Bullish on Commodities? Consider DryShips

The parabolic growth rate of China and India, with a combined population almost ten times that of the United States, continues to drive an unending global demand for iron ore, coal, fertilizer, grain, and oil. This is clearly evidenced by recent trends in the leading positions within each sector.

Growth sector indicators (3/26/2008):

Company - Sector - Gain from 52-week low

Nucor (NUE): iron-mining 72 %

Vale (RIO): iron-mining 102 %

Rio Tinto (RTP): iron-mining 83%

Peabody (BTU): coal 36%

Fording (FDG): coal 138 %

Consol (CNX): coal 105%

Potash (POT): fertilizer 209 %

Mosaic (MOS): fertilizer 288 %

Transocean (RIG): deepwater drilling 69 %

Diamond (DO): deepwater drilling 49 %

The dry bulk carriers are the primary transporter of iron ore, coal, grain, and fertilizer – a necessary link in the global industrialization boom. DryShips, Inc. (DRYS), the largest U.S. listed dry bulker with a market capitalization of $2.3 billion, reveals staggering growth metrics. They own and operate a fleet of 39 vessels and 8 new builds including capesize and panamax vessels. Year on year revenue growth weighs in at 195% with earnings growth of 443.5%. A trailing price to earnings of 4.70 highly discounts the phenomenal growth. DryShips, operating on a combination of “spot charter” and “period time charter” rates, is well positioned to take advantage of the strength in rates and will likely continue to lock in longer time charters as the rates continue their upward trend. 63% of their fleet remains unfixed hence will benefit from rising rates. With the advent of summer and fall, the BDI is poised to begin its ascent from a recent value of 7884 and is expected to remain strongly bullish in the foreseeable future.

Based upon the current charter rates for vessels (2/15/08), DryShips’ daily revenue is approximately $2.25 million. Their average expense per day per ship in 2007 was $6,387. This extrapolates to daily expense of $249,093 for 39 vessels. The net daily revenue minus expenses is $2.01 million. Hypothetically, even if bulk rates do not increase for the remainder of the year, earnings for 2008 should be $822 million. Recent guidance from the company places 2008 EBITDA at $840 million. With the BDI close to its yearly nadir, both of these estimates could prove to be extremely conservative. For comparison purposes, 2007 revenue was $582 million. Also, in light of global demand, future estimates are likely conservative. At an average vessel age of 8.9 years, DryShips maintains one of the newest fleet of vessels in the industry. The older vessels typically have more difficulty obtaining long-term time charters and usually lease for lower rates due to increased dry dock time. Lack of financing, inadequate shipyards, limited crews with experience, and rising cost of steel all will mitigate an influx of new ships in the near future. Increased scrapping of older vessels, prized for the value of steel, should further restrict the pool of available vessels.

DryShips’ recent foray into deep water drilling adds another dimension for future cash flow. Their recent purchase of a 30.4% stake in Ocean Rig, ASA and current options to build two drillships marks their entry into the highly lucrative field of deep water oil drilling. Day rates for deep water drillships are expected to run upwards of $650k/day and major players Transocean and Diamond Offshore remain strongly bullish towards the sector.

Growth and value comparison (3/16/2008):

Company - Price - EPS 2008 - Current PE - Earnings Growth [YOY]

DryShips (DRYS) - 63.91 - 18.35 - 4.80 - 443.5%

Google (GOOG) - 458.19 - 19.91 - 34.5 - 17.0%

Research in Motion (RIMM) - 118.15 - 2.24 - 63.2 - 111.5%

Intuitive Surgical (ISRG) - 323.97 - 5.12 - 87.5 - 107.9%

First Solar (FSLR) - 220.19 - 2.48 - 108.4 - 682.2%

Baidu (BIDU) - 241.50 - 3.98 - 94.1 - 79.0%

Apple (AAPL) - 145.06 - 5.13 - 31.8 - 57.5%

Cash is King

As of 3/14/08, DryShips has available liquidity of $680 million and a net debt to capital ratio of 25%. With a peak price last year of $131.34 and a lack of significant relationship to the U.S. economy, a PE ratio of 4.8 seems a fire-sale price for this company. Conservative earnings growth estimates, based upon guidance correlated with a reasonable PE ratio of 10 to 15, would value the price per share at potentially $189 to $283. With recent consolidation in the mid $50 range, DryShips may well warrant a second look. As spoken by Warren Buffett:

Most people get interested in stocks when everyone else is. The time to get interested is when no one else is.

Disclosure: Author is long DRYS and RIG and has no positions in NUE, RIO, RTP, BTU, FDG, CNX, POT, MOS, DO, GOOG, RIMM, ISRG, FSLR, BIDU, AAPL.

Comments

[daverichmond]

I spent almost 2 hours with the CEO, George Economou at the 3/20/08 shipping conference in NY. He had all the right answers to all of my questions regarding corporate strategy and plans. I suggested that with DRYS selling below 60, he should get authorization from the board to buy back stock because it was even a better investment than the drillships. He agreed!

[IRONMAN6]

The numbers for this company look great. It seems though that the market has factored something else into the equation. It badly trails its peers in valuation.

I am long and have added to my position...beginning to wonder if this is the proverbial "value trap".

[paultaut]

Newly listed SBLK is my choice among the container shippers....No following, will probably have a greater percentage payout than the others listed, is already buying back shares and trades at a very low valuation.

Baltic Bulk is currently smack in the middle of its recent trading range....want to know where commodity prices are going.....follow shipping costs.

[Jack Yetiv]

Ironman raises the same question I have:

Given the compelling metrics, what are investors seeing that is allowing this stock to be trading at a ridiculous PE of 5?

Jack Yetiv

[Jack Yetiv]

How do the metrics of SBLK compare to DRYS?

[drys long]

I think the stock has the valuation that it has because of scepticism regarding the CEO and, from what I understand, the market expects a flood of newbuilds in 2009 (I can't confirm this). Between now and then DRYS will likely trade as a leveraged play on the Baltic Dry Index. As the index bounces around so will DRYS but more violently (I'd love to know the beta for DRYS vs. the BDI). With sell-side research price targets ranging from $55 to $160 there is certainly room for both longs and shorts to be involved. Thanks to daverichmond for the color (above).

[20-20 Hindsight]

Please read:

Forbes.com 3/10/08
Curious George, by Nathan Vardi

"DryShips (DRYS) is a public company. But the way George Economou runs the place, you'd hardly know it. .... "

[ocean man]

The Street is worried about DRYS because of its foray into oil drill ships (Ocean Rig and options on 2 drill ships). Hopefully the front page of the WSJ speaking to the brilliance of the CEO of Seadrill in developing the exact same assets will allay fears about DRYS. DRYS is the most undervalued stock in all US traded equities.

[gaucho]

The only thing holding this stock back is a hedge fund that still has 5 million shares shorted. They controlled the price all day and limited any significant upward movement. It called selling into the bid a typical manipulation method.

[User 166933]

The reason drys is trading at such a low multiple is based on several facts, mostly centered around their CEO. First, he has a track record of screwing people over. He ran another company in the 90s, borrowed tons of cash, defaulted on the loans, and finally settled paying pennies on the dollar. Second, he has conflict of interest issues with Cardriff, the company that basically manages the fleet. Third, most people seem to think the investment in ocean rig is a bad idea. Currently ocean rig has a negative return on equity. Also, the CEO purchased 4% of the company himself, which has gotten drys on the hook to potentially be forced to buy the rest of the company do to norwegian law. I believe the 30% investment was in the neighborhood of 400 mil, meaning they're on the hook for potentially 700+ mil of forced investment. 4th, there is an expected massive influx of new ships in 2009 and 2010. 5th, drys has 1 bil in debt. 6th, they pay a really crappy dividend compared to other shipping stocks. 7th, the author's PE is not correct, the company has sold another 4 mil shares, so the total shares outstanding is now over 40mil as opposed to 36 mil, which as a percentage is rather large.

The main thing that kills this stock in my opinion is the high debt, the low div payment and the crappy investment in ocean rig.

[gaucho]

USER stop your bashing. I know you work for the hedge funds that are shorting DRYS.

Here are some of your BS statements:

'Third, most people seem to think the investment in ocean rig is a bad idea" I did not know you did a sample survey of the whole investment community. This is a great basher trick, make people believe that every one thinks this is a dab Idea.


Here is another example of half truths:"Also, the CEO purchased 4% of the company himself, which has gotten drys on the hook to potentially be forced to buy the rest of the company do to norwegian law. " Norwegian law says an offer must be made, but it does not say how much. Besides it is becomming obvious that he wants to diversify DRYS from just renting shipping to also renting oil drilling rigs.

Here is an example of an exageration:"ther... is an expected massive influx of new ships in 2009 and 2010." Yes more ships are to enter the market but many existing ships are over 25 years old and ready to be scrapped.

Here is another examople of doom talk and general bashing: "PE is not correct, the company has sold another 4 mil shares, so the total shares outstanding is now over 40mil as opposed to 36 mil, which as a percentage is rather large. " I guess 11% is rater large to you but not to most of us. He did raise 600 million for the purchjase of ocean rig. No the P/E will remain about 4 due to the huge ncrease in the shipping rates.

All in all your BS is full of half truths and hugely negative slants that rae missleading

[Itsonlymoney]

What's the worry. If DRYS is undervalued, and I think it is, then this is an opportunity to add to your positions. The market will eventually award this stock its correct value. In the mean time load up.

[Lion is King]

(Iron ore + Coal + Grain) / (1.3B Chinese + 1.2B Indu People) x YOY growth = Extreme Demand. You're going to need ships to deliver.
Long DRYS!!

[User 166933]

The law states that if someone else bids for the company, DRYS must better that bid and buy the entire thing. Considering it only has a market cap of 2.2 bil, a potential 700 mil forced investment is huge. Second, if you actually looked into it, you'd realize that the number of new ships being built greatly exceeds the number of old ships being decomissioned, and that older ships are much less efficient than the newer ones... Meaning on aggregate shipping supply will go up a lot, thus decreasing revenues. And if you did more research you'd know that the supply of dig oil rigs is also set to increase dramatically in the next few years, thus making their investment in ocean rig less valuable. Also, if you don't think 11% is large, then I really don't know what to tell you. 10% yearly return on a portfolio is supposed to be good.

Finally, saying I must work for a hedge fund that is shorting this stock is laughable. You sir, are a fool. I'm glad to know that the extent of your ability to analyze a stock consists of WOW IT HAS A LOW PE, IT MUST BE GREAT! Get a clue please. People like you are part of the reason why this stock is so volatile. You guys jump in thinking you're making a great investment, then when the stock drops 10% you panic and sell. Rinse and repeat.

[james shaw]

As what I know that Shanghai's BaoShan Steel is building several of the world biggest ships for their own use to ship iron cores to reduce their shipping costs. Delivery will be next year.

[VintonCounty]

DRYS has assets/equity ratio of 2.29. That amount of liabilities is not big; but it might worry investors, because shipping is cyclical. What if day rates were a fifth of present value, as in 2006? Would DRYS be able to make loan payments? Worse, ship values would fall; and lenders would probably demand more collateral. Normally I would say that lenders have incentive to consider such circumstances, so it must be safe. But we have seen recently that lenders sometimes fall under a spell and enter loan contracts they later regret.

I compared Dryships (DRYS) with Diana Shipping (DSX). I found a data reliability problem for return on assets (ROA). For DRYS, Morningstar says 27%; Yahoo Financial says 13.7%; and I calculated 474.6/2346.9=20.2% from the 20-F form. That affects return on equity (ROE), because ROE=2.29 x ROA. For DSX, Morningstar says 18.45%; Yahoo says 9.99%; and the 2007 annual report gives 134.2/944.3=14.2%.

Another thing that might make investors nervous is that DRYS retains most of its earnings for buying more ships. In a normal business, investors could be fairly confident that the retained earnings would build equity. But if a ship glut developed, ship values would fall; and it might be a long time before the retained earnings add their weights to the equity line. It's a wild business, suitable only for the bold.

On a happy note, I am amazed that no one comments on the most beautiful feature of international shipping: shippers pay no income tax.

[headgeek]

How I learned to stop worrying and love the shorts.

The hedge funds a slapping this stock around. They run it down to about 55 then they run it back up over 70.

You can either sit around pointing fingers or you can "buy low (55) sell high (75) then wait for it to go back down and buy it back.

I have been playing this stock for a year now. I am up 8% YTD.

Just today I made 4 bucks a share before breakfast.

So to the hedge funds I say. Keep up the good work. If I had kids you would be putting them through college.