fleet carries several drybulk products including coal, iron ore, and grains, bauxite, phosphate, fertilizers and steel products. The company also owns 2 ultra-deep-water semi-submersible drilling rigs and 4 ultra-deep-water newbuilding drillships. DryShips also owns 12 oil tankers. Recently, the stock of the company has lost a substantial portion of its value due to the poor performance of the company. Let's look at what future holds for the company.

Yet Again Poor Performance:

Recently, the company reported its third quarter earnings and the results were again disappointing. DryShips reported a quarterly net loss of $51.3 million compared to a profit of $25 million for the same quarter last year. Total operating expenses for the company went up by 46% to $307 million. The operating expenses went up mainly due to higher drilling rigs expenses. At the end of the third quarter, cash and cash equivalents stood at $986.8 million for the company, and debt was $4,453.5 million. At the end of 2011, cash and cash equivalents, and debt stood at $251.1 million and $4,241.8 million, respectively.

Drybulk carrier segment revenues declined by 47.1% and only generated $46.9 million. Further, tanker segment revenues went up by more than 226% year-over-year. The tanker segment generated $11.1 million in revenues. Drilling business showed strong growth and recorded revenues of $285.7 million, growing by 26.4%. However, strong performance of deepwater oil drilling unit OceanRig UDW Inc. (NASDAQ:ORIG) was offset by tepid results of DryShips' legacy drybulk shipping cargo division. The drybulk shipping and oil tanker segments are suffering from oversupply, causing the spot rates to drop.

Drilling the Future:

DryShips is converting itself to an ultra-deep water drilling company rather than continuing as a simple drybulk cargo operator. Ocean Rig's acquisition was a step in the right direction and it diversified DryShips' assets and sources of cash flow. Moreover, Ocean Rig's expertise has equipped DryShips with the essential platform to vie for the best contracts in the sector. At the moment, the company has a 65% stake in OceanRig. The drilling segment is flourishing due to growing expenditures from oil companies and success in deep water oil field discoveries.

The deepwater drilling sector is presently experiencing shortages of rigs all over the world as the energy companies have increased their production levels. Compared to companies like Transocean (NYSE:RIG) or Seadrill (NYSE:SDRL), Ocean Rig is a small player in the drilling industry. Drilling in ultra deepwater assets is extremely attractive as rates here are higher and more sustainable. We have discussed the drilling industry at length in our coverage of Seadrill; detailed analysis can be found here. At the end of the quarter, OceanRig had an order backlog of more than $4.5 billion. For DryShips, drilling segment will be the main driver for EPS growth in the future.

Is the Company Fairly Valued?

Every so often, there are some valuation anomalies in the market. DryShips looks like a good example at the moment. The company's stake in Ocean Rig is worth more than the company's present market capitalization. DryShips' market capitalization is just above $650 million, and OceanRig is valued at over $2 billion by the market. If we compare the DryShips stake in OceanRig, there is a difference of $651 million. At present, the company is valued at half of its stake in OceanRig. In other words, the market is saying that DryShips is worth negative $650 million. It is a clear indication of the expectations of the market about two different businesses.

Currently, the market is bearish about the shipping industry for obvious reasons; as a result, DryShips is valued at such low levels. On the other hand, deepwater drilling is in demand and the market is very bullish about the prospects of the companies in the drilling industry. It is no surprise that the companies operating in the drilling industry have remarkably high P/E ratios. However, it is not possible to value DryShips on a P/E ratio due to the recent losses. Nonetheless, the company has an attractive forward P/E of around 16.

Shipping Not Dead Yet:

The Chinese economy can play a vital role in the revival of a number of industries. It is especially true for the shipping industry. China has announced an increase in its infrastructure expenditures, which may cause the shipping industry to move slightly faster on the road to revival. Furthermore, the energy needs of Europe are heavily dependent on coal, which is a key product transported by shippers. The increase in coal consumption should provide a boost to DryShips and its peers if the recent measures can stimulate some economic growth.


Clearly, the stock is not a screaming buy and has its own risks, which may not suit to a range of investors. However, for risk savvy investors, it can be an interesting pick. The company is evidently undervalued based on the assets it holds. Moreover, strong growth from the drilling segment should drive growth in EPS. OceanRig stock is trading at around $15 at the moment. DryShips can provide an alternative to take a position in OceanRig. However, I must stress that DryShips has substantial risks attached to it, and only high risk tolerance investors should consider the stock.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: EfsInvestment is a team of analysts. This article was written by Ahmed Ishtiaq, one of our equity researchers. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.