On March 19, 2012, I wrote a piece entitled DryShips: Overvalued Relative To Baltic Dry Index, Trade Accordingly. In that piece, I argued that Dry Ships Inc (DRYS) was a sell based on its valuation relative to the Baltic Dry Index. In the time since that piece was published, as shown by the chart below, DRYS shares are down more than 33%.
Improved Relative Value
In my previous piece, I included a chart that showed, year to date, that DRYS shares were up 69.3% while the Baltic Dry Index was down by 46.18%. In total, the divergence was just more than 115%. Now, as shown by the chart below, the divergence has shrunk to just more than 66%. This represents a improvement in relative valuation from before. However, I believe room remains for a continued convergence between DRYS and the Baltic Dry Index.
In addition to the improvement in short-term relative value, the long-term relationship between DRYS and the Baltic Dry Index has also improved. At the time of my previous piece, the long-term spread between DRYS and the Baltic Dry Index was just more than 33%. Now, as shown by the chart below, the spread has narrowed to just more than 18%.
The biggest concern for DRYS is the large debt load. Currently, the company has more than $4 billion in debt. This compares to less than $1 billion in equity. DRYS, like the rest of the shipping companies, Genco (GNK), Excel Maritime (EXM), Eagle Bulk Shipping (EGLE), and others has struggled to show profits in recent years. DRYS recently reported a five cent per share loss for the second quarter. The weak earnings report has led to speculation that the company might consider selling some ships. A ship sale would be a major positive for the stock, but the debt issue remains a key risk for DRYS.
Ocean Rig UDW Inc
DRYS is the majority owner of Ocean Rig UDW Inc (ORIG). The company has, over time, been selling some its shares as a way to raise cash. Some have argued that the ORIG stake is the most important part of the company. While I do not think ORIG is more important than the company's core dry bulk business, I do believe it is a significant part of the company and has the ability to move the stock. DRYS could be poised to benefit from a move higher in oil because of ORIG.
I am upgrading DRYS to neutral from sell for a few reasons. Most importantly, the spread between DRYS and the Baltic Dry Index has narrowed significantly. However, it remains likely that the spread will continue to narrow. While the Ocean Rig UDW stake represents an interesting upside catalyst, the heavy debt load is a major concern. For me to become more bullish on DRYS, I would need to see improvement in the Baltic Dry Index.