Dry Bulk Shipper Anomaly in Spot Pricing Creates Buy Opportunity

Right now an anomaly exists in dry bulk shipping. The rates for chartering vessels for 1 to 2 year periods are far greater than the spot rate. Usually it's the other way around.

For instance, you can get $157,000 - 167,000 a day to rent out a Cape sized vessel for a year, $135,000 a day if you go out 2 years, much better than the $116,391 at the current spot rate. The Panamax sized vessels have similarly higher prices for one ($71,000) and two ($63,000) year charter periods over spot rates ($57,450). That doesn't make much sense. When you charter a vessel for a one or two year period, you get the comfort of knowing you've got a steady stream of income coming in. Typically, you give up some of the higher rates of the spot trade for this long term safety.

This anomaly tells us a lot about where dry bulk shipping is now. First, the rates are wonderful for the shippers. It costs them only $6,500 dollars a day to run a cape sized vessel. The rate of return is phenomenal. You can currently get $150,000 to 160,000 a day in profit for one year charters!

Second, the fact that period rates are better than spot rates tells us that the demand for vessels is so great that the market is willing to pay whatever it takes to charter a boat. There is a palpable worry that all the rates are going higher -- spots, periods -- and the sooner you can lock in the price, the better. We've seen lots of evidence. The Baltic Dry Index, the index that compiles the spot rates for 40 routes of dry bulk shippers, is rising sharply, up about 40% in a little over a month.

In addition, iron shipments are going to skyrocket. For months, iron shipments have been held back. That's about to change. Vale (RIO) just negotiated a 65% iron price increase with Japanese, Korean, and Chinese steelmakers. Iron makes up about 40% of dry bulk shipping. That resolution will unleash the pent up shipments of coking coal and iron that have been held back these three months.

How to play the dry bulkers? Those dry bulkers who specialize in longer charters like Genco Shipping & Trading Limited (GNK) (who have a couple of vessels getting ready to re-contract) are going to benefit as their current contracts come due. They will take advantage of the appetizing charter rates. But much much more exciting are the dry bulkers who primarily do spot trades like DryShips (DRYS). DRYS can pick and choose. Most of their boats are already at spot. They have very few long term commitments. As rates continue to climb, DRYS can continue the spot market or, at any time, go longer term, take advantage of the high period rates and be guaranteed to make a killing.

Disclosure: Long DRYS and GNK

Comments

[Option Dragon:]

Great article. very informative.

2008 Feb 27 09:27 AM

[tessant:]

the more i read, the more i love drys

scott
growthportfolio

2008 Feb 27 10:14 AM

[Linkster:]

Most investors don't realize that 75% of the world's GDP comes from countries outside the Industrialized world. Their growth continues irrespective of American and European economies.

Linkster

2008 Feb 27 10:54 AM

[shara:]

very int and informative article. But if this is true then why is this sector getting beaten up regularly?? why is it so volatile?? even now DRYS stock prices are soaring ... any comments/insight on this??

2008 Feb 27 03:25 PM

[DSX Lover:]

Its $117 for a Capesize today, and the information that the rates are going up to $135 to two years is innacurate. Look at the deployment fleet on DRYS website and you will see that it has Capesizes for $76K per day on Spot, because those are the rates that the chartered got between Nov-Dec when the trip was booked. That is huge drop from the record $184K per day booked on the previous trip. DRYS Spot rates are so volatile also because of port Congestion, in some ports of Australia the waiting time is higher than 30 days so there's no need to rush the shipments if the bulks are going to be waiting for that long. DRYS has massive debt, and unpredictable earnings, that's why is not worth $120 today. The record earnings for Q4 will not be duplicated again, and if you look at the fleet deployment you will see that most of the Panamax Fleet is chartered at rates between $45K and $60K a day and not the $85K a day it got on Q4. According to analysts in the Capital Conferences the average for Panamax for 2008 is 55K and 105K for Capesize. So make your earnings forecast based on those, and not the 95K and $175 it made on Q4. The Chinese economy will cool off after the Olympics and with that 65% increase in Iron Ore Prices and 7.5% inflation, China is exporting inflation that the World is not going to be able to pay. All these risks are priced in the Stock.

2008 Feb 27 04:25 PM

[ACEMAN:]

Emerging markets, especially China, and the Baltic Dry Index move together with commodities. But take a good look at the Index and you'll see a dramatic drop. Could emerging markets follow?

2008 Feb 27 09:44 PM

[A.S.D.:]

I picked up some Genco in the low $20s back in '06 when it was paying about 10% yield. I can't imagine anyone getting so excited about it in the $60-$70 range. If you must have it now, be ready to get out with any big move up -I will not be holding any shares this summer.

2008 Feb 27 10:20 PM

[R. Richard ...:]

How about data on the rate of DRY shipbuilding and scheduled deliveries from the yards.

2008 Feb 28 08:57 AM

[TIRED:]

dsx is a great buy now it has long term contracts pays great dividend

2008 Feb 28 09:15 AM

[skates77:]

Couldn't the earlier lower spot price be caused by a different reason? Meaning, there is (or was) more spot supply or less spot demand, therefore the earlier lower prices?"

So maybe there was a slowdown or a preceived slowdown in this market. And it could be that the shippers were/are hedging the future price increases, but having less takers on the long or one and two year contracts, so possibly is there less demand?

This might be putting more capacity or ships in the spot market? Thus lowering price.

So wouldn't the fact that spot prices are still lower than long positions be a reason for caution. Or, do you see that chaning soon? Just posing the question, not attacking your position.

2008 Feb 28 12:15 PM

[Gaucho:]

According to the Friedman Billings and Ramsey's analysts who wrote this article on Feb. 25th, world wide power plants need to immediately purchase 150-200 Million Tons of coal in order to replenish their reserves which have fallen to dangerously low levels as a result of the flooding in Australia, the chronic power outages in South Africa and the coldest winter in Southern China in fifty years. These events collided in a near perfect storm to severely disrupt world wide coal mining operations for several months. In addition, this article also forecast that by 2012, the world will require another 1.3 billion tons of coal to be mined and shipped in order to satisfy 1,000 new coal powered plants which are being built to provide the world with an additional 300 gigawatts/annum of power. Since most of this coal will be shipped from Australia, Africa, North America and South America to Asia and Europe, the world will need a heck of a lot more dry bulk cargo ships both in the short run and in the long run. To put this into perspective, to haul another 1.3 billion tons of coal using ships which carry on average 100,000 tons per trip, will require an additional 13,000 dry bulk freighter trips per year. This does not account for other huge freight increases which will also occur from shipping commodities such as iron ore, cement, copper ore, etc.
Additionally Japan importing from the US for coke/coal due to problems in Australia.
The recent resolution of negotiations for the ore prices and subsequent catch up in shipments you have a perfect storm for the dry shippers.

2008 Feb 28 02:09 PM

[Eric Schleien:]

World's Scariest Stock: DryShips
By Rich "Cap'n Blood" Smith October 29, 2007 Comments (20)

60 Recommendations

Ahoy, investors! Methinks me sees a ghost ship cresting the horizon. Sails tattered, the Jolly Roger hoisted -- why, it's not just a ghost ship, it's a ghost ship manned by pirates, arggh! And its brig is crammed with the lost souls of investors, imprisoned behind the iron bars of logic.

The Flying Dutchman, you say? Nay, landlubber. This is something faaaaar scarier. This is Athenian cargo carrier DryShips (Nasdaq: DRYS).

Gasp! What's that sound?
Originally chartered to ferry loads of coal, steel, and other commodities across the waves, DryShips bears a different cargo today. You can hear the wails of lamentation emanating from its hull, the moans of investors who've publicly panned DryShips' stock on Motley Fool CAPS -- and suffered the consequences:

TMFOtter: "In the 1990's, the last time capital was cheap, [DryShips CEO George Economou] took an identical company public and evaporated every last penny of shareholder capital."

Steve819 [Quoting Barron's editor Kathryn M. Welling]: "When someone asked why he was [taking his company public, Economou] actually said, basically, 'Because Americans are the dumbest investors around, and there's lots of liquidity in this market.'"

Allstar13913: "The CEO is crooked, and directly owns a competing company." (privately owned Cardiff Marine, Inc.)

TMFEldrehad: "'We do not intend to sell shares,' [Economou] said. This means the company can put a big part of equity back into buying vessels. Economou added: 'We can deliver more money for every dollar invested in the company.'... [S]elling shares in a secondary offering will result in more equity with which to buy ships, but that's not what he's saying -- he's saying not selling shares translates into more equity. I need some Dramamine, because my head feels like it's spinning from trying to understand this."

These CAPS players have three things in common. First, they're all extremely leery of DryShips' management. Second, they're all good enough investors that their concerns should be your concerns, too. Each and every one ranks in the top 1% of investors tracked by CAPS. Third and finally -- they've all lost big time in their bets against DryShips, in some cases, seeing the stock rise more than 1,000% since placing their bearish bets.

Madness
Has an epidemic of insanity swept the coast of CAPS-land? Or is there truly something wrong with DryShips? As one of the many investors who've seen their CAPS ranking decimated by betting against the company, I've asked myself this question more than once. But the more I look, the more I see red flags waving alongside the skull-and-crossbones at DryShips. Consider a few numbers:


Price-to-Book


Profit Margin (trailing 12-month)


CAPS rating (out of 5)

DryShips


7.2


63.9%


**

Diana Shipping (NYSE: DSX)


4.9


56.4%


*****

Excel Maritime Carriers (NYSE: EXM)


4.5


36.4%


****

Eagle Bulk Shipping (Nasdaq: EGLE)


3.3


30.4%


****

Quintana Maritime (Nasdaq: QMAR)


3.1


26.6%


*****
Data from Yahoo! and CAPS.

In what sane universe do capital-intensive companies like these deserve multiples to book value approaching those of asset-lite profit leaders like Google and Microsoft?

And while I'll grant you that the dry bulk shipping industry is booming, I fail to see why a single player within this industry -- DryShips -- should enjoy a valuation more than 50% higher than its nearest rival, and more than twice that of some of the ships giving more distant chase.

Sure, it gets the best margins of the bunch, but that just raises more flags. Reviewing DryShips' results, we see that much of its profit over the past year was derived from gains on the sale of assets. Meanwhile, the firm's cash flow statements don't show this supposedly wildly profitable firm generating any cash profits since its IPO. On the contrary, over the last year, the firm has burned through nearly $500 million in free cash flow, as its long-term debt ballooned from $418 million to $728 million. Somewhere, this corporate ship has sprung a leak.

If DryShips can't generate free cash flow on sky-high margins, I shudder to think what will happen when those profit margins splash back down to sea level. And you should to -- because this is the scariest stock in the world.

Source: www.fool.com/investing...

2008 Feb 29 11:22 PM

[DSX Lover:]

DRYSHIPS hit $66 today. Buy it when it stops going down.
Panamax SPOT $69K, Capesize $137K, today, if they stand for the next 15 days, DRYS will beat estimates for the next quarter. It should be a hell of a Run into the next earnings call. Just Hope George Economou don't do foolish things with the company's money, and bleeds the company's future like buying junkie assets at exhorbitant prices like OCEANRIG.

2008 Mar 07 04:59 PM

[feedtheyak:]

Market remains sloppy nearby,
but sentiment is for a huge pick up. (One of the better articles on dry bulk freight).
George Economu and the gang looking to relet the whole fleet and
lock in big profits, before the 2009 market turn down......
freight stocks a buy in the next few weeks, be out before the end of the year!!!!

2008 Mar 14 11:22 AM

[bdp1Consult...:]

The charter numbers quoted actually made it into the Journal of Commerce, but the JOC never understood the freight futures market, now, did they?

There are very slight premiums for 2 Q 2008 settle on paper contracts,but overall, 2008 presents parity withs spot, at best, for Panamaxes and Capes. But do you really think that George Economou will put his fleet out on time charter to capture these numbers? He put three ships on period last Oct/ Nov at the peak. Out of thirty something, maybe forty in the fleet. The forward curve is downward sloping for a reason guys.

2008 Mar 24 02:10 PM