Those huge panamax and capesize freighters may look peaceful as they sail slowly across the oceans, but the stocks behind them are anything but. Betas in the dry bulk space are exceptionally high, with many companies sporting betas above three. Pick the right stock at the right time, and it is easy to see how shipping built the fortunes of many a magnate. Of course, picking the wrong stocks can be like tying your money to an anchor and tossing it over the side.

In Pictures: 7 Forehead-Slapping Stock Blunders

A Simple Business
Dry bulk shipping is quite possibly one of the simplest industries for an investor to approach. The nature of the industry is to acquire ships, contract with customers and deliver the cargo. When Peabody (NYSE:BTU) wants to send coal to China or Archer Daniels Midland (NYSE:ADM) wants to send grain to Japan, they contract with a dry bulk shipping company.

A Way

to Play the Recovery?
The biggest reason to own a shipping company stock today is the nascent economic recovery. As economies recover, trade should rebound, and that will increase the demand for international shipping. That, in turn, should lead to an increase in shipping rates, which is often measured through the Baltic Dry Index (BDI).

Of course, China is a major factor here as well. China has been a voracious consumer of coal and iron ore in recent years, and it does not seem that these imports are tailing off. Longer-term, it is possible that India could emerge as more of a factor as well, but that is many years away. (For more, see The Baltic Dry Index: Evaluating An Economic Recovery.)

A Delicate Balance
There are two major risks to any shipping investment: demand and supply. Pricing in this industry is extremely sensitive to even minor changes in the economic balance, and there is practically no such thing as an economic moat in this sector. Consider the fact that the rates for panamax ships are now less than half of what they were in 2008, but nearly a third higher than in 2009.

Some analysts in this space have publicly fretted about the amount of new supply coming onto the market - maybe as much as 10% a year for the next few years - but so far at least, new ship deliveries have been trending far below the announced order books, as much as 80% in the case of Handymax ships. So long as this fragile economic recovery continues and new deliveries are slow to come, these stocks could work.

Names to Watch
Investors are not exactly hurting for choice when it comes to shipping stocks. Genco Shipping (NYSE:GNK), Excel Maritime (NYSE:EXM), Navios Maritime (NYSE:NM), Eagle Bulk (Nasdaq:EGLE), DryShips (Nasdaq:DRYS) and Diana (NYSE:DSX) are all major names in the space. Remember, though, that does not include the crude carriers or container ship companies.

There are a few relevant ways to sort out this group. First, you can look at the basic operating philosophy vis-a-vis long-term contracts versus spot rates. Signing customers to long-term charters guarantees a stream of revenue, but leaves the company high and dry if spot rates jump. Of course, spot rates can plummet and companies without those contracts can go bust if rates drop below operating costs. DryShips and Navios both operate with very high levels of contract coverage, while Frontline (NYSE:FRO) operates much more on spot rates.

Fleet size and composition is also important. Generally speaking, newer fleets are cheaper to operate and maintain. The type of ship is also important, though. I believe Eagle Bulk has an inherent advantage in having a large fleet of the smaller handymax-type of ship. This ship class can service the smaller ports that are common in Asia and developing markets, and this gives the company an advantage until newer, larger ports become commonplace.

I would also like to mention two other unconventional names: Kirby (NYSE:KEX) and Ship Finance (NYSE:SFL). Kirby is basically a ringer; it is not a dry bulk carrier, but rather an operator of inland barges in the U.S. Ship Finance is effectively a lessor of ships that orders and finances ships, but then contracts them out to operators like Frontline. With long-term charters in place and a respectable history of cash flow and dividend payments, Ship Finance could be an idea well-suited to the more income-oriented investors.

What to Do
Industries like shipping sometimes lead me to an unconventional piece of advice: do not obsess about the fundamental analysis. I would never suggest that shipping stocks make good long-term holdings, and when you are looking for successful trades or looking to play themes, the fundamentals can fool you. So while the high debt levels and low ROICs of this space do worry me, they will not really matter if the BDI jumps back to 2008 levels.

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