DryShips: Set To Sink Deeper

| About: DryShips Inc. (DRYS)

Summary

DRYS has been pummeled badly in 2016 as the conditions in the shipping industry have worsened, and it is likely that it will continue to fall further.

The World Container Index’s shipping rates are near 11-year lows as shipping demand is stagnant and supply has increased, leading to low charter rates for DRYS.

DRYS is seeing weaker rates as China’s trade is declining due to overcapacity in the iron ore and coal markets, which are key drivers of drybulk shipping.

Looking ahead, China will cut down on steel production and also see a decline in electricity generation from coal, which will production and lead to lower trade activity.

The drybulk shipping market has been under a lot of pressure due to the oversupply in the industry as demand has declined. This is clearly seen in DryShips' (NASDAQ:DRYS) performance on the market this year, as it has lost more than 44% of its market capitalization. But what's even more alarming is the extent to which DryShips' financial performance has eroded on the back of a decline in time charter rates.

For instance, DryShips saw a huge decline of 96% in its revenue last quarter to just $23.8 million. Looking ahead, I believe that the company will continue to see its top line diminish as the conditions in the drybulk shipping market are expected to worsen. Let's see why.

Industry oversupply is hurting DryShips

The dry bulk shipping business has experienced a dramatic decline in the past couple of years due to increasing supply and declining demand, and this has been the primary headwind for DryShips. For instance, the global dry bulk fleet supply rose 22% to 750.3 million dwt in 2015 from 617.1 million in 2012. But, at the same time, the rate of demand growth has slowed down to just 2.1% in 2015 from 10% in 2012.

This clearly indicates that drybulk demand is lagging behind supply growth, leading to a drop in charter rates. As a result, the Baltic Dry Index has plummeted approximately 83% since its peak of 2,330 in the beginning of 2014 to just 406 at present. Due to the decline in the Baltic Dry Index, which is an indicator of shipping freight rates, it is not surprising to see that charter rates have declined massively of late.

For instance, the World Container Index's shipping rates are near 11-year lows currently. Considering that demand for shipping had increased just 1% last year and supply increased 8%, this is not surprising. This oversupply clearly reflects on DryShips' charter rates, as shown below:

Source: DryShips

As can be seen above, DryShips' utilization levels dropped to 96.2% last quarter from 99.1% in the prior-year period. This was despite the fact that DryShips had elected to sell 17 vessels, including 13 Capesize and 4 Panamax bulk carriers, though it was not able to dispose all of them. This weakened its utilization rates last quarter.

Moreover, due to the industry oversupply, DryShips' time charter equivalent and total voyage days for vessels declined 61% and 34%, respectively, year-over-year.

A recovery is difficult

The prospects of the drybulk shipping market appear bleak going forward due to unfavorable demand and supply dynamics. Historically, iron ore and coal trade have been the two key determinants of drybulk demand. Unfortunately, both of them have slowed down considerably of late, owing to a decline in demand for commodities in China. For instance, China's iron ore imports for January 2016 declined 14% to 82.19 million from the previous month.

Meanwhile, coal imports in China were down approximately 9.2% for the month due to a severe capacity glut, thereby leading to a drop in prices that eroded the cost advantages usually enjoyed by foreign suppliers. In fact, Chinese coal imports have fallen nearly 30% in 2015 from 2014 levels.

Going forward, at least in the short run, the demand for coal and iron ore in China will continue to decline. This is because the country has been focused on cutting steel production to mitigate the oversupply that's being faced by the sector. In fact, by 2020, the Chinese government has decided to slash steel production capacity in the range of 100 million tons to 150 million tons. Additionally, the Chinese government has also elected to ban new steel projects, which will have a negative impact on iron ore demand.

Last year itself, China's steel production was down 2.3% to 803.8 million tons, which was the first decline in 34 years. At the same time, coal usage in China is also declining. As reported by The Guardian:

"China's coal use has fallen in 2015 across a wide range of measures and its national carbon emissions are likely to have fallen by about 3% as a result. There was a 3.5% drop in coal production, coal-fired electricity generation fell 2.8% and overall power generation dropped 0.2%, the first fall in 50 years. There were similar decreases in coal-intensive heavy industry such as iron, steel and cement."

Looking ahead, over the next three to five years, China's thermal power generation is anticipated to drop at a CAGR of 2%-4%. This will reduce the country's demand for coal further and hurt the shipping industry.

Conclusion

DryShips has already struggled a lot due to difficulties in the end-market, and it is likely that its struggles will continue in the future. The market for drybulk shipping is oversupplied and as demand falls in China for key products such as iron ore and coal, the conditions will get worse. So, staying away from DryShips will be a prudent decision as the stock will sink further after being decimated badly this year already.

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

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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