Investors in shipping companies haven't had it easy over the last couple of years and shareholders had to swallow a serious depreciation in their investments. The dilemma of the dry bulk shipping industry can be summarized quickly: After the financial crisis swept into the real economy, trade volume contracted, and with it, shipping rates. But that wasn't the only problem. Overcapacity issues also continue to haunt the dry bulk shipping market and its operators to this day. Just before the financial crisis hit, many operators increased their fleet size and made substantial, debt-financed investments only to see the market disappear right in front of their eyes.
Some shipping companies such as FreeSeas Inc. (FREE) had a particularly troubled year with shares literally in freefall: FreeSeas' shares are down 63% just last year alone. And other shipping companies haven't been doing much better; Genco Shipping and Trading Ltd. (GNKOQ), a dry bulk cargo ship operator, recently filed for bankruptcy due to continued depressed charter rates. Bloomberg reported on April 21, 2014:
The shipping industry has suffered from a glut of vessels after buying too many before the 2008 global recession, driving down rates and saddling companies with debt, said Erik Nikolai Stavseth, an Oslo-based analyst at Arctic Securities ASA.
"They were all victims of the exuberance we saw in the shipping market in the mid- to late-2000s," Stavseth said in an interview before the bankruptcy filing. "High leverage on expensive assets is what killed them."
Georgiopopulos's General Maritime Corp., which operates in more than 230 ports in more than 70 countries, filed for bankruptcy in November 2012. Its restructuring gave Oaktree Capital Management LP most of the company's new stock.
Other ocean-transport companies have sought bankruptcy protection since the financial crisis, including Overseas Shipholding Group Inc. in 2012 and Excel Maritime Carriers Ltd., which filed last year and emerged on Feb 14.
The dry-bulk shipping market is recovering from the biggest glut in history, according to Clarkson Plc, the world's largest shipbroker. The fleet has swelled 84 percent since 2008 while trade advanced 31 percent, according to Clarkson's data.
Genco owns 53 dry-bulk carriers, consisting of nine Capesizes, eight Panamaxes, 17 Supramaxes, six Handymaxes and 13 Handysizes, according to its website. Capesizes are the largest, and Handysizes the smallest, by carrying capacity.
Genco Shipping and Trading is only the latest victim brought to its knees by an increasingly harsh consolidation wave that is sweeping through the shipping market.
Other companies such as Diana Shipping (NYSE:DSX) are doing somewhat better and shares are up at least 2% over the last twelve month. Shares of DryShips (NASDAQ:DRYS) have shot up over the last year and actually delivered a gain of 39% to shareholders, even though shares are down approximately 40% from their 52-week High of $5.00 per share. As the share price is leveling off in the $3 neighborhood, the stock might be an interesting opportunity for contrarian investors.
Is DryShips a turnaround bet?
Let me clarify something first, to make sure readers know where I am coming from: I am specifically looking for distressed investments in sectors that receive overwhelmingly negative commentary (maybe with a few odd exceptions). I believe investors who go against the crowd can make substantial amounts of money and the dry bulk shipping sector certainly is fair hunting ground. In fact, I think many investments that have corrected substantially from their 52-week Highs, are attractive simply because they have put off so many investors. Why is a stock at $3 less attractive than a stock at $5?
In any case, DryShips felt the pinch coming from falling shipping rates. The Baltic Dry Index -- a shipping rate benchmark -- has been extremely volatile over the last year and shares of dry bulk shipping operators are closely correlated to shipping rates, despite the fact that many operators enter into long-term fixed-rate contracts. Why? Ultimately, contracts will have to be renewed and volatile/falling shipping rates are not necessarily easing the anxiety of investors. In other words: Investors are extremely emotional and easily panic about rates even if they are not immediately affecting the earnings prospects of the shipping operator.
Business fundamentals less important than shipping rates and iron ore demand
Much has been said about the relevance of iron ore for the dry bulk shipping industry and a recent interview with George Economou, Chairman & Chief Executive Officer of DryShips highlighted the importance of Chinese iron ore imports for the shipping sector (see interview transcript here). The most relevant section of the interview, in my opinion, is reproduced below:
George Economou: Let's not let short term volatility, which will always exist in the commodity and shipping markets, cloud the longer term fundamentals of the industry, which in our opinion remain unchanged.
The Cape market has temporarily weakened, but we expect a stronger freight market as the result of the factors we discussed. But let's put things in perspective. During the first eight months of 2013 spot Capesize freight rates averaged $8,000 per day. During the last four months of 2013, they averaged $28,000 per day. Year-to-date in 2014 Cape rates averaged $16,000 per day as compared to $6,000 per day during the first quarter of 2013.
With planned mining capacity expansion, industry experts expect that an additional 120 to 140 million tonnes of Australian and Brazilian iron ore cargoes will come to the market this year.
As I mentioned, overall Chinese iron ore demand is expected to continue to grow and an additional boost to demand will come from the trend to replace domestic iron ore with imports. And, lower iron ore prices can actually accelerate this trend.
All this means additional demand for ships, especially Capesize vessels. But a stronger Cape market ultimately lifts the other segments as well. Also, newbuilding deliveries are slowing during this year as well as into 2015 thus tightening the supply demand balance. Even if Chinese demand slows temporarily, as buyers wait for prices to fall further, this does not reverse the longer term trend.
The dry bulk market is bound for a recovery in the coming weeks, as the market will be better balanced, said Mr. Michael Bodouroglou, Chairman and CEO of Paragon Shipping, in an interview with Hellenic Shipping News Worldwide. Mr. Bodouroglou attributed the lacklustre performance of the market since the start of the year to a high level of newbuilding deliveries and a slowdown of grain and iron ore trade.
We expect the low iron ore prices to boost imports to China, while we also expect a solid grain trade out of the US, and a continued strong grain trade out of South America as political issues in Argentina get worked out. These two factors, along with a slower delivery schedule for the rest of the year, should cause a very strong fourth quarter, and rates may even start to improve as soon as the summer.
I know what many investors will be saying: The turnaround in the shipping industry has been awaited for so many years, why should the market turn around now? For one thing, if more and more CEOs go on record expecting shipping rates to turn around and benefit from higher projected iron ore exports to China, investors should listen. Secondly, investors cannot reasonably expect analysts to come knocking at their door with a crystal ball and tell them when shipping rates exactly hit the bottom. Investors get paid for taking risk.
I think the price of DryShip's shares will be largely determined by increased iron ore imports in China and a rebound in shipping rates and not by specific earnings releases. DryShips will report first quarter earnings on May 22, 2014 after the markets close. While I do not expect much of a catalyst from DryShips' quarterly results, DryShips is a good bet on improving sentiment in the depressed shipping industry nonetheless. Given that the stock has consolidated approximately 40% since its 52-week High and has been leveling off, contrarian investors could consider a first entry position in the $3 region. Once the extraordinary amount of negative sentiment with regards to shipping companies subsides, DryShips does have a solid chance of becoming a multibagger over a 3-5 year period. Contrarian BUY.
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