If this is what an economic recovery looks like, investors in the shipping sector should shudder to think what even worse times might look like. While DryShips (Nasdaq:DRYS) has fared better than several of its rivals in drybulk shipping, the stock has been punished as shipping rates continue to decline below the operating costs of even the best operators. Though this is not a sustainable set of circumstances, and Capesize rates have spiked up recently, it could be some time before the shipping industry looks truly healthy again.

Investopedia Markets: Explore the best one-stop source for financial news, quotes, and insights.

Disappointing Results For Q2
DryShips did not report an especially strong fiscal second quarter. Revenue was basically flat, as positive (albeit disappointing) growth of 16% in the offshore drilling segment was offset by a 19% decline in net voyage revenue in the drybulk business. Revenue in the drilling business was hurt by several rig mobilizations (companies typically do not get paid while they move rigs to a new jobsite); though that is a valid issue, it is one that the company could (and should) have communicated to investors earlier.

DryShips also disappointed on profitability. Operating expenses were sharply higher, even after excluding a large ($88 million) vessel impairment charge. In the drybulk business, vessel voyage and operating costs jumped almost one-quarter, while drilling rig operating costs doubled and general corporate expenses rose almost 60%. All told, adjusted EBITDA fell 11% and the company missed its average earnings estimate.

The Break-Up Is Coming
DryShips is going to be a very different company in a fairly short period of time, as management pursues the spin-off of the Ocean Rig business. At present, this is a sizable part of the DryShips income statement and the Ocean Rig should do well as more rigs emerge from drydocks and take up productive work. Ocean Rig's fleet is busy in West Africa and Greenland working for large oil concerns like Cairn Energy and Tullow, and if commentary from the management of rivals like Transocean (NYSE:RIG) is to be believed, dayrates should start improving in this industry.

It is not as though DryShips investors will be left clinging to driftwood after the split, though. The company's decision to acquire OceanFreight (for about $118 million in cash and $500 million in total costs) adds 11 bulkers to the fleet at fairly attractive prices. Though investors may fret about the added exposure to Capesize and VLOC ship classes, the fact is that that is a big part of what DryShips does and has always done.

Rates - Buy The Rebound?
For most of this year it seemed as though every time drybulk rates found a new bottom somebody threw a new shovel down the hole. Recently, though, Capesize rates have been spiking upward. Now a little perspective is in order - these rates are certainly better than what the industry has seen lately, but they are still well below the level of DryShips' current charters. What's more, Panamax and Supramax rates are still pretty lousy and DryShips has a fair amount of charters rolling off soon (about half of the company's Panamax fleet is on spot or going off contract in the next few months).

The trouble is not so much about demand - China continues to gobble up iron ore and miners like Vale (Nasdaq:VALE) and BHP Billiton (NYSE:BHP) aren't talking about any imminent collapse. Rather, the problem is that fairly rational competitors like Diana (NYSE:DSX), Safe Bulkers (NYSE:SB), Genco (NYSE:GNK) and Excel (NYSE:EXM) have to deal with competition that isn't always rational. Eventually these low rates are going to winnow out the field - the global credit market is not so strong as to endlessly extend capital to money-losing shippers, and sooner or later, companies will go bankrupt and/or scrap vessels. The problem is that investors can lose a lot of money waiting for "eventually."

The Bottom Line
In many respects DryShips looks like a deep-value turnaround. The company has the balance sheet to withstand this environment (at least for some time) and it seems only logical to think that when rates are below the operating costs of efficient shippers, that's an unsustainable market bottom. What's more, investors may be attracted to fundamentals like a price-to-tangible book of about one-third - though investors should realize that current asset values in the space suggest that book value could be overstated.

Between parent DryShips and soon-to-spin-off Ocean Rig, the drilling business seems like the better bet in the near future. Moreover, investors interested in shipping should, at a minimum, also consider names like Nordic American Tanker (NYSE:NAT), Golar LNG (Nasdaq:GLNG), Safe Bulkers and Costamare (Nasdaq:CMRE). It is hard to imagine that current drybulk rates could be the "new normal," but investors considering a play on DryShips should remember the warning that markets can often stay irrational longer than the players can stay solvent. (For additional reading, take a look at The Baltic Dry Index: Evaluating An Economic Recovery.)

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

Related Articles
  1. Stock Analysis

    Allstate: How Being Boring Earns it Billions (ALL)

    A summary of what Allstate Insurance sells and whom it sells it to including recent mergers and acquisitions that have helped boost its bottom line.
  2. Options & Futures

    Cyclical Versus Non-Cyclical Stocks

    Investing during an economic downturn simply means changing your focus. Discover the benefits of defensive stocks.
  3. Investing Basics

    How to Deduct Your Stock Losses

    Held onto a stock for too long? Selling at a loss is never ideal, but it is possible to minimize the damage. Here's how.
  4. Economics

    Is Wall Street Living in Denial?

    Will remaining calm and staying long present significant risks to your investment health?
  5. Stock Analysis

    When Will Dick's Sporting Goods Bounce Back? (DKS)

    Is DKS a bargain here?
  6. Investing News

    How AT&T Evolved into a Mobile Phone Giant

    A third of Americans use an AT&T mobile phone. How did it evolve from a state-sponsored monopoly, though antitrust and a technological revolution?
  7. Stock Analysis

    Home Depot: Can its Shares Continue Climbing?

    Home Depot has outperformed the market by a wide margin in the last 12 months. Is this sustainable?
  8. Stock Analysis

    Yelp: Can it Regain its Losses in 2016? (YELP)

    Yelp investors have had reason to be happy recently. Will the good spirits last?
  9. Stock Analysis

    Is Walmart's Rally Sustainable? (WMT)

    Walmart is enjoying a short-term rally. Is it sustainable? Is Amazon still a better bet?
  10. Stock Analysis

    GoPro's Stock: Can it Fall Much Further? (GPRO)

    As a company that primarily sells discretionary products, GoPro and its potential falls right in line with consumer trends. Is that good or bad?
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>

You May Also Like

Trading Center