Recently the bulk shipping industry is showing signs of recovery and the shipping rates are rising after many years of rate weakness. DryShips (DRYS), a Greece-based global marine transporter, is one such company that has been able to sustain its business through increasing its dry bulk shipments. We expect that the company is poised to benefit from the rising rates through its diversified bulk shipping fleet. Orders for the majority of ships in the dry bulk shipping fleet rose during October 4 - 11. The orders for "Capesize" carriers surged to 10.68% from 10.32% in the previous month and "Panamax" carrier orders increased to 16.99% from 16.64% in the previous month.
On the other hand, DryShips reported a net loss of $18.2 million in the second quarter of 2013, which was the same as last year's second quarter. It also observed flat revenue of $336 million during the quarter. One of the reasons for this flat performance was weak shipping rates that resulted in more than 27% year-over-year decline in dry bulk carrier segment revenue to $42.4 million. Conversely, the stock price is up by around 87% in this year, and since the second quarter of 2013 announcement on August 7, 2013, it has skyrocketed by more than 43%.
Diversified fleet to save the ship
Orders for Capesize carriers increased during October this year, the major reason behind this was the rise in shipments from Brazil and Australia. The company owns 42 carriers, out of which 10 are Capesize carriers. Around 40% - 50% of DryShips' revenue is dependent on the highly volatile shipping rates of this carrier. The shipping rates for this carrier peaked in September this year, reaching around $20,000 per day and significantly surged in October to $40,000 per day. One of the major reasons for the increase in the rates is high shipment demand from China, which is one of the largest iron ore exporters. A 10% climb or fall in the Capesize rates would affect overall dry shipping revenue by 4%-5%. If this increasing trend continues, we believe it could have a positive effect on the company's top line.
In our view, the increase in rates of Capesize is accompanied by an increase in rates for Panamax carriers, which is the second best carrier in DryShips' diversified fleet. The company now owns around 28 Panamax carriers, which operate on spot rate, and it is observing an upward trend. As illustrated in the chart above, the Panamax rate was stagnant at $9,000 per day in September but crossed $15,000 per day in October. We expect that if Capesize carrier rates get very expensive in the coming quarters, customers will tend to split the Capesize cargo into two Panamax ships. So, if overall demand for shipping sustains, Panamax rates and orders will continue to rise and will offset the decline in orders for Capesize carriers, if there are any.
Moreover, DryShips has most of its Capesize in fixed-rate contracts, which are set to expire 2013 and 2014 and will have to be renewed. The contract renewal is a part of capital expenditure, and the company will require funds to renew them. In order to fund this, Dryships recently announced it will team with Evercore Partners (EVR) to offer and sell up to $200 million in common shares. The primary reason for doing this is to fully or partially fulfill its funding needs of around $150 million through 2014. According to the company, Dry Bulk shipping rates and orders will increase in the upcoming years. We believe selling common shares will aid the company to fund the contract renewal and focus on increasing the number of orders it will obtain next year.
Cash flow to play an important role
Capesize and Panamax are bright spots in DryShips' future, but it has a massive debt figure of $3.38 billion as of second quarter of 2013. The company's debt burden of $3.38 billion is daunting compared to its cash balance of only approximately $380 million. In our view, the cash flow from operations should possibly reduce the debt. Inversely, DryShips reported a negative $102 million cash flow from operations in the second quarter of 2013 compared to $128 million in the same quarter in 2012. This was due to decline in the shipping rates, which impacted the operations negatively.
We believe situations will improve in the coming quarters, based on the contracts scheduled to start for its drilling operations in the coming years. DryShips, through its subsidiary Ocean Rig UDW (ORIG) and an ownership interest of around 76%, also provide deep water drilling service. In August this year, Ocean Rig acquired a 3-year drilling contract from Repsol Sinopec Brasil S.A., which is schedule to start in November this year, benefitting DryShips. The company also announced that it successfully took delivery of its Newbuilding drillship, the Ocean Rig Mylos, and it will function in Brazil under the same contract.
Moreover, Ocean Rig also announced that it signed a contract with Samsung Heavy Industries to construct a 7th generation ultra deepwater drillship. This 7th Generation drillship is scheduled to be delivered to Ocean Rig in December 2015, and the project value price is estimated to be approximately $600 million. In our view, DryShips will benefit from this in terms of revenue and could help it realize positive cash flows from the new contracts. Although it will take a few years to have its effect on the balance sheet, we are confident that these contracts will help the company to reduce its debt in the long term.
Dryships has to share the space in the shipping industry with other players such as Eagle Bulk Shipping (EGLE) and Genco Shipping & Trading (GNK), which also engage in marine transportation of dry bulk shipments through a wide fleet of dry bulk carrier vessels worldwide. Together with DryShips, Eagle Bulk and Genco Shipping are facing industry headwinds from low shipping rates that resulted in revenue decline and losses. Eagle Bulk reported a net loss of $3 million in the second quarter of 2013, which was an impressive decline from $23.1 million in the second quarter of 2012. This decline in net loss was due to diversified cargo mix and operational efficiency, which the company aims to continue in the coming years.
Whereas, Genco Shipping posted net loss of $45.4 million in the second quarter 2013 compared to $27.7 million in the same quarter last year. The company incurred losses because it continued to operate a large and modern dry bulk fleet through cost effective ways, as daily vessel operating expenses were below its budget. Though the losses have increased, Genco Shipping has been taking initiatives to reduce its expenses and lower down its losses. It will focus on controlling cost though operational efficiency, which will help negate the effect of declining shipping rates. Unlike for Dryship, its competitors' strategies are working in their favor and we believe it is having favorable effects on the balance sheet.
When compared on the basis of shareholder returns, Dryships' performance seems to be impressive with 91% in this year.
EGLE data by YCharts
Eagle Bulk was able to provide over 305% in this year, which is astounding, but on the other hand, Genco Shipping provided negative returns of approximately 8%. This shows that Eagle Bulk has clearly outpaced its peers and has potential to grow. In addition, in comparison to the shipping industry, DryShips is undervalued; it holds a P/B ratio of 0.43 times and the P/B ratio for shipping industry is 1.4 times.
In our view, this could make the stock more attractive for a buy, and the factors discussed above coupled with rising shipping rates will result in upward movement in the stock price in the years to come. Also, all these companies are expected to release their third quarter of 2013 results in the coming weeks, which we believe will be another positive for investors.