Are the Dry Shippers Value Traps?

Only seven months ago, dry bulk shippers were on top of the world. The rapid growth in spot prices transformed mundane companies like DryShips (Nasdaq:DRYS) and Excel Maritime (NYSE:EXM) into multi-billion dollar growth stocks, trading millions of shares per day.

It's a different world today for the dry bulk shippers. Slowing growth in China means less demand for their boats, which transport iron ore, coal and grains. Combined with the inability of customers to obtain credit and plummeting commodity prices, these factors have caused spot prices to fall off a cliff.

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Shares of dry bulk shippers have fared no better. So with both spot prices and shippers down 93-96%, are we at a good entry point? Bulls would say so. They argue that at these prices the shippers will be taken private and old ships retired. Plus, they say, the revenues of shippers like DRYS and EXM are tied as much to high-priced time charter contracts as they are to volatile spot prices.

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I’m not convinced. With financing so hard to come by, levaraged buyouts will be difficult. And those contracts? Noneconomic contracts have a way of being broken. Even if the contracts are ironclad, remember that they are only as good as the solvency of the counterparty. Also, the shippers and shipping companies each have an interest in renegotiating unfavorable contracts, because neither benefits in the long term by enforcing a contract that impairs the business of the other.

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There is some good news. First, much of the supply that was to come on board in 2009 and 2010 will be delayed or canceled. There will be new builds, but nowhere near as much as was feared only a year ago. Second, if you believe the rumors, China is mulling an increase in base metal purchases. Imported metals and ores will need to be transported. Third, fuel and labor costs are decreasing.

Bottom line: If we get a broad market rally, the dry bulk shippers like DRYS and EXM will squeeze the shorts. However, that won’t change the headwinds that impact their business. Unless the BDI recovers to a point where the spot prices are profitable, the future of dry bulk shippers is grim.

I’m not sure where this inflection point lies, but for most dry bulk shippers it is probably above 2000, or more than 3 times current spot prices. There will likely be a number of bankruptcies in the industry. Before you bet on a buyout or the continuation of a large dividend, consider first whether the company will even be able to weather another bad year.

DISCLOSURE: No positions.

Comments

[mkreisel:]

The few that survive this carnage is going to thrive, but we just don't know who's going to survive.

2008 Dec 08 03:56 AM

[Distressed ...:]

Nice post. I actually just wrote a post about the dry bulk shippers.. It's a very interesting situation w/ the letters of credit/demand freeze.. The global Government sitmulus could drive up demand again. Once risk appetite comes back in full inflation will also be an issue. Everything happens so fast these days that you never know... The risk appetite trade is up tonight... Hopefully it can stick. www.distressedvolatili...

2008 Dec 08 04:06 AM

[investor88:]

Agree with Microcap Speculator views. Watch trends but do nothing as it could be quite risky. Right now the markets are rallying, so shorts may have to get out of the way first then re-assess.

2008 Dec 08 07:41 AM

[Richard Col...:]

EXM is an excellent opportunity to accumulate shares.
The climate is very favorable for a sizeable profit and very slim chance this company will go bankrupt. Less than 1 x earnings and shipping of commodities is still important.
If you are afraid to invest a few bucks here then you better get out of the market altogether as almost every company on the market depends on the economy.

Dan Kowkabany

2008 Dec 08 10:08 AM

[NOWHEREMAN:]

New Builds are being delayed and occasionally cancelled with forfeiture of the deposit. DRYS is in particularly bad shape since it needs something like $1.4 Billion by the end of 2009 for all of the New Builds it has in progress. Their latest 10K spells out their problems.

The only Tanker fleet I currently own is a 54% spinoff from TeeKay (TK) or TNK, my average cost is around $13. After this quarters payout, it will be around $12.

They are scheduled to take delivery of two Tankers in mid-09, but since both are from their parent, I doubt whether postponement will impact their bottom line. I am expecting their next payout to decrease by at least 2/3rds but am confident that by the end of 09, increases will again be in the offing. IMHO

2008 Dec 08 10:44 AM

[jimmy46:]

And those contracts?
Noneconomic contracts have a way of being broken.
Even if the contracts are ironclad, remember that they are only as good as the solvency of the counter party.""""""

GOOD POINT, AND SOMETHING MOST BLOGGERS OVERLOOK.

2008 Dec 08 01:28 PM

[James Wilson:]

The only value trap in bluk shipping is those who hold contracts on new ships only and no leased ships they can use incase of a break down of one or more in their fleet.

2008 Dec 10 02:07 PM

[poor&unempl...:]

Shipping has been around for 100's if not 1000's of years. Show me a single publically held shipping company which is 50 year old!

Try to enforce US laws in Greece!

2008 Dec 10 07:54 PM

[einstein p ...:]

The world is literally printing money, so sooner or later the credit crunch should begin to ease. My understanding is that there is still a great deal of demand for dry bulk shippers and oil tankers --- the problem lies in the letters of credit needed to ship cargo from one port to another. No dividend is truly safe in this environment, but the risk reward on EXM and PRGN looks interesting at these levels. Bought both at half the price and sold half the position, so there isn't much risk, but I would consider buying more if the BDI began to move again.

2008 Dec 25 01:52 PM

[antiquary:]

Good analysis. There's a point I'd like to make, though. There are long runs, and there are longer runs. Even if EXM slashes its dividend, and even though some of the other shippers have already, even to zero, these are companies in the dividend habit. They produce boatloads of cash, if you'll excuse the pun. Buying a dividend company for prices that don't reflect investors who would be in it for the immediate payout is the way to get paid back in only two or three years once the economy recovers-- as it will-- and they start paying again. Now, there's an astounding opportunity.

Feb 13 06:30 PM