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After years of pain, dry bulk carriers may finally be reversing their fortunes. This turnaround is tentative, however, and highly dependent on questionable macro trends. Financially sound carriers Navios and Dryships own a high percentage of Capesize ships whose rates are currently gaining the most while struggling carrier Genco could be headed for bankruptcy if the rally in dry bulk rates reverses.

The main shippers in play are:

• Navios Holdings (NYSE:NM) and Navios Partners (NYSE:NMM) - Financially sound Greek shipping group and its wholly owned MLP.

Dryships (NASDAQ:DRYS) - a diversified player focused on the larger end of the dry shipping market.

Diana Shipping (NYSE:DSX) - a carrier focused exclusively on larger dry bulk ships.

Genco Shipping and Trading (GNK) - a broadly diversified dry bulk shipper that has been teetering on the verge of bankruptcy.

Some background on Dry Bulk

Prior to the financial crisis, the Baltic Dry Index (BDI) was frequently toted as a bellwether for the global economy. Calculated using a weighted average of Capesize, Panamax and Supramax freight routes, the index gives observers a quick overview of the level of freight rates for the three largest categories of dry freight ships.

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The freight market is closely linked to the markets in large bulk, particularly iron ore and coal. As such, investors have often used the BDI as a proxy for the health of the real economy.

However supply and demand considerations within the freight market itself have led to a decoupling of the BDI with broad economic trends.

Until 2003, dry bulk freight rates had averaged well below 2000 points on the BDI index. Along with the commodity supercycle, freight rates began to rise so far as to briefly reach above 10,000 in 2007 and 2008. This increase spurred record orders for new shipping capacity which is just now being delivered.

At the same time that new shipping capacity was being built, the financial crisis and ensuing recession reduced worldwide growth expectations and many commodity prices plunged, setting the stage for an extended bear market in freight rates.

While the BDI has declined over 90% between 2008 and 2012, the largest Capesize ships which primarily ship iron ore were the hardest hit, with day rates plunging 98% to $4,000 from a record of $234,000 set in June 2008.

It is precisely these depressed Capesize rates which are rallying significantly for the first time since lows reached in early 2012. In searching for opportunity within the dry bulk sector therefore, carriers with fleets consisting of a large percentage of Capesize ships may have the most to gain.

Panamax rates have been rising more slowly while Supramax rates, for the smallest of the 3 shipping classes, have yet to rise significantly.

The Likely Winners

Navios Maritime Holdings offers investors two ways to invest through its holding company and its subsidiary MLP . With 17 owned or long-term chartered Capesize vessels, 33% of NM's fleet consists of Capesizes while NMM will own 8 Capesize vessels when counting its upcoming delivery of 1 Capesize and 2 Panamaxes, bringing its percentage of Capesize vessels to 35%, an industry-high.

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Analysts expect NM earnings to turn positive in 2014, while NMM's are currently positive and expected to decline into 2015.

Net profit margins at NM have turned negative but no worse than industry average while NMM's margins have averaged a solid 40% for an MLP. Expansions in forward PE multiples at both companies show that the buyside sees strong potential for a rebound in these two stocks.

While NMM has not reacted much to the strong gains the BDI has shown in the past month, it has been appreciating all year. NMM's success is tied to NM's continued strength however and NM probably represents the purer play on a rebound in dry bulk and particularly Capesize rates.

NMM recently issued 5 million new shares at $14.26, raising capital to further expand its fleet. The stock naturally gapped down in-line with the follow-on offering and is currently trading near the offering price point.

Dryships may offer the best value of the bunch as it is a diversified player which is nonetheless focused on the larger end of the market, owning 10 Capesizes, 2 Very Large Ore Carriers and 28 Panamaxes.

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While profit margins are currently negative at DRYS, they are more attractive than much of the competition and earnings are expected to turn positive as soon as mid-2014. A significantly compressed forward PE of 12x indicates DRYS has so far been neglected compared to peers.

Diana Shipping has a strong focus on larger ships, owning 8 Capesizes and its entire fleet being of Panamax size or larger. Net long-term debt at DSX is low and earnings are expected to become positive in 2015. However, profit margins have been declining steadily and forward earnings valued at 97x appear very expensive.

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Should DSX's stock price pull back without BDI's rally being endangered, there may be an attractive buying opportunity.

What if the rally in dry bulk rates fails?

Genco Shipping & Trading provides the most interesting short opportunity should the rally in dry bulk rates reverse.

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While GNK owns 9 Capesizes and 8 Panamaxes, its Capesizes only represent 16% of its total fleet as it owns a large number of Supramaxes and Handysizes, ships on the smaller end of the scale which are not benefitting from the rally in rates that has benefited larger ships.

Net profit margins at GNK declined steeply in the past year and now rest at -99.1%, while earnings are expected to remain negative for the foreseeable future.

Rumours of GNK's imminent bankruptcy were spread earlier this year and only the current rally in dry freight rates can justify hope for the company's survival. In the event BDI's rally reverses, GNK is likely to see the sharpest decline in its shares.

Keeping Tabs on the Situation

It is crucial to understand which factors will materially affect the potential turnaround story.

Iron ore shipping has been the primary driver of resurgent rates. An important reason for renewed iron ore shipping has been the low prices reached by iron ore which may be pulling future demand for iron ore forward.

As such, a bet on a rally in dry bulk carriers is not simply a bet on China resuming its strong growth, but also on iron ore demand continuing to drive large dry bulk shipping rates. This will be particularly challenging considering new supply coming to market via shipbuildings.

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Considering how notoriously doctored China's growth statistics can be, keeping an eye on the BDI index and iron ore prices is still one's best bet to monitor the macro environment shippers are working in.

The Fed's decision not to proceed with tapering gave dry bulk shipper shares an extra push, in particular DRYS which is now overextended. GNK is the only stock of the group still far below the initial highs set in early September.

Waiting for a pullback before entering a long would be the optimal course, especially for DRYS.

On the other hand, GNK (which is up over 100% since early August) could easily drop over 50% if the progression in dry bulk rates were to reverse.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Source: Dry Bulk Shippers: Turnaround Or Mirage?