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In my last article, I made the bold statement of calling the bottom with DryShips, Inc. (DRYS). The response seemed to be about evenly split between those that were in agreement and those that think it could still fall further. I believe this recent conference call confirms that while the storm isn't over yet, the company has a good plan for how to reach a safe harbor and return to profitability. In this article, I am going to look at the operations of the company independent of market conditions. There were several items discussed in the recent conference call that need to be looked at further. The first is the decision to expose the fleet to the spot market vs. seeking out charters. The second is the leveraging of Ocean Rig UDW Inc. (ORIG) to keep them afloat and what it means to ORIG. The third is the decision to sell off ship contracts before they have been completed.

Exposure to the Spot Market

During the call, the strategy was outlined going forward of getting as much of the fleet exposed to the spot market as possible. Right now, they have 48% of the fleet on fixed contracts. This will fall over the next two years to 19%, exposing 81% to the spot market. While the company doesn't expect the spot rate to dramatically increase this year, the lucrative fixed charters will help them generate cash flow. As was discussed in the conference call, and in other articles, a slowdown in iron demand from China and a glut of ships in the industry, will both compete against a rising spot rate. As the long-term contracts end in 2014 and further into 2015, the company believes the rising spot rate will help it return to profitability.

Another positive brought up during the call was the low daily debt amortization of $8100 per ship. While the breakeven price will be higher (factoring in fuel, labor, and overhead costs), the company is pushing for refinancing that will lower that cost, and thus lower the breakeven point. This will also have a positive effect when exposed to potential improvements in the daily spot rate.

Leveraging ORIG

The company's share of ORIG, 78.3 million shares valued at $1.3 billion, is the reason the company was able to survive the past few years. During this past quarter, they sold 7.5 million shares at a value of $123.1 million (share price of $16.41) in order to assist with the sale of four contracted ships. The company stated they still have debt amortizations the next two years of about $130 million. During the question and answer portion of the call, Mr. Economou stated that they are trying to work with ORIG to avoid having to sell more shares on the open market, including the potential of a dividend.

The dumping of 7.5 million shares of ORIG on the market had a dramatic effect on the price of ORIG. The price fell from a high of $17.50 to just under $14 in two weeks, a 20% drop. Since then the price has recovered (an excellent buying opportunity for those that recognized what was happening). While Mr. Economou stated that he will try and minimize the volume that is sold in the future, when it does come time to sell, it will be a great opportunity for those that can identify the increased volume on no news. ORIG averages around 300,000 shares traded a day, so even a modest offer to sell could cause the price to fall on a solid company. On the other side, if Mr. Economou is able to persuade the company to offer a dividend, this could cause the price to rise, and thus increasing the value of the share held by DRYS.

Selling off ships

During the previous quarter, the company sold off four contracted ships that were set to be delivered and took delivery of three other ships. Two of those sold off went to a private company with no connection to DRYS. The other two went to a company that is associated with Mr. Economou. We can speculate that they were purchased by Cardiff Marine INC, a private company set up by Mr. Economou, which competes in the same market space as DRYS and has a different strategic objective. Instead of competing in the short-term spot rate market, they strive for long-term charters.

In spite of this seeming conflict of interest, the company stated that those four ships were sold off because they had no contracts prepared for them and they would have been subject to the spot rate immediately. In order to conserve the long-term prospects of the company, they opted to sell them off for the short-term loss. Without the short-term loss that was taken in the 1st quarter, the loss would have been $41.3 million, 15% better than last year.

Potential Landmines

There are always caveats to any way ahead. The first one is the potential for the economy to recover slower than expected. As was mentioned in the conference call, with China slowing their steel imports, the spot rate will probably rise slower. There has still been an increase in exports from Brazil and Australia, and China and Japan are still importing coal, which will help the price climb. The second caveat is the oversupply of ships. Older ships need to be scrapped, and new ships need to be built at a slower rate. These two issues (supply and demand) will be the main driver of the spot rate and future contracts.

Conclusion

I still maintain that the bottom is here with DRYS. With their stake in ORIG, they can weather the storm and hang on for the improvement in the economy and the rise in shipping rates. This recent conference call reaffirmed that management has a clear plan for returning to profitability.

Source: Looking At The Future And Operations Of DryShips