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Incorporated in 2004, Athens, Greece headquartered Dryships (NASDAQ:DRYS) is one of the largest ocean transportation services in the world. As of March 2013, the company operates a fleet of 36 drybulk carriers. These vessels, altogether, can carry up to 5.1 million tons of weight. Dryships also diversified itself by engaging in ocean drilling services. The company operates 6 drilling units comprising 2 ultra semisubmersible offshore drilling rigs, and 4 ultra deepwater drillships. While the company's drilling business is doing fine, its core shipping segment is losing money. As a result, the stock lost 45% in the last 12 months alone. Currently, it is trading substantially below the book value. Let's look at what future holds for the company.

Industry Background

One could easily say that without international shipping and transporting companies, global trade will tend to cease. The movement of raw materials, food, coal and other heavy material would have been impossible without such dry bulk carriers. It is because of companies like Dryships that about 90% of world's dry bulk transportation occur. Dry bulk shipping business is scattered among 1500 owners of drybulk carriers, most of which work independently.

DryShips exceeds its competitors in terms of fleet capacity and worldwide trading routes. Most of DryShips' competitors -such as Diana Shipping (NYSE:DSX), Excel Maritime (NYSE:EXM), and Navios Maritime (NYSE:NM) - offer quite the same services. However, they operate mainly in specific geographical regions. Consequently, they depend on both global and region-specific economic conditions. Moreover, DryShips has invested over $600 million to new dry bulk ships and more than $460 million to new tankers to be delivered in the next few years. These investments might lower operational costs as a single ship has at least 25 years of useful life.

While Dryships is a leader among its peers, the industry itself is going through tough periods. Last year was one of the most difficult years for the shipping industry. About 90% of the world trade is done through the sea lanes. However, global trade has been extremely slow, resulting in a miserable time for the shipping industry. Furthermore, fleet capacity has grown by more than the growth in demand, which has resulted in an oversupply problem. At the moment, the rates are even below the breakeven rate and most of the carriers are operating at a loss. The problem of oversupply might remain, as there is an imbalance between fleet capacity and demand.

Why DryShips?

DryShips is not just a dry bulk cargo operator; it also operates as an ultra-deep water drilling company. The company has a substantial stake in Ocean Rig (NASDAQ:ORIG), which provides it a regular source of cash flow. Ocean Rig stake enables DryShips to compete enthusiastically in the ultra-deep water drilling sector. While there is an oversupply of dry bulk carriers, the situation is reversed in deep water drilling market. There is a shortage of drillers in this industry.

Shortage of rigs is observed in the deepwater oil drilling divisions globally, because production from ocean rigs has been on the rise. Discovery of new deepwater oil reservoirs is also another catalyst which increased the demand for deepwater drilling services. DryShips have been divesting its assets to companies. These divestments prove to be a vital source in reducing the yearly expenditure, which is dropped by 101 million dollars.

Moreover, the increasing demand of coal and iron ore can also raise the demand for drybulk carriers in the coming years. Iron ore and coal are in demand, because of the growing production of electricity and steel in the developing countries. 35% of the world's dry bulk shipping trade are because of China alone.

Hazards and Rewards

DryShips is currently going through a great loss. The rates of capsized ships, used only for dry bulk goods, decreased in the spot market. The daily charter rates of the company is much lower than the pre-crises level. The oil tanker rates were also slightly reduced.

On the positive side, oil business and deep water oil fields can prove to be a success for offshore drilling sector. With the rise in the production of energy, a shortage in rigs is faced by the deepwater oil producers. By the end of 2012, Ocean Rig had orders for the worth of about $5.1 billion, for the next three years. With the rising commodity demand in India and China, the demand for deep water drillers will be higher in 2013 and beyond.

Revenue Estimates (In millions of $)

Q1

Q2

Q3

Q4

Year

2011

207

224

318

328

1,078

2012

248

336

344

283

1,210

2013

306(NYSE:E)

340(E)

356(E)

491(E)

1,492(E)

2014

2,030(E)

While the revenues experienced higher rates, the sales did not translate into higher earnings. Dryships reported losses of 36 cents per year in the last year. According to Zacks, the losses are expected to increase by 4 cents this year.

Earnings per Share Estimates (EPS is operating earnings before non-recurring items, but including employee stock options expenses)

Q1

Q2

Q3

Q4

Year

2011

$0.16

$0.04

$0.16

$0.07

$0.44

2012

($0.11)

($0.01)

($0.09)

($0.15)

($0.36)

2013

-$0.13 E

-$0.05 E

-$0.07 E

-$0.15 E

-$0.40 E

2014

$0.31 E

Source: www.Zacks.com

Challenges Ahead

DryShips did not report strong earnings in the last quarter. The strong performance of the Ocean Rig deepwater oil drilling unit, whose majority is owned by the company, did not prevent the company from reporting losses. The losses observed in the dry bulk shipping cargo and oil tanker division overwhelmed the success of the deepwater drilling unit.

Severe challenges were faced by the industry. The competition is though, and it is becoming tougher as more independent carriers infiltrate into already shrinking market. As a result of this competition, the prices kept going down, offering really low, even negative margins. Uncertainty in the global economy, and a slow down in the industrial demand is another challenge. Rising demand in the market can, however, cause the dry bulk shipping market to recover in 2013.

(click to enlarge)

Source: Finviz.com

Summary

Clearly, the stock is not a screaming buy and has its own risks, which may not suit to a range of investors. Many shipping contracts are under the unstable spot rate market, which is another problem of DryShips. Nevertheless, for risk savvy investors, it can be an interesting pick. The company is evidently undervalued based on the assets it holds.

The shipping industry stocks are experiencing some sort of recovery in this year. Following its peers, Dryships returned about 17% since January. However, it is still trading at a fraction of its pre-recession valuation. Dryships holds a majority stake in Ocean Rig, which has a market cap of more than $2 billion. The value of its stake in Ocean Rig is much higher than Dryships's current market cap of $775 million. 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 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.

Source: Is It Time To Consider DryShips?