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Summary

  • China’s iron ore exports will increase in the coming years.
  • Dividend from Ocean Rig will improve DryShips cash position.
  • Capesize and Panamax vessel rates are expected to increase.
  • Revenue and EPS are expected to improve in the next two years.

Shares of DryShips (NASDAQ:DRYS) surged more than 190% during the last year. However, year-to-date, the stock has lost more than 30%. Nevertheless, the stock still has a great upside potential because the market conditions are improving for the dry bulk carrier industry.

Since the beginning of the year, the Baltic dry index has dropped more than 50% due to decrease in iron ore demand from China due to its New Year. However, this effect is temporary, and the index will improve as iron ore demand increases. DryShips' entire fleet is under long-term fixed rate locked contracts, so short-term fluctuations in daily spot rates will have no effect on the company.

As the consumer of 60% of global iron ore, demand of dry bulk vessels is heavily dependent on Chinese iron ore imports. China plans to increase its spending on infrastructure that will drive the steel demand. China is likely to set another record this year in steel production. The country's steel production is estimated to reach 802 million tons this year, and 819 million tons in 2015. Due to rise in steel production, its iron ore imports will reach 872 million tons in 2014, and 916 million tons in 2015. Shipments from Australia will rise 19% to a record 687 million tons this year and climb to 749 million tons next year.

Iron ore prices are also expected to decline in the next few years, which is positive for DryShips and its peers. The Bureau of Resources and Energy Economics [BREE] expects the spot price of iron ore to fall from its average of $126 a tonne last year to $87 by 2019. Decrease in iron ore price will encourage traders to import more iron ore. Increase in Chinese iron ore imports will drive the demand for dry vessels and push spot rates higher. According to projections from Clarkson Capital Markets, Chinese demand for coal and iron ore will drive the demand for dry-bulk vessels by 4.5% this year and 5.4% in 2015. That growth should easily outstrip the rate of construction of new ships, which Clarkson projects will increase some 4.3% in 2014 and 2.8% in 2015.

(click to enlarge)

Source: 2013 Annual report

DryShips owns a total of 42 drybulk carriers: 12 Capesize, 28 Panamax and 2 Supramax vessels with a combined deadweight tonnage of approximately 4.4 million dwt and an average age of approximately 9.7 years. The chart shows us that the company's three Capesize vessels will be free within the next two years. According to Clarkson Capital Markets, Capesize vessel rates will reach $24,301 per day in 2015 from recent rates of around $8,400. This means that DryShips will benefit from the surge in Capesize vessel rates next year. Contracts at high rates will mean higher revenue and higher profit for the company. Besides this, its two Panamax vessels will free up in 2015, and two in 2016. Rates of Panamax vessels are also expected to jump at least 65%.

DryShips has a very high debt-to-equity ratio of 147x, and that has caused many to think the company may need some help staying afloat. High debt is also the main obstacle in generating profitability. In 2013, the company reported a net loss of $223 million. The net loss include interest and finance costs of $332 million, up from $210 million in 2012. Excluding interest and finance costs, its net loss would turn into a profit of $109 million. Last year, the company also recorded depreciation and amortization expense of $357 million. Depreciation and amortization are non-cash expenses that have no effect on its cash flows in the period. If we exclude only this expense from the loss of $223 million, DryShips' net loss would turn into a profit of $134 million. So, my calculation says that the company is still generating money, not losing.

DryShips also has a stake in Ocean Rig UDW Inc. (NASDAQ:ORIG) that gives it some flexibility. Recently, Ocean Rig announced its first common stock dividend. It declared a quarterly cash dividend with respect to the quarter ended March 31, 2014 of $0.19 per common share, to shareholders on record as of May 20, 2014 and payable on or about May 30, 2014. Although this dividend will have no impact on DryShips' earnings, it improves its cash position, which in turn will help to manage its debt.

Analysts are also bullish on DryShips. According to Yahoo finance estimates, the company will report revenue of $2.02 billion this year and $2.39 billion next year. EPS is estimated to be $0.18 and $0.51 in 2014 and 2015, respectively.

Bottom Line

The future of DryShips is looking bright. China's iron ore imports are expected to increase, and that will drive the demand for dry bulk vessels. Although its high debt indicates some risk, improving market conditions and the dividend from Ocean Rig will help to manage this debt easily. In my opinion, DryShips is an attractive investment for long-term investors.

Source: DryShips: A Buy Or A Sell?