What Is Happening With DryShips?

Aug. 7.14 | About: DryShips Inc. (DRYS)

Summary

The core business of the company continues to show weakness and the prospects of drybulk business still remain unclear.

The financing costs continue to increase as the company borrows to fund newbuilds program.

Margins are getting better as the off-shore assets continue to win contracts at attractive rates and cover the financing costs.

DryShips (NASDAQ:DRYS) announced its earnings yesterday with an improvement in its income, and the company did a lot better than what the market was expecting. The average consensus for EPS stood at 8 cents a share while the actual loss turned out to be 1 cent a share. The company has made some huge improvements thanks to its subsidiary, Ocean Rig (NASDAQ:ORIG). However, it still has to deal with many issues on its income statement and balance sheet. In this article, we will look into the company's earnings to specify the growth areas and also look at the weak areas. Furthermore, we will look into the drilling segment's future growth to figure out the company's opportunities and threats.

Pinpointing the Improvements

In the second quarter, DryShips reported a substantial improvement with net loss of $5.6 million as compared to $18.2 million last year. Its total revenues jumped 57% from $336 million to $527 million. Specifically, the revenues from voyage grew 13.2% while the revenues from drilling contracts grew roughly 70%, making it the main driver of growth.

Source: SEC Filings

We also have seen a significant boost in the company's operating margins in the second quarter. Operating margin went up from 11.6% in the last year to 24.8% for the second quarter this year, the operating margin improved by 13.2 percentage points. This improvement, however, was partially offset by the rise in voyage expenses which alone could have dragged the company down if it was not for the drilling contracts.

Problem Areas

DryShips' biggest problem has been its finance cost which is the main reason that absorbs all its profits. The interest cost it is bearing right now was far greater than its whole operating profits, and ended up eating all the profits of the company. This year, finance costs have increased by 54% from $56 million to $86 million. However, the adverse effect of this increase was offset by the 235% increase in operating profits. Therefore, in this area, the company has made some progress despite an increase in financing costs - however, the growth mainly comes from its subsidiary, OceanRig, in shape of new drilling contracts and the earnings from its core operations remain poor.

The improvement in the operating profit is due to the attractive day rates offered by off-shore drilling - these day rates remain substantially higher than the financing cost - as a result, despite an increase in financing cost, the operating margins have improved. Most of the new financing was done to increase the fleet size of OceanRig as it is industry norm in this sector that companies borrow funds in order to finance new builds program. The company does not hold much cash in hand to fund this kind of investment. In fact, the cash in hand also decreased 15% year-over-year. However, it does not necessarily suggest a tight solvency situation. This is because an equivalent of the decreased amount was increased in "Other current assets" on the balance sheet which could be short term investments or working capital.

A good thing which will benefit the company in the short-term is the refinancing of its debt. The company has refinanced a big chunk of its debt i.e. $500 million which was taken at 9.5%. Now this debt is refinanced at 7.25% saving finance cost of $10 million a year for the company. DryShips also raised $1.3 billion through senior secured term loan to refinance previous loan worth $1.35 billion. With that, the company increased the availability of cash up to $75 million for ocean rig. In addition, it also bought some time on its maturity through this step.

Growth in Backlog

During the second quarter, the company landed some new drilling contracts making its order backlog grow even further. One was announced on 5 June, 2014, a three year contract with ConocoPhillips (NYSE:COP) for drilling off-shore Angola. This project has the total revenue potential of $1.3 billion. In addition, it won another contract with its semi-submersible drilling rig, which has the total revenue potential of about $164 million. Drilling for both these contracts will start during the next year.

Conclusion

DryShips is not in an ideal condition but it is making the right moves in order to turn around its business as drybulk carrier business continues to disappoint the investors. OceanRig is an important asset of DryShips as prospects of off-shore drilling are better than the drybulk business at the moment and this asset will continue to support the overall business of the company. As OceanRig has also started to pay dividends, this will further enhance the benefit of holding OceanRig for DryShips. However, concerns about the core business of the company remain as the drybulk market is showing slow recovery. An increase in economic activity might stimulate the demand but the short-medium term prospects of drybulk business remain unclear.

Additional Disclosure: This article is for educational purposes only and it should not be taken as an investment recommendation. Investing in stock markets involves a number of risks and readers/investors are encouraged to do their own due diligence and familiarize themselves with the risks involved.

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Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.