Vincent Fernando

Dryships' Questionable Deals Don't Help Investor Confidence

Mark Anthony, it still benefits him even if he owns a stake in DRYS. If you own 35% of one company and 100% of a private company, then it benefits you to transfer cash from the partly owned to the fully owned. This is a classic and common technique in developing markets. Listed companies get bilked of cash by a shareholder who funnels business and cash flow to their private companies. Thus despite his stake in DRYS it is still to his benefit.

Never Enough Lessons on Forward P/E

For dry bulk, demand and supply are extremely inelastic, thats why the rates are so volatile and hard to predict. Iron ore & coal generally need to be shipped regardless of price, and on the flip side ships must be filled else they just lose money. Generally, even if rates are really bad, its still worth it to lose less money by filling your ships. (fixed costs are high, variable low) Same applies for a large part of dry bulk commodities demand.

Never Enough Lessons on Forward P/E

btw, I have done the dry bulk supply/demand math in the past using industry research data from Clarkson and Marine Strategies International. Roughly, Global demand growth in a bullish scenario for china is in the high single digits (and this includes both volume and distance effects), while 2009 - 2011 supply growth goes from about 10 - 18% per year (I think about 10, 14, 18 in that order), even with about 25% cancellations factored in. These are rough numbers, but when I did the math it was clear that supply growth was going to be well ahead, with room for error, of demand growth. The scary thing is that in a bearish near term china scenario, global demand could actually go negative. If a negative growth rate butts up against a 10%+ supply growth rate, rates would collapse substantially further to perhaps something like BDI 1,000.

Never Enough Lessons on Forward P/E

On China steel production growth long term, surely a huge story there, though we might have a near term slow down or contraction. The problem though is that Chinese demand growth only gives us the demand side of the shipping equation. The main danger is the supply side of the equation. Massive supply growth, well beyond even the best years we've seen for dry bulk demand growth, are on the way 2009 - 2011. So really its important to do some work on the supply side. Bulls will argue that a lot of ships scheduled to come won't be completed or will be delayed. It could be the case, but the supply growth well ahead of even bullish china demand scenarios, thus it has room to lose some steam due to ship cancellations, but still overwhelm a relatively bullish china demand story 2009 - 2011. I think nevertheless that the current global turmoil warrants a good study of what kind of cancellations we could see. They would have to be like 50% or more of the vessels scheduled for 2009 - 2011. Thus I think concerns for dry bulk go beyond the near term demand problems we have seen lately. I think no one will argue against the point that the China/Vale problems are temporary and that China still has a strong long term steel production growth story.

Never Enough Lessons on Forward P/E

I simply don't have the time to do a full analysis on DRYS. I also tend to not make full recommendations for stocks online. The decision making process would also probably take more than a blog post to fully explain and defend. My goal with the post was to try and cut through a lot of false reasoning when it comes to arguments for or against stocks. Criticism is healthy for thought.

As for how might someone value dryships? Well let's think as if one were actually in the industry looking to expand your fleet. An industry player can either buy ships in the market or buy a company that owns ships. If you get far more ships for your buck buying DRYS than buying int he market, then I think that's a decent starting point, but we must be very careful since even dry bulk (and rig) asset prices can fluctuate quite substantially. Thinking from an industry buyer perspective would be simply thinking about the value of a dry bulk company as the actual players in the industry do. I promise you they don't forecast 1 year of earnings and then calculate a multiple. Wall street analysts frequently do, and companies put simple multiples in their investor presentations, but trust me actual shipping players don't make decisions like this. DRYS has rigs and bulk vessels, plus perhaps some additional value from its organization and customer relationships. But you would probably want to be getting DRYS at a price where you were getting its assets at a good discount to market prices, as this would give you some cushion. (these asset prices can fall, so good to have a margin of safety). Just don't forget that DRYS has a lot of debt, so you would want your adjusted NAV (adjusted to include a margin of safety vs. asset price declines) to be much higher than Enterprise Value (not market cap).

Never Enough Lessons on Forward P/E

Many dry bulk companies have a portion of their ships in fixed contracts, yet lower rates on their spot portion of their fleet still hurts. There are many examples of bulk shippers with some fixed contracts who have seen their share prices collapse. The main point of the piece was in regards to the unreliability of depending on forward earnings performance of a bulk shipper. At the current price, DRYS might actually be a decent Buy now but I don't have time for the full analysis. Note that I have seen tons of company reassurances such as you show above. The reality of the situation is that dry bulk rates hit sky high levels and weren't sustainable long term. Even the current levels on the BDI are strong by historical standards. What this means is that we could still have a strong demand story, but rates could actually fall. Why? Massive vessel supply is coming online, and this will accelerate through 2010. Credit problems could slow some of it, but supply growth is so large that we could have a lot of cancellations, yet still have strong dry bulk supply growth nevertheless. The China steel slowdown will compound with the supply growth problem and is likely to really hurt dry bulk rates. Again, realize that the current BDI level is actually a strong level historically. It still represents a lack of ships globally. As this bottleneck gets cleared, and chinese steel demand softens, the BDI could still go lower and not be a disaster situation relative to history. BDI 3,000 is very strong actually. The problem for dry bulk stocks like DRYS was one of the stock price depending on meeting sky-high forward expectations. To believe that BDI 10,000 was sustainable long term was utterly ridiculous. Dry bulk as a business can't earn outsize profit margins, higher than a lot of advanced tech or branded media outfits, for what is basically an easy to enter business. Sky high expectations are easy to miss, and they were, thus dry bulk stocks when from ridiculous valuations down to what actually could now be decent levels for value investors. Finally, while fixed contracts are likely to be honored, keep in mind that in the past major dry bulk downturn, a lot of customers walked away from their fixed contracts when times were tough. Thus while its good DRYS has some fixed contracts, they aren't bulletproof. If its worth a lot of money to walk away from a contract, or force a renegotiation, then some customers might think its worth the loss to their reputation. It happened last time.