Demystifying Dry Bulk Shipping: Low P/E Companies That Aren't Properly Valued

by: Dhinesh Ganapathiappan

The dry bulk shipping industry is often misunderstood by investors but presents a lucrative opportunity to benefit from the rising global demand for transporting basic materials around the world. The business of dry bulk shipping involves operating large shipping vessels and renting them out to transport grains and metals. Metal miners and purchasers alike don’t have the resources to haul their goods without chartering the dry bulk shippers.

The industry has a lot of potential as demand for metals and grains have skyrocketed and the supply of ships to haul them is limited. The result is pricing leverage for the companies operating within the oceanic shipping industry. The rates paid to these companies is often locked in with forward contracts, but the current pricing power is tied to the Baltic Dry Index. The index has risen from 2000 two years ago to a peak of 11,000 in November to 9200 currently.

The huge run-up in the index has been mirrored in the performance of the major shipping stocks. Diana Shipping (NYSE:DSX) has doubled this year, but is down 40% from its November peak when the Baltic Dry Index crested. The optimism from the dramatic rally in the Baltic Dry Index was the primary catalyst for the stock price appreciation, and similarly had a negative impact on the industry as the Index started a nosedive.

With both the Baltic Dry Index and shares of individual shipping companies falling hard the last two months, attractive entry points have presented themselves for investors. Worries of oversupply in the near future as new ship building is commissioned won’t have as bad an impact on the industry as expected since metals demand continues to grow leaving an inherent need for shipping services.

One company in particular has exciting prospects is DryShips (NASDAQ:DRYS). The $2.3 billion company operates a fleet of 35 dry bulk shipping vessels. Shares are currently trading at just 9 times current earnings, and very cheap 4.4 times future earnings. The company has exceeded the analyst estimates for the past four quarters, and future estimates may be just as conservative. DryShips is a steal when you compare these splendidly cheap financial ratios to its peers and the general market where P/E’s of 10-20 are considered first class.

DryShips stock still has 70% to go to return to its peak of $131 a share set in November amidst the rally in the Baltic Dry Index. Further compounding the woes of DryShips was the announcement that the company bought a 30% stake in a deep-sea oil drilling company. This $400 million investment caused many to worry that the company was predicting the dry bulk shipping industry is beyond its prime, but in reality management saw an opportunity to enter a side business with great potential that will be immediately profitable and accretive to earnings.

DryShips CEO George Economou owns a 45% stake of the company so his interests are clearly driving up profitability in the company. Furthermore, by not selling any shares he is showing confidence in the business. Entering a side business may seem like a bearish sign, but for DryShips this simply translates into more earnings for shareholders. The company’s return on equity stands at a whopping 57%, signaling that management has a history of making effective investments.

Analysts at Jeffries last week came out with a buy rating and $160 price target, more than double the current price, citing that shares are trading at merely 3.6 times 2008 earnings estimates. Even the most cautious analysts have set targets above $100 a share. Even if a recession materializes, there is a baseline demand for shipping services that the shippers will benefit from.

Shares of the dry bulk shippers have all been beaten down as the Baltic Dry Index has taken a fall. The fundamentals for the industry remain very positive for the next few years and this is an excellent time to invest in the dry bulk shippers. In addition to the top players of DryShips and Diana Shipping, a few other options within the sector to look at include Quintana Maritime (QMAR), Excel Maritime Carriers (NYSE:EXM), and FreeSeas (FREE).

Although there is an overhang of uncertainty clouding the judgment of investors, business will remain strong and the shippers will continue to generate massive profits. Expect the Baltic Dry Index to stabilize in the coming months and jumpstart the rally as sentiment towards the industry improves. In the face of a volatile stock market, your best bet to outperform the market is to stick with low P/E companies that aren’t properly valued, and the dry bulk shippers fit the mold.

Disclosure: Author holds positions the above-mentioned securities.