Diana Shipping: Prime Rebound Candidate

Despite a bit of back and fill action the last few days, it appears the market is putting in at least a short-term low. While the long-term direction of our markets could take on any number of different outcomes, the climactic low placed last week in wake of the Bear Stearns (BSC) debacle should mark a support point and give the markets several weeks of relief.

During this time, shorter-term traders should be able to take advantage of a lift and many depressed stocks will show very attractive rebounds. Returns after such a fearful low can often stack up very quickly and account for the lion's share of the full year's profits.

In looking for names that are likely to benefit from this improving environment, I have been drawn to many of the shipping names. These companies include Diana Shipping (DSX), Dryships Inc. (DRYS), TBS International (TBSI), Eagle Bulk Shipping (EGLE) and more. While the names all rise and fall according to some of the same economic metrics, you should do your homework to determine the fundamentals of each before putting your capital to work. In this article I will cover a few of the issues facing the entire group and then make some specific statements about DSX. However, the discussion can be applied to many other names within the group.

The dry bulk industry, as it is called, has a very close relationship with prices of commodities, supply and demand for those commodities, and the growth of emerging economies. As nations like China and India demand more and more in the way of grains, metals, and many other materials, shipping rates have been increasing and the supply of available vessels has been stretched. Naturally, when demand for transportation soars and supply of vessels is relatively inelastic, the price for the use of those vessels will rise sharply.

This is the phenomenon we have been dealing with for the last several years. Since it takes quite a bit of time for new ships to be manufactured, current owners of the vessels have enjoyed profits as day rates were pushed higher.

Within the past few months, however, the economic issues have caused concern about the sustainability of commodity prices. As inflation ramps up in some emerging economies, there have been questions as to the long term growth in demand for commodities. At the same time, some negotiations between the Chinese government and BHP Billiton (BHP) as well as Rio Tinto (RTP) over iron ore shipments from Australia to China have caused disruptions in the shipping schedules.

While the long-term fundamentals still look very good for the shipping industry, lower spot day rates have caused significant drops in the share prices of many of these shipping companies. These declines present investors with attractive opportunities to pick up stock at very reasonable multiples, especially compared to the high prices that these companies were fetching just six months ago.

When looking more specifically at the companies individually, there are some key differences that typically hinge on 3 different metrics.

1. The first issue is financing. When companies decide to purchase a new ship, they can finance that purchase with cash on hand by issuing debt or by issuing new equity. Since most companies do not have enough capital lying around for such a large purchase, they have turned to selling bonds or preferred stock to finance such transactions.
   Diana Shipping has a unique approach in that management has decided to purchase most of its new vessels using equity, and so when it finds an attractive purchase, it issues a secondary stock offering to fund the purchase. This cuts down on risk as the capital is permanent, and while it may at times be dilutive to current shareholders, most are usually constructive on the opportunity to purchase a new cash generating asset.

2. The second issue revolves around the company’s dividend policy. While many management teams have decided to keep earnings in-house to build book value and possibly finance growth initiatives, Diana has decided to pay out the majority of its cash flow to investors, thus keeping its dividend yield very high. In looking carefully at the returns to investors including the past dividends, the stock has a very attractive historical return.
   One benefit of a healthy dividend policy is that it often helps to stabilize the stock somewhat as investors are unlikely to sell a holding that pays an attractive cash flow on a regular basis.

3. Finally, a firm must strategically decide whether to operate under the fluctuating daily spot rates or whether to engage in long-term charter rates. While the prices were steadily rising, it seemed to make the most sense to take advantage of the potential revenue increases by accepting the daily rates offered by the market. But in volatile times, it now seems wise to charter a large portion of available shipping days with long-term contracts to stabilize revenue and provide a more reliable earnings stream.
   Diana has historically made extensive use of long-term charters, and while that may have caused management to forfeit some opportunity, the stable earnings and more recent new contracts at attractive rates have served the company well.

The last interesting dynamic to point out is that each ship has a definitive useful life before it must undergo extensive repair or be scrapped. New capacity is coming online in the form of new ships being built, but an aging industry fleet will likely have to retire ships, taking a bite out of the new capacity. As scrap rates increase sharply this year, there is more incentive for owners of aging vessels to go ahead and take their ships offline which could throw current assumptions about the shipping supply into transition.

As the industry adapts to the growing need for global shipping, and as the price and demand for commodities continue to rise, shippers are likely to enjoy growth as an industry. The recent market dynamics create an opportune time to look at many of these names as short-term trading vehicles, and a few qualify for long-term investments.

As always, please trade responsibly and with damage control in mind, but also have the discipline to step into the market when opportunities set up for high quality profits.

Disclosure: Author has long positions in DSX and DRYS.

Comments

[DSX Lover:]

I totally agree with this article on Diana. Diana has very low debt, the newest fleet in the industry, average vessel is under 5 years old with useful life of 25-30 years. With 19 ships, 6 Capesize ships chartered long term 3-6 years, all 13 Panamax Ships chartered 100% through Sept 2008, with 2 becoming available at the time of the grain harvest, where prices are higher. Diana discloses with great detail, who its customers, are, how much are they paying for the ship, and for how long, it updates the fleet deployment chart on the day the change takes place, unlike other shipping companies. It even provides a fleet positioning map to see where the ships are and where are they heading. With 9% Div Yield, and increasing earnings looks to be a horrible short.
Also the last 6 Panamax Ship charters will increase earnings for 2008 by over 75% of 2007. Just look at the rates
Ship 2007 Rate 2008 Term Charter
Erato 30,500 80,300 12-15 months
Dione 28,500 82,000 12-15 months
Protefs 31,650 70,000 6 months
Alcylon 22,582 34,500 5 years
Calypso 26,750 55,000 12-15 years
Nirefs Avg Spot(50K) 60,000 2 Years
Diana Shipping beats the Treasury Yield by 600 Basis Points, with upside potential, and stability.

2008 Mar 28 10:33 AM

[Fundamental:]

I don't find the article informative. In fact the previous comment is more helpful than the article itself. The author is essentially arguing three things: 1. equity financing is better than debt financing; 2. dividend payout is better than reinvestment; 3. long term contract is better than spot contract. All are subject to debate, and answer should be "depending on the situation...". However, the author failed to put any of these in perspective of the dry-bulk shipping industry. That the increase of scraping rate will alleviate supply side concern, as contented by the author, will likely provide a false comfort. Ships have useful life of almost 20 years and the normal scrapping will only take out 5% capacity annually. Unless the author presents quantitative measure to show the current scrapping rate is significant, this point should not be trusted.

2008 Mar 28 10:57 AM

[dn4911:]

I disagree with a number of the conclusions the author has made.
1. DSX's latest fixtures have been spot, not time charters.
2. THere are better dry bulk shippers that follow the DSX strategy of long term charters.

For example, look at Paragon. PRGN.

Metric PRGN DSX
08 PE 6.1 9.0
Yld 11% 8.8%
09 PE 9.8 6.5 (this is the one that concerns me most about dsx)
Fleet age 7.5 4.2
NAV/Price 1.53 1.02 (adjusted for mkt value of fleet)
08%DivPayout 66.6% 79.5%
09 %DivPayout 71% 86%
Debt/EV .89 .10
08 EV/EBITDA 3.8 7.4
09 EV/EBITDA 7 8.5

So while the author is correct about the low debt and young fleet, DSX earnings per share and dividends are less that PRGN and DSX pays out more of its earnings as a percent of income.

Starbulk is another one that is better than DSX.

2008 Mar 28 12:41 PM

[dn4911:]

Sorry I reversed the 2009 PE numbers. I project DSX 2009 PE to be 9.8 v. 6.5 for PRGN.

I should add that I have made a lot of money off DSX in the past, in fact still own a few shares and have had a nice run up last few weeks, but based on the current valuations I would put money in DRYS, PRGN, GNK, SBLK or NM before DSX.

2008 Mar 28 12:45 PM

[Itsonlymoney:]

You guys are awesome! Great insight from everyone and no name calling.

2008 Mar 28 01:07 PM

[DSX Lover:]

SBLK, has an old fleet. DRYS earnings are very volatile, any plunge in Spot rates, there goes the stock, aslo 1.25 billion Debt. PRGN, GNK, SBLK, and NM are highly leveraged with older ships. DSX is sound, the higher P/E does not reflect the company's strong capital, and with 50% earnings growth for 2008 is misleading, meanwhile DRYS will not grow EPS by 50% and has to serve that Huge Debt. Other carriers that pay higher dividends than DSX are leveraged 100% to 300% more, hey if DSX borrowed it could doubled its Dividend and still be superior, but that is not the way it operates. It is a more conservative company, and as long as Panamax Rates stay at 50K or more you can count on that 9% safe dividend. With 50% chartered for 3 years or more, Diana is safe, while all the others could get shellacked with Spot Rates dropping

2008 Mar 28 01:15 PM

[berniemill:]

where does ESEA fit into the shipping picture?

2008 Mar 28 03:10 PM

[User 169832:]

I'm surprised no one has included Ocean Freight (OCNF) in this conversation. With a nice dividend and reasonable valuation, I'd choose OCNF over most of the bulk shippers previously mentioned.

2008 Mar 28 10:04 PM

[EGLE roosted:]

Any thots about EGLE??

2008 Mar 29 12:36 AM

[Bhakta:]

Good article. I am a long term holder of DSX. I appreciate the comments from others giving good suggestions too. Thanks

2008 Mar 29 12:39 AM

[notsosmart:]

i apologize if this is the wrong place but check out FRO & draw your own conclusions.

2008 Mar 29 09:28 AM

[cherylish1:]

I am sticking with Ocean Freight OCNF - Dividend payment was very nice this quarter ( March08) .77 per share

2008 Mar 29 10:22 AM

[Zachary Sch...:]

Hey all,

Thanks for the comments - a lot of very astute followers of Diana and the other shippers out there. I obviously haven't published the pages and pages of analytics necessary to fully cover this industry, but hopefully my comments give a basis from which to launch a more thorough analytical process. You may be interested in looking at my previous article on DSX from January.

Jim-Bob,

I have to respectfully disagree with you in that the smaller investor actually can have an advantage in this market. With the volatility increasing and the swings occurring quickly, smaller investors can sweep in and take a meaningful position (long or short) when fear or greed push prices out of balance where it takes larger institutions much longer to build their positions to a meaningful size.

All - good luck trading this market and thanks for the good spirited discussion!

2008 Mar 29 02:33 PM

[thefuture007:]

Hello ALL
Followed Shipping Sector for a bit,had my dad buy..OMM at $6.55 and out at 27.50/Sold to TK. before following ships became Fashionable...oops I mean a Momentum play.Good Analysis on fellow Responders here.The dry's and Oils gotta be moved and these Sectors are Solid but with any Stock the Markets/Players cause big swings so make bets near Technicals 50DMA/200DMA's and use Options/Hedging up/Downside.!I like TBSI,ACLI,TK,TNK.and EXM after takeover,and sure DSX is good DIV as is prgn but if you know about Drydocking and ship Replacement you'll understand the True worth of a Company vs Present stock price..Read the 10-k on this Web-site of TBSI,for info about How shipping is this quarter,it Also explains their companies Drydocking COSTS and Future Drydocking costs = STEEL cost..ETC.and days in dry dock.Or read the companies 10=k's before Investing and see,capitallinkshippin... or Dry bulk index site to see where " Rates are and do Comparative of Stock price VS Spot or Charter and " NET" vs the Index and Vs the Market.As the Momentum players drive it up too high or too low too quick vs the actual rates they are getting thus creating Stock Value as soon as you Purchase,or you'll understand when a particular stock is overvalued.Those charts are provided on that site.I think end of Quarter Rebalancing will be good time but Remember this whats a shipping/Freight/Rail/... Biggest Expense.?..YUP....OIL.... oil goes up expect lower profits at Quarters end,as oil is now,$100/Barrel, " Fashionable/Momentum play theres no saying it can't hit $150-200 not that it will but hedge funds are greedy and if a Trades going up they play it that way..ETC.But if oil Stablizes and some Genuis at one of these shipping companies Hedges Boom Profits can soar even on a Time chartered outfit,more so for Spot Rate guys..DSX..etc..oh if you didn't know it the EU and Japan/korea area are Requiring Double Hulled tankers thats why theres a Shortage of tankers and Credit problems loom for Smaller players whom Can't Finance with cash or issuing stock in Net P/E positive way.That Doesn't Affect a Dividend.!just a hint but guess where and by whom most ships are being built.?And why 500tons of Steel for a Complete 1 Ship,Drydocking makeover are Driving iron ore and steel prices up or maybe it's the 1 Billion new Consumers Demand they have also.Happy Trails All.

2008 Mar 29 05:56 PM

[Bigwavedave:]

Good reading here.
www.reuters.com/articl...

2008 Mar 29 07:41 PM

[tjschoenlein:]

I've been looking to add a couple dry bulk shippers to my portfiolio and this article as given me some good insights and names to research. This is the type of information & discussions that make Seeking Alpha a daily visit.
Thanks!

2008 Mar 30 01:22 AM

[Marol:]

I hate to drag down the level of this terrific discussion, but I have a basic beginner's question, which is particularly pertinent to shipping (esp, FRO, etc):

I just don't understand why we should care about dividends, when the stock normally declines by the same amount each time the dividends are paid. I mean, I don't understand either short-term or long-term.

Am I missing something? Help! -- and thanks.

2008 Mar 30 03:21 AM

[attack:]

What about seaspan? (ssw)

2008 Mar 30 08:50 AM

[jjc7477:]

To Marol:

Perhaps it would help to create a spreadsheet similar to one I've been using to give a historical perspective of dividend influence. I use Yahoo Finance's historical pricing and dividend data and download the info to an Excel spreadsheet. Then I use the history to perform a study based on a ten year period. I start with a $100 investment and then follow the stock to determine what the valuation would be if I didn't touch it again. A great example (not specifically related to this article) is ticker BPT. It's amazing how much value you can gain by having high yield stocks. In a bear market when stocks depreciate, you gain value by being able to purchase more shares as long as the dividend stays consistent (dollar wise) or growing. In the case of BPT, the dividend does fluctuate, but the dollars are so high you still gain a decent return. An important note: dividends are taxable and this of course affects the annual return. By the way, exclusive of taxation, $100 of BPT bought April 15th, 1998 would be worth $2600 as of January 14th, 2008 (AND the stock has increased since then!).

2008 Mar 30 01:45 PM

[SCK:]

A beginner's question: Would selling a covered call during the dividend stock run-up and then buying it back after the ex dividend date make sense as a profitable strategy? I am assuming that I would make money on the call spread and earn the dividend. Am I missing something?

2008 Mar 30 09:39 PM