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Do you believe that Asian economies like China and India will lead the economic recovery, and you’re looking for a way to make money from that? Take a look at Diana Shipping (NYSE:DSX).

At current prices, Diana is about significant upside and limited downside. The shipping industry, which is characterized by incredible volatility, is facing two countervailing forces.

On one hand, there is excess construction of new ships dating from the pre-crisis market high. During this period, the Baltic Dry Index (BDI), which measures the price of shipping dry bulk commodities (the service that Diana provides), hit a high of 11,793 points in May 2008. The BDI hit a low of 663 points in December 2008, a 94% drop,[1] and has now come to a low intermediate point of 2,468 as of August 21.

Although new ship orders have nearly disappeared and there is some pressure to cancel existing projects, the shipbuilding industry has been sustained by existing orders through the financial crisis, including an effort by the Chinese to beef up the size of their own mercantile fleet [2]. This suggests an oversupply of ships and lower shipping rates down the road.

The countermanding trend, however, is that aside from the lengthy process of completing these ships in the current environment, there are financial obstacles to getting them in the water to move goods, and incentives to not do so. The first is financing. Shipping was hammered by the crash in shipping prices during the crisis, and shipping banks are not well positioned to write loans [3].

When the shippers do buy, the need for cash flow will press them to deploy the ships as soon as possible regardless of how low the price.

The second is that because of how the shipping sectors work, shipyards and ship owners have a mutual incentive to delay the completion of pending orders. Even though contracts may be in place, the yards are motivated to work with the owners to delay delivery because they don’t generally want to keep the ships.

While shipyards do sometimes become ship owners, providing unwelcome competition to the traditional owners—and there is evidence that is presently happening in some quarters—that kind of conglomerate structure ultimately dilutes profit. Ship owners make money from effectively managing their risks as shipping fees go up and down, trying to make the best decisions on when to lock their ships into contracts and when to purchase new ships to meet future demand. Shipbuilding is more focused on steadier margins, getting the best contract price to produce a ship and then constructing it to specifications.

Combining the two deprives the shipyard of its basic and arguably most predictable opportunity for profit, a good contract price for a ship, because the ship will be sailing on the yard’s own account [4]. Diana is keenly aware of this backdrop [5].

Sailing above all this, Diana built a fleet that is lean, new, and was largely booked when the bottom fell out of the market [6]. Its debt/equity and debt/asset ratios, 0.23 and 0.17 respectively, are stunningly low compared to peers Genco Shipping (GNK) (1.49 and 0.59), DryShips (NASDAQ:DRYS) (1.12 and 0.47), and Navios Maritime (NYSE:NM) (1.41 and 0.49). Now with a bundle of cash from a well-timed equity offering in May that raised $218 million at $16.67 a share, Diana can afford to buy ships meeting its exacting specifications at fire sale prices, all while it continues to profitably function [7].

Of course a big unknown is what will happen in Asia. Commentators tend to focus on certain big commodities and customers, like iron ore and coal ordered by China, as driving the train since that’s what they’re familiar with. My own sentiment is that this focus tends to overlook all the other possibilities for increased demand in this wildly developing region—whether it be aluminum for new car industries, cement for new construction, or grain for expanding economies shifting from agriculture to manufacturing—so that the potential for the market being surprised to the upside at some point is high.

Finally, as well run as the company is, I would not view Diana as the best stock to hold for the long term without watching it. The lows in shipping are low, and investors may want to trim holdings after a big rise before the next downturn. That being said, we are now far enough along to see who in the dry bulk sector is best positioned to make money when the East shifts back into high gear. The case for Diana is strong, and those who jump on board now in the $12-$13 range ($13.36 at close on August 21) will likely be able to make an attractive profit.

Disclosure: The author is long on Diana Shipping as of the original publication date of this post. The author does not hold a securities position in Genco Shipping (GNK), DryShips (DRYS), or Navios Maritime (NM).

Footnotes

  1. “Baltic Dry Index,” from Wikipedia, July 30, 2009 here.
  2. See public download of the China Research and Intelligence (NYSE:CRI) Report, “Report of Chinese Shipbuilding Industry under the International Financial Crisis,” March 16, 2009, here. See also OECD, “Fall in shipbuilding set to continue for some time, says OECD Council Working Party on Shipbuilding,” July 17, 2009, here.
  3. See Diana Shipping Q1 2009 Transcript (August 6, 2009), p. 5, May 6, 2009, here.
  4. The Rise of “Shipbuilder Owner,” World Yards, June 8, 2009, here.
  5. See Diana Shipping Q2 2009 Transcript (August 6, 2009), p. 4 here.
  6. See “Diana Shipping” at Wikinvest, June 30, 2009 here.
  7. See Diana Shipping Q2 2009 Transcript (August 6, 2009), here.

Source: Eastern Winds Favor Diana Shipping