Ship Shape

12/30/2005 12:00 am EST

Focus:

Vivian Lewis

Editor and Publisher, Global Investing

"Our Global Investing strategy is simple; we buy outside the US using equities, closed-end funds, and ETFs that trade on US markets," says Vivian Lewis, one of the most respected advisors in the global arena. Here, she looks at a Greek shipping firm.

"A host of shipping companies from exotic lands recently raised capital with initial public offerings. These are cyclical, small-cap, leveraged companies. Most of them are based in funny tax havens, pay high dividends, and are owned by Greeks. They haul iron ore, coal and grain, the major bulk cargos. Amidst the gang from Piraeus, there is a shipper with a difference: DryShips (DRYS NASDAQ).

"Unlike most of the industry, this firm, run by MIT grad George Economou, is playing the drybulk marginal market. Rather than signing up fixed charters for its fleet, DryShips uses the spot market for 87% of its capacity. That makes it more profitable but more risky than rivals. DryShips is the only NASDAQ-listed shipper with contracts tied mostly to the more lucrative spot market. It's the least dependent on fixed-voyage contracts of any US-traded Greek shipper. That makes it more risky than the others if there is a reversal in trade volumes. But it also means it is a potential fast grower if commercial shipping picks up again from its present plateau. Meanwhile, spot rates can be more profitable now than contract rates.

"The market is terrified there will be a repeat of the long period of low demand for dry bulk, which murdered charter prices for 25 years from 1974 to 1999. Recently, at the Harvard Club, I watched an interesting exchange between optimistic 50-something CEO Economou and the venerable retired US chief of giant shipper AP Moeller-Maersk about the risks of a repeat of the period of surplus capacity.

"Indeed, there was a sharp drop in large-vessel spot rates in the middle of this year, from $35,736 per day to $25,883. So the current market slightly favors charter rates. But that has made DryShips cheap if you believe in their concept. The company reacted to the drop, caused by a Chinese purchasing slowdown and cuts in steel production, by dry-docking part of its fleet. However, despite the drop, shipping rates are still very high.

"After its IPO early this year, DryShips set out to buy the right ships for its strategy with the proceeds. It now owns the largest US-listed drybulk fleet, and moreover, relatively new ships with an average age of ten years. That means they can keep running longer than older fleets. Meanwhile, the number of new ships put into service overall is set to decline starting in 2007, and the number of aged vessels ready for the scrap-heap will grow.

"The main business of drybulk carriers is hauling iron ore and coal to Asia. China needs imports to make steel to support urbanization and industrialization. While it does mine coal, it doesn't mine enough. India, meanwhile, another industrializing country, is suffering from acute shortage of coal. Even a quite modest growth rate in bulk cargo tonnage of 4.5% next year translates into a deficit in cargo capacity for 5.7%. In 2007, modest growth will push the world fleet into shortage of 6%, and by 2008 it will turn dramatic, at 7.5%. If demand picks up more than 4.5%, the deficit will come sooner.

"If you listen to Economou, demand for iron ore and coal will grow 6.7% a year starting next year, vs. a mere 1% during the 90s. You will have to listen to him if you decide to buy the stock, though, because there really are no comparable numbers for 2004 worth anything since his company bought most of its fleet after the IPO. This is a high-risk play, and the company has net debt equal to nearly 60% of its capitalization. That is the downside. It plans to start repaying debt next year.

"Here is the upside: For every $1,000 change in spot market rates, DryShips' earnings will fluctuate 28 cents per share. That has both upside and downside potential. But the steel-producing capacity of China and India steel capacity are only just at the levels of Japan in the early post-war years, so they will need shipments. Meanwhile, the stock pays a low dividend (for a shipping firm) of 40 cents per share and trades at a forward p/e ratio of 5.8 times earnings, assuming all its new contracts in 2006 are spot, while the average of most of its competition is in double digits, so it is comparatively cheap."

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