Is It Time To Buy Dry Shippers?

by: Justin Kuepper

The dry shipping sector has rebounded strongly over the past month, according to data from Tickerspy. Their index is trading up 18.3% over the past month, which is 14.6% higher than the S&P 500 over the same time period. And some of the strongest players are trading more than 150% higher over the past couple of weeks. So, is now the time to buy again?

Some of the stocks included in this index are:

  1. Baltic Trading Ltd. (NYSE:BALT)
  2. DryShips Inc. (NASDAQ:DRYS)
  3. Diana Shipping Inc. (NYSE:DSX)
  4. Eagle Bulk Shipping Inc. (NASDAQ:EGLE)
  5. FreeSeas Inc. (FREE)
  6. Genco Shipping & Trading Ltd. (NYSE:GNK)
  7. Star Bulk Carriers Corp. (NASDAQ:SBLK)
  8. Seanergy Maritime Holdings Corp. (NASDAQ:SHIP)
  9. Paragon Shipping Inc. (PRGN)
  10. Excel Maritime Carriers Ltd. (NYSE:EXM)

A Brief History Lesson…

Investors looking for an ugly chart don't need to look any further than the Baltic Dry Index (BDI), which provides an assessment of the price of moving the major raw materials by sea. After reaching nearly $240,000 in 2008, the index fell sharply to its current levels of less than $20,000, and right near its allow-time lows reached in late 2008 after the collapse.

Two factors led to this terrible-looking chart:

  1. The economic downturn in 2008 led to a sharp reduction in the raw materials needed by major economies and therefore hurt the demand side of the equation;
  2. And, many dry bulk shippers had ordered new vessels pre-decline that were delivered precisely at the wrong time, which led to a sharp increase in the supply side.

The negative economics for the dry bulk sector were magnified by the high debt seen in individual companies. Since ships are rather pricey to purchase, many of these companies had debt-to-equity ratios that far exceeded stock market norms. And the failure to refinance these debts ultimately led to a few restructurings and bankruptcies.

Turnaround? Analysts Remain Divided.

The dry bulk shipping industry isn't getting any better, according to many analysts. RS Platou Economic Research, a unit of Norway's largest ship broker, told Bloomberg last week that conditions are likely to weaken this year as the supply of ships outstrips demand. The analyst suggests that the fleet would increase 11-12% this year, which was double its original forecast.

However, other analysts remain more optimistic. A recent Wall Street Journal article cited Douglas Mavrinac, managing director at Jefferies in Houston, as saying that the number of vessels hitting the water will slow during the second half of 2012. Meanwhile, the demand for ships and the number available will align by the end of the year, he added.

Still, many companies in the dry bulk shipping sector face insurmountable debt problems that will weigh on them even if a recovery in the industry takes hold.

A Different Explanation for the Strength

Many investors and analysts believe that a combination of short covering and bottom fishing may be what led to the recent rally.

Short covering - the repurchasing of shares by those who shorted the stock - may have resulted in upside pressure. The actions of a few short sellers may have put enough upside pressure in place to trigger stop-loss and take-profit levels for other traders and so forth. This is certainly a good possibility given the high short interest in the sector.

The rally may have also attracted a few long investors who saw the rally as the start of a recovery. Many have held the belief that the market may be bottoming out and therefore now is the time to build up a long position for when the industry recovers. But again, this limits the fields to only a few players with manageable debt loads.

In the End…

Investors may want to tread cautiously during this recovery, and if they do invest, stick with names that have low levels of debt, such as Diana Shipping Inc. And perhaps traders may also want to consider a pair trade - long DSX and short the industry - when a retracement takes place or at least hedge any long bets with some industry puts.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.