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Edited by Kate Boehme

Recently, concerns over supply and demand prospects within the shipping transportation industry have become increasingly apparent. As previously mentioned, the economic slowdown of key industry factors in China and Europe is challenging future growth expectations. Companies like DryShips (DRYS), which engage in the water transportation of dry bulk and oil cargoes, are subsequently under dispute. After 2008 and the economic crisis, global demand for dry bulk products decreased significantly. As a consequence, DryShips has exhibited signs of declining business as its daily earning rates fell by 65 percent which, in turn, led to mixed financial results. For the first quarter of 2012, the company reported net losses of $47.5 million.

As a result of this financial turbulence, many investors suggest that shipping companies are a lost cause. Investors worry who will buy the products being transported if all the biggest buyers are experiencing economic distress. We must therefore investigate whether or not this is actually the case. Furthermore, can Dryships itself survive the sector's current overcapacity?

World Economic Prospects

Dry bulk commodities shipping provides an upright way to invest in global trade. If a positive trend in global trade could result in higher demand for dry bulk vessels, then it could also lead to an increase in profits for the dry bulk shipping companies.

At the moment, world trade trends are not encouraging, thereby confirming speculations. However, there are some figures that suggest future positive results. In particular, the recent IMF world economic outlook (pddf) suggests that, despite the risks, global growth prospects are gradually strengthening. Notably, the real GDP growth in both emerging and developing economies is expected to decrease from 2011's 6¼ percent to 5¾ percent in 2012. However, the GDP growth is predicted to revert to 6 percent in 2013. Based on IMF projections, world trade volumes annual change will remain at 4.0 percent in 2012, with an increase toward 5.6 percent in 2013. According to OECD, for the first quarter of 2012, merchandise trade exhibits moderate growth (pdf) in most major economies. G7 and BRIC countries' total imports and exports grew by 1.0 percent and 0.6 percent respectively. It is worth mentioning that, in Japan, imports increased by 1.5 percent, and in South Africa by 6.3 percent. Japan, in particular, is expected to contribute to the acceleration of demand in raw materials toward 8 percent during 2012 and 2013. After the recent disaster, caused by the Fukushima earthquake, Japan has been concentrating on the reconstruction of damaged areas. This will lead to a higher short-term demand for dry bulk shipping services.

Dry Bulk Trade

Despite the low rates in the dry bulk market and the oversupply of vessels, there is still room for positivity. Scrapping activity is expected to remain elevated throughout 2012. Such high scrap metal prices motivate ship owners to scrap vessels at an earlier stage.

Moreover, speaking of demand, seaborne dry bulk trade is expected to expand by 8 percent in 2012 and 9 percent in 2013. This expansion is estimated due to growth expectations in iron ore and coal trade. Seaborne iron ore and coal trade are reckoned to grow by 4 percent year-on-year in 2012. In total, analysts suggest that iron ore trade will account for 42.8 percent of total dry bulk trade by the end of 2012. Imports of iron ore are expected to reach 1.092 million tones and coal 747 million tones. Furthermore, distance-adjusted seaborne dry bulk trade is expected to increase by 9 percent in 2012 and 10 percent in 2013.

In spite of slowdown concerns, the biggest importer of dry bulk products will continue to be China. Estimations project that, throughout 2012, Chinese imports will keep growing by 11 percent. This is mainly due to iron ore prices having fallen sharply over the past two years.

Last, but not least, order book figures may also be cause for consideration. Recent cancellations of orders resulted in a 13 percent decline. However, still, order book numbers account for 30 percent of the total current fleet, with Supramax in first position with a 39 percent share.

The Baltic Dry Index

The BDI provides an overview of the sector. It measures the demand for bulk shipping versus the amount of current shipping capacity. On May 2008, the index reached the peak of 11,793 points. Since then, it has dropped significantly.

Baltic Dry Index Historical Performance

(click to enlarge)

Currently, BDI stands at about 1.000 points. After an initial plunge in the first quarter of 2012, the index now shows a slow but stable upward trend. The main issue with the performance of the BDI is the pace with which the dry bulk fleet expands.

However, as mentioned before, scrapping activity is still expected to increase. In 2011, 23.2 million dwt were scrapped achieving a record level high since 1964. In fact, 2012 is expected to be an even more successful year. During the first two months of 2012, 4.1 million dwt were recycled: about 3 million dwt more than the same period last year. Until May 2012, 225 vessels containing about 13.8 million dwt have been scrapped. Analysts expect that scrapping could double during 2012, reaching 58 million dwt. If scrapping activity follows these trends, we will see a powerful comeback from the BDI in the short-term. Moreover, dry bulk shippers will enjoy noteworthy gains at current scrap metal prices.

Fleet Utilization

Compared with its peers, DryShips is in a much better position. Fleet utilization of the company's dry bulk ships and tankers currently stand at 99 percent and 100 percent, respectively, while the Time Charter Equivalent [TCE] per day amounts to approximately $22.257. Meanwhile, the TCE for Genco Shipping & Trading Limited (GNK) is $10.981, while the Excel Maritime Carriers Ltd (EXM) value stands at $19.642. In Q1 2012, Navios Maritime Holdings Inc (NM) reported a TCE decrease by 12.7 percent to $21.496 compared with Q1 2011. Similarly, Diana Shipping Inc (DSX) reported a decrease of about 23 percent in Q1 2012.

Summary

Even in a worst-case scenario in which demand fails to rebound, DryShips maintains several "aces" up their sleeve that suggest long-term success. As described in a previous article, DryShips's income from drilling units has a made significant impact on their balance sheet. The recent three-year contract with Total E&P Angola to drill in offshore West Africa provides an estimated order backlog of $652 million. Combined with its current fleet utilization, the backlog ought to produce future positive financial results. In addition, DryShips aims to start employing four Panamax vessels to travel through Arctic waters. According to George Economou, the company's CEO, daily rates for an Arctic voyage can post compelling earnings for ship owners. In fact, Arctic voyages can be charged four times higher than a voyage through the Suez route, even though the Artic route is generally about 40 percent shorter than options via Panama or Suez.

In general, I believe that DryShips can offer a solid investment. The stock currently trades at $2.32 following a positive trend toward a 52-week high of $3.86. One-month stock returns equal 5.48 percent, while year-to-date stock returns amount to 15.50 percent. Furthermore, the P/S ratio stands at 0.87, making DryShips an intriguing investment. When considering the company's relative performance during such a harsh time for the industry, future performance prospects are encouraging. It is also expected that the recent drop in fuel prices will help the company further raise short-term profitability. Overall, I strongly support the notion that, DryShips could prove to be a rewarding choice for this year and beyond.

Source: Can DryShips Survive The Sector's Current Overcapacity Problem?