Dry Bulk Shipping Valuations Approach "Bubble" Proportions

Includes: DRYS, GNK
by: Sandeep Gill

Genko Shipping and Trading (NYSE:GNK) rose almost 20% on Thursday, July 19th after it announced late Wednesday that it had agreed to acquire nine Capesize vessels from companies within the Metrostar Management Corporation group for a total of $1.1 billion. Two of these deliveries are expected during the third quarter, while the remaining seven vessels are expected to be built and delivered to Genko between the fourth quarter of 2007 and the third quarter of 2009. This announcement added 250 million dollars to GNK’s market cap. Can creating wealth be that simple? If so, a widget making company should immediately announce that they are acquiring a few bulk carriers (even at market prices) and watch the markets swoon over their share price. And any widget maker can do so-for there are no barriers to entry in this industry. Shipyards do not have any spare capacity but one can buy ships at market prices in the very active second-hand market. The management of the ships can be outsourced to a third party (even a related third party; Dryships (NASDAQ:DRYS) anyone?).

The share prices of most dry bulk shipping companies follow the rise and fall in the Baltic Dry Index or BDI. This is an index covering dry bulk shipping rates and is managed by the Baltic Exchange in London. Between 1985 and 2003, this index ranged between 600 and 2200. But then, in 2003 it took off and is close to 6600 today. No wonder then that the dry bulk shipping sector has been red hot. The share price of the most leveraged shipping company DRYS, is now almost 6 times its 52 week low. It trades at 4 times book value. Is the rise in the BDI and related share prices justified or is this a mega short opportunity? Let’s take a look at the facts.

  • The demand for commodities from China and India combined with the shortage of dry bulk ships, is leading to an enormous increase in dry bulk rates, which for cape size ships are now almost $95,000 a day. The cost to operate these ships is under $10,000 a day.
  • The world’s shipyards are backlogged with orders and the earliest deliveries available for new orders are in 2009.
  • As energy hungry China has increased consumption of its own coal at the cost of exports, Japan and Korea have had to get supplies from Australia, resulting in extreme port congestion and tying up dry bulk capacity for weeks on end, thus leading to a further increase in dry rates.
  • In the long term for this industry, there are no barriers to entry, no pricing power, and this sector should not trade at much above Net Asset Value.
  • This sector is notorious for reneging on contracts. All those fixed time charters at today’s stratospheric rates? Once rates fall, the long term contracts will sink along with the sector!
  • So it comes down to this: If you believe that the supply and demand imbalance fueled by the growth of world trade and especially the rise of India and China, will continue, then by all means go long. But if you believe, as I do, that human ingenuity combined with capitalistic greed, leads to efficient pricing, then this is a wonderful opportunity to short the entire sector. I shorted DRYS today at $63 and GNK at $62 based on the knowledge that even as you read this- Australia is taking measures to relieve port congestion, China has 14 yards under construction and another 9 due for completion by 2010 which are already taking orders, shipyards are doubling shifts to meet orders, old tankers are being converted into dry bulk carriers, insiders are looking to sell you their shares and the smart money is going short even as analysts raise estimates. And the BDI ? It has never disappointed-always volatile it always reverts to the mean.

    Baltic Dry Index
    Baltic Dry Index