DryShips (DRYS) stock has suffered throughout 2011 along with most of its shipping peers, losing a total of 28% in market price since January 2011.
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Although the dry bulk market has been greatly depressed for the past two years, DryShips' majority-owned subsidiary (78.4% ownership), Ocean Rig UDW, has been producing solid financial results. It is for this reason that many investors are viewing DryShips as an “oil rig play” instead of as a dry bulk shipping company with a few oil rigs. I am taking the contrarian approach and will break down the finances of DryShips to show that there is a hidden value play in this stock (ironically in the worst-performing sector).
Ocean Rig UDW Financial Contribution
DryShips’ oil rig division has been boasting strong performance and a contract order backlog. This backlog boost represents a $126M contract value in addition to the already announced $2B contract backlog (1Q11). In the most recent quarter, Ocean Rig posted a profit of $29.9M (158% gain y/y) on revenue of $109M (36% gain y/y). This recent profit represents an operating margin of 26.4%, which is very impressive compared to the low (or even negative) current operating margins in the dry bulk industry. Ocean Rig has a net debt load of $649M, but this is supported by drillship assets of $3.14B. This gives Ocean Rig a net valuation of $2.5B ($1.95B owned by DRYS).
To assess an accurate valuation of DryShips' fleet, we can look to recent ship sales by the same company. On July 21, DryShips sold four ships with a book value of $182.4M for an aggregate price of $75.5M, or roughly 41.4% of value. It should be noted, however, that the average age of these ships was 14 years and no contract was attached.
Accounting for the recent ship sale, DRYS now owns a fleet of seven Capesize (5.3 years avg), 26 Panamax (8.1 years avg), and two Supramax (8.5 years avg). DRYS has stated that it plans to continue selling off older ships, so brace yourself for a few more 50-60% BV losses.
In addition to the drybulk fleet, DRYS also boasts a 12 ship tanker fleet, of which five are 2011-builds, four are 2012-builds, and three are 2013-builds. Since these are brand new vessels, book value will be assessed at a 80%-100% valuation.
DRYS does not list its dry bulk sector performance individually, but the numbers can be obtained by subtracting 78.4% of Ocean Rig's profits from DRYS' total profits. This results in a 1Q11 profit of $3.13M on revenue of $98M for an operating margin of 3.2%. It should also be noted that these are GAAP earnings, so depreciation and interest charges are factored into these results. I personally think that the current depreciation system (straight line over 25 years) is flawed for dry ship valuations, but that is another discussion in itself.
Balance Sheet and Liquidation Values
DRYS’ dry bulk and tanker division carries a net debt of $1.46B against stated asset values of $2.11B. This at first presents a scary debt-to-asset ratio of 69% (against an expected liquidation value of under 50%); however, there are two caveats to this number that I believe most investors are overlooking:
- The DRYS tanker fleet (12 ships) is brand new and is in a highly-performing sector. These ships are worth far more than 50% liquidation value. Unfortunately, DRYS does not break down the assets between tanker and dry bulk so I can’t get the exact numbers here.
- Ocean Rig adds a net value to DRYS f $1.95B.
Assuming that the tanker fleet only boosts the total fleet valuation to 60% (moderately conservative), DRYS has a liquidation valuation of $1.56B. DRYS is currently trading at $1.5B market cap which represents a liquidation discount of 4%. There are other stocks such as Excel Maritime (EXM) and Starbulk Carriers (SBLK) that also trade at a liquidation discount, but they are not backed up by a profit generating machine like DRYS is.
Since there is already an additional 4% premium against the worst-case (bankruptcy and liquidation of the shipping division), I see no barriers to entry on this investment. Both divisions continue to earn profits, with the drill-ships division poised to pop.