Finding Opportunities in the Sinking Shipping Industry

by: Simon Monger

Analysts may be bearish on Genco Shipping & Trading Limited (NYSE:GNK) and Eagle Bulk Shipping Inc. (NASDAQ:EGLE), but the shipping industry has outperformed the S&P 500 this month and several companies could be poised for strong gains amid the weakness. In this article, we’ll take a look at the industry’s dynamics and some of promising opportunities that investors may want to consider moving forward.

Lower Day Rates and Debt Burdens

Some shipping companies have experienced the twin burdens of lower day rates and high debt. FBR Capital downgraded both Genco and earlier this week for these reasons. The analyst believes that GNK is at risk of violating its debt covenants by year end, while EGLE has both a high debt load and potential covenant risk overhangs.

The oversupply in the shipping industry, combined with the lack of a durable recovery, has led to problems for companies that had taken on a lot of debt to expand in the past. Meanwhile, lower day rates have proven dangerous for companies betting heavily on a recovery by refusing to lock customers into long-term pricing contracts.

Depressed Sector with Many Opportunities

While these problems face some companies, others have managed to avoid them through prudent expansion and long-term pricing contracts. These companies tend to have fleets that are near-fully utilized with favorable pricing and little debt load. These opportunities include companies like Diana Shipping Inc. (NYSE:DSX), which has almost no debt and 14 of their 20 ships chartered through 2011.

The sector also appears to be trading at a significant discount to its long-term potential, as evidenced by DryShips' (NASDAQ:DRYS) recent agreement to acquire OceanFreight Inc. (OCNFD) for a very significant near-100% premium. This takeover valuation could help boost multiples throughout the entire sector and perhaps open up the market for additional consolidating over the coming quarters.

A Look at a Few Key Opportunities

  • DryShips' acquisition of OceanFreight could translate to some real long-term value for shareholders, according to Goldman Sachs. The analyst believes that DRYS could unlock value through a one-time special dividend of OCNF stock or cash, a share repurchase authorization and a recurring stock dividend. Meanwhile, the analyst has a $6.00 per share price target on the stock – a significant 60.4% premium to the current market price.
  • Diana Shipping Inc. (DSX) offers one of the safest and strongest plays in the sector with very little debt and strong fundamentals. Meanwhile, the stock trades at less than 1.0x its book value and under 10x its trailing 12-month earnings figure. Of all the companies, DSX or GNK may be the most likely additional takeover targets given their fundamentals and valuation, respectively.

An Options Pairs Trade to Mitigate Risk

Investors looking to take positions in these opportunities may want to consider purchasing long-term equity anticipation securities (LEAPS) call options against an industry ETF put option, such as the Guggenheim Shipping ETF (NYSEARCA:SEA). As a result, investors can hedge themselves against any declines industry-wide and profit from the outperformance of these few securities in the sector.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.