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Industry Analysis

In 2008, the Dry Bulk Shipping Industry was at its peak, as the Baltic Dry Index (BDYI) soared over the 11,000 mark in May that year. However, a couple of factors led to the collapse of the Shipping Industry, and now most of the industry players find themselves on the brink of bankruptcy, as the BDYI has crashed by almost 90%.


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The Dry Bulk Shipping Industry derives its demand from that of dry bulk material, which includes coal, grain, sand, iron ore and gravel etc. To understand the industry's stocks, one needs to take a close look at the factors that lead to a decision, on part of managements, to expand/contract the existing fleet of vessels. The demand for vessels is influenced by changes in exploration or production of energy resources, location of production/exploration sites, location of consuming regions, developments in international trade, changes in transportation patterns, currency rates, and the number of orders obtained to transport the material between places. The following factors have come into play in deciding the industry's fate:

  • The current global downturn has negatively impacted the shipping business. Major players like China are facing slow growth, which has led to a reduced demand for iron ore and steel, which in turn has led to overcapacity of shipping vessels. Forecasts for the next 2-3 years for dry bulk orders do not promise much as well. The current demand for dry bulk is 100 million dead weight tons (dWt), which is expected to fall to around 20 million by 2014. Dry bulk vessel deliveries, which form 25.5 % of the total deliveries executed by the existing fleet, are forecasted to decline to 6.8% in 2013. With the threatening European debt crisis, and the fact that six of the top ten global container terminals are located in China, EXIM volumes will remain subdued across the major container trading route between Asia and Europe.


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  • Excess supply of iron ore in China has resulted in falling iron prices and increased stock piles at Chinese ports. Iron ore inventory at major Chinese ports surpassed 100 million tons this June, as compared to 90 million last year.
  • Threats of piracy have led to customers turning to other modes of transportation for dry bulk. DryShips (DRYS) 20-F claims that in 2011, 45 vessels were hijacked and 802 crew members were taken hostage. The Gulf of Aden off the Coast of Somalia has been a hot spot for such activities.

The industry is also going through some other problems, including a financing issue. Back in 2007, the boom in the Shipping Industry, and the increase in money supply, on the back of low interest rates, helped financial institutions lend cheap credit to the Shipping Industry. The industry, anticipating tremendous growth, ordered more fleets than were actually required. By the time the ships were delivered (it takes more than two years to fulfill any order), the demand had drastically squeezed. The unwanted increase in the supply of ships led to overcapacity, which in turn brought down the fair value of the vessels owned by the Shipping Industry. This fair value forms an integral part of the loan-to-value ratio, which a firm has to maintain under the covenants signed with lenders. As the valuation plummeted, firms had to renegotiate the loans at highly unfavorable rates.

  • The freight rates for dry bulk have taken a hit due to excess capacities and an overall decrease in global demand. Also, there is intense competition, as the industry is highly fragmented, with the market divided amongst 1,600 independent dry bulk carriers. A falling BDYI is a good indicator of how the rates have been falling, which resulted in weak profitability for the industry.
  • However, oil prices have gone down. Some predict that this development is a good sign for dry bulk transporters, due to a reduction in costs of transportation. However, plunging oil prices more significantly show slow growth in the global GDP, which grew at a modest 4% in CY11.


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Major Companies

Factors

DRYS

EGLE

EXM

GNK

DSX

EBITDA (TTM):

569.1M

95.87M

130.31M

197.79M

150.78M

Operating Margin :

23%

10%

-7%

19%

39%

Net Income :

-144.69M

-26.44M

-247.16M

-21.11M

94.32M

EPS :

-0.40

-1.72

-2.90

-0.59

1.17

PEG (5 yr expected):

7.83

0.02

-0.09

-0.23

27.11

LT Debt

4.39B

1.14B

1.07B

1.70B

393.27M

LT Debt/EBIT

7.71

11.89

8.21

8.59

2.61

Ev/EbitDA

10.28

12.32

20.35

8.32

3.94

YTD performance

2%

-17%

-62%

-59%

-2%

Ships + Tankers

49+12

45+0

47

53

23

Next Earning Announcement

30-Aug

3-Aug

27-Jul

26-Jul

3-Aug

DryShips Inc.

DRYS faces extreme headwinds going forward, specifically because of its dependence on China's growth, for its own financial strength, share dilution, and exposure to high levels of floating rate debt. Once trading at $110 in October 2007, the share has crashed to $2 as of this June.

However, given the YTD performance, it shows that the firm is playing well in a harsh environment. This has primarily been made possible by the diversification of DRYS in rigs, as it currently owns 65.2% of the Ocean rig's shares. The firm managed to fund its CAPEX by selling off 11.5 million shares of Ocean rig to the public. Therefore, levered cash flow may not be a good metric to use during the analysis. Also, the firm's debt level is quite manageable, as compared to its close competitors. Having the second lowest LT debt/EBITDA ratio amongst its peers, DRYS faces less exposure to the potential breaching of the loan covenant, due to plummeting valuation of vessels. Also, revenue from dry bulk is only 25% of the total revenue earned by the company. Bears have commented that cash from ORIG's shares is the only reserve left with which DRYS can survive. The following computation shows that this is not true.

EV of ORIG

4626.5 M

Ownership of DRYS

65.20%

Value

3016.478 M

DRYS' current EV is $5,803.07 million, which is greater than the value of ORIG's ownership, showing that DRYS is not a "free business". However, it can be safely stated that as long as DRYS acquires the backing of General Electric (GE), which owns shares in DRYS, the company holds a strong chance of surviving this bottom.

Diana Shipping Inc. (DSX)

Having an EV/EBITDA value of 4.0x (significantly lower than it direct competitors), showing a positive EPS, and having such a low debt/EBITDA, shows that the stock is undervalued by investors. The fact that the firm has recently spun-off its loss-making container ship division, strengthens the case. Currently, the main issue that dry bulk companies are facing, as mentioned already, is that of financing. The firm, which has enough to live through this bottom, will be a successful buy for investors. DSX, with its low level of debts, "sufficient" cash reserves, and being solidly locked in charter coverage, seems to pose the best position amongst its competitors, which is why it has recently managed to draw down a $10.325 million loan with the Nordea Bank on June 25, 2012.

Eagle Bulk Shipping Inc. (EGLE)

EGLE is desperate to live through the slump that the Dry Bulk Industry is experiencing right now. The execution of a recent stock split of 1-for-4, in order to stay listed on the NASDAQ, and an LT Debt/EBITDA of 11.4, much higher than its competitors, raises doubts regarding EGLE's ability to survive this slump. EGLE does not even have enough cash to cover its interest payments. The company claims to enjoy a competitive advantage in the form of being the largest U.S.-based owner of Handymax dry bulk vessels. With only $28 million in cash reserves (as compared to $450 million for DSX and $150 million for DRYS), the stock would have collapsed, had the company not managed to get a loan from the Royal Bank of Scotland (RBS). EGLE has had some fresh air to breathe, after it finalized an "equity for debt" deal with RBS. Even though the firm has diluted the ownership of its shareholders, the deal has guaranteed them to be a going concern until 2017 at least. The deal comprises of debt being converted to loan, set with a maturity till 2015, along with an inflow of $20 million, to curb the liquidity problems. After this deal, investors will prefer to long the stock, despite the fact that it has lost all of the gain that it made after the loan was announced.

Other players in the industry include Excel Maritime (EXM) and Genco Shipping (GNK).

Conclusion

The main catalysts to look out for:

  • The recovery of the global demand of coal, iron ore and dry bulk, especially in the Asia-Pacific region.
  • A firm being able to secure financing to survive until the demand for dry bulk materials recovers.
  • A firm with low manageable debt level and adequate cash flows is expected to survive this bottom.
Source: Which Dry Bulk Shipping Stocks To Buy?