I have followed Dryships (NASDAQ:DRYS) for around 2 years while increasing my focus on their UDW holdings. Following the successful spin-off of Ocean Rig UDW (NASDAQ:ORIG), announced in September 2011, DRYS has used ORIG equity sales to fund debt payments and additional capital expenditures for the core drybulk and tanker fleets.
The drybulk and tanker markets are uncertain-at-best, the earliest possible turnaround will be late-2013. The best presentation, in my opinion, is Genco Shipping's (NYSE:GNK) May 2012 Investor Presentation (PDF file), look to slides 10-16 for "Industry Overview." Long story short, we are in a bad environment for the next 2+ years. If DryShips can survive for 2 years without burning away too much of their ORIG holdings, they will give a massive return on investment. The higher ORIG remains on the market, the more cash DRYS can retrieve while sacrificing less ownership. Thus, ORIG's price is the key to DRYS' valuation, and ultimately to their survival.
My first article on DryShips, written in late July 2011, recommended a buy based on the value of the drillship division. I received some valuable feedback in the comments pertaining to sketchy management (insider dealing by Economou) and the likely deterioration of the dry bulk sector. I did not break down individual ship values in my analysis, but rather applied a "50% asset liquidation" shortcut. While this was (near) accurate at the time, ship values have continued to drop, and a re-evaluation is critical.
In October of 2011, I was awarded an "Editor's Choice" for my article that pinpointed DRYS' valuation above $4. Based on ship valuations and ORIG holdings, I estimated that DRYS should be worth between $2.77 and $4.12.
Ocean Rig Liquidity
According to Yahoo Finance, ORIG has an average analyst 1yr target of $21.78. With a current price of $13.09, and DRYS ownership of 65.2%, or 85.87M shares, approximately $1.12B in extra liquidity is available. If ORIG hits $21, DRYS will have $1.8B in liquidity. There are two tradeoffs that DRYS must make:
- Stock Pricing - wait for higher ORIG prices in the market or sell immediately?
- Earnings - Is ORIG worth more based on earnings (and pass-through dividends) than the stock is currently trading at?
In both cases, I believe that ORIG is worth far more than $13 per share and any immediate share sales will drive the price down further, hurting future returns from DRYS.
Value of Ocean Rig Stock?
Economou, CEO of DRYS and ORIG, is the ultimate insider. During the latest offering, "companies affiliated with [Economou] have agreed to purchase 1.9M common shares from [DRYS] in the offering" at a price of $16.25 per share. As the common expression goes, "money talks and bs walks." Economou has placed his money behind ORIG at $16.25.
The future of oil drilling and underwater exploration is uncertain. With the price of WTI oil dropping below $80, many analysts are predicting increasingly tough times for this sector.
Ocean Rig will be able to avoid a rocky season in drilling through their long-term contracts. In the recent Q1-12 presentation, ORIG boasts $2.9B revenue backlog with 100% coverage in 2012. At 90% estimated utilization for 2Q-12, ORIG will generate revenues of approximately $260M. I estimate EPS of 30 cents and OCF/s of 75 cents ($98M). Under new debt provisions that also eliminated cross-default provisions, ORIG has permission to pay 50% of their earnings in dividends. Full earnings potential will not be known until ORIG's remaining three drill ships come online in 2013. If the market worsens, ORIG stock will likely follow. Current pricing suggests a negative outlook. I believe that the fair value for ORIG stock, once the 50%+ overhang of DRYS' ownership is eliminated is approximately $20.
Valuation of DRYS Fleet
DryShips has three main subcategories-drybulk, tankers, and drill ships.
Drybulk: DRYS has a deliverable fleet of 46 vessels.
- Capesize (9 @ 8y: 28.5) + (4 @ 0: 40.1) + (3 @ -1: 43.3): $546.8M
- Supramax (2 @ 10y: 15.4M): $30.8M
- Panamax (24 @ 9y: 18.6M) + (2 @ -2y Ice-class: $29M): $504.4M
- Net Value: $1.082B - $354.7M capex: $727.3M
Tankers: DRYS has a deliverable fleet of 12 tankers.
- Suezmax (3 @ '13: 56.8) + (2 @ '12: 55) + (1 @ '11: 53.7): $334.1M
- Aframax: (3 @ 2012: 39.6M) + (3 @ 2011: $38.3M): $233.7M
- Net Value: $567.8M - $439.6M capex: $128.2M
Drillships: Valuation is comprised by ownership of ORIG shares.
- Net Value: Market price of $13.09/sh @ 88.87M shares: $1.20B
Market-Adjusted Valuation of DRYS Equity:
To achieve an image of Dryships' balance sheet, all Ocean Rig assets and liabilities must be removed from the Q1-2012 consolidated DRYS reports.
Net debt of DRYS after subtracting all cash and other current assets and adding in relating liabilities is $1.33B. Following the recent ORIG share sale, net debt is $1.14B.
Add back the rest of ORIG @ $13.51, the net tanker fleet, and the net drybulk fleet, and DRYS' market-adjusted book value (true equity) is $873M, or $2.30/share.
The net value of DRYS is only 22.5% of stated equity! Ironically, 22.5% is actually a good number compared to many shipping companies. Excel Maritime (NYSE:EXM) and others are far underwater.
ORIG is the Key:
With DRYS at $2.19, the market is pricing in either a decline in the value of drybulk and tanker vessels, or an ORIG pricing of $13. If ORIG meets the 1y price target of $21.78, DRYS will have "true equity" of $4.23. If ORIG plummets to $10, DRYS will be worth only $1.59.
How long can DRYS hold off on their ORIG shares? Expect an article highlighting this relationship and the "ticking time bomb" soon.
If you believe that the drybulk market and tanker market will improve in the future, DRYS represents massive upside. They are safer than most shipping investments with a few exceptions. Diana Shipping (NYSE:DSX) and Navios Maritime Holdings (NYSE:NM) are much better managed and have stronger balance sheets. If you believe that ORIG has a strong future and is a "steal" at $13.09, and you are not terrified of future drybulk/tanker prospects, DRYS is a good stock for you. My personal price target for DRYS is $4. This is not for the faint of heart. This is not "easy money."