6/7/2014 Dry Bulk Shippers: Turnaround or Mirage?

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Dry Bulk Shippers: Turnaround or Mirage?
September 23, 2013
By Mercenary Research Team
After years of pain, dry bulk carriers may finally be reversing their fortunes. This turnaround is tentative,
however, and highly dependent on questionable macro trends. Financially sound carriers Navios and
Dryships own a high percentage of Capesize ships whose rates are currently gaining the most while
struggling carrier Genco could be headed for bankruptcy if the rally in dry bulk rates reverses.
The main shippers in play are:
Navios Holdings (NM) and Navios Partners (NMM) Financially sound Greek shipping group and
its wholly owned MLP.
Dryships (DRYS) a diversified player focused on the larger end of the dry shipping market.
Diana Shipping (DSX) a carrier focused exclusively on larger dry bulk ships.
Genco Shipping and Trading (GNK) a broadly diversified dry bulk shipper that has been
teetering on the verge of bankruptcy.
Some background on Dry Bulk
Prior to the financial crisis, the Baltic Dry Index (BDI) was frequently toted as a bellwether for the global
economy. Calculated using a weighted average of Capesize, Panamax and Supramax freight routes, the
index gives observers a quick overview of the level of freight rates for the three largest categories of dry
freight ships.
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The freight market is closely linked to the markets in large bulk, particularly iron ore and coal. As such,
investors have often used the BDI as a proxy for the health of the global economy.
However supply and demand considerations within the
freight market itself have led to a decoupling of the BDI with broad economic trends.
Until 2003, dry bulk freight rates had averaged well below 2000 points on the BDI index. Along with the
commodity supercycle, freight rates began to rise so far as to briefly reach above 10,000 in 2007 and 2008.
This increase spurred record orders for new shipping capacity which is just now being delivered.
At the same time that new shipping capacity was being built, the financial crisis and ensuing recession
reduced worldwide growth expectations and many commodity prices plunged, setting the stage for an
extended bear market in freight rates.
While the BDI has declined over 90% between 2008 and 2012, the largest Capesize ships which primarily
ship iron ore were the hardest hit, with day rates plunging 98% to $4,000 from a record of $234,000 set in
June 2008.
It is precisely these depressed Capesize rates which are rallying significantly for the first time since lows
reached in early 2012. In searching for opportunity within the dry bulk sector therefore, carriers with fleets
consisting of a large percentage of Capesize ships may have the most to gain.
Panamax rates have been rising more slowly while Supramax rates, for the smallest of the 3 shipping
classes, have yet to rise significantly.
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The Likely Winners
Navios Maritime Holdings (NM) offers investors direct investment in their holding company (NM) and its
subsidiary, Navios Maritime Partners (NMM). With 17 owned or long-term chartered Capesize vessels,
33% of NMs fleet consists of Capesizes while NMM will own 8 Capesize vessels when counting its
upcoming delivery of 1 Capesize and 2 Panamaxes, bringing its percentage of Capesize vessels to 35%, an
industry-high.
Analysts expect NM earnings to turn positive in 2014, while NMMs are currently positive and expected to
decline into 2015.
Net profit margins at NM have turned negative but no worse than industry average while NMMs margins
have averaged a solid 40% for an MLP. Expansions in forward PE multiples at both companies show that
the buyside sees strong potential for a rebound in these two stocks.
While NMM has not reacted much to the strong gains the BDI has shown in the past month, it has been
appreciating all year. NMMs success is tied to NMs continued strength however and NM probably
represents the purer play on a rebound in dry bulk and particularly Capesize rates.
NMM recently issued 5 million new shares at $14.26, raising capital to further expand its fleet. The stock
naturally gapped down in-line with the follow-on offering and is currently trading near the offering price point.
Dryships (DRYS) may offer the best value of the bunch as it is a diversified player which is nonetheless
focused on the larger end of the market, owning 10 Capesizes, 2 Very Large Ore Carriers and 28
Panamaxes.
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While profit margins are currently negative at DRYS, they are more attractive than much of the competition
and earnings are expected to turn positive as soon as mid-2014. A significantly compressed forward PE of
12x indicates DRYS has so far been neglected compared to peers.
Diana Shipping (DSX) has a strong focus on larger ships, owning 8 Capesizes and its entire fleet being of
Panamax size or larger. Net long-term debt at DSX is low and earnings are expected to become positive in
2015. However, profit margins have been declining steadily and forward earnings valued at 97x appear very
expensive.
Should DSXs stock price pull back without BDIs rally being endangered, there may be an attractive buying
opportunity.
What if the rally in dry bulk rates fails?
Genco Shipping & Trading (GNK) provides the most interesting short opportunity should the rally in dry
bulk rates reverse.
While GNK owns 9 Capesizes and 8 Panamaxes, its Capesizes only represent 16% of its total fleet as it
owns a large number of Supramaxes and Handysizes, ships on the smaller end of the scale which are not
benefitting from the rally in rates that has benefited larger ships.
Net profit margins at GNK declined steeply in the past year and now rest at -99.1%, while earnings are
expected to remain negative for the foreseeable future.
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Rumours of GNKs imminent bankruptcy were spread earlier this year and only the current rally in dry
freight rates can justify hope for the companys survival. In the event BDIs rally reverses, GNK is likely to
see the sharpest decline in its shares.
Keeping Tabs on the Situation
It is crucial to understand which factors will materially affect the potential turnaround story.
Iron ore shipping has been the primary driver of resurgent rates. An important reason for renewed iron ore
shipping has been the low prices reached by iron ore which may be pulling future demand for iron ore
forward.
As such, a bet on a rally in dry bulk carriers is not simply a bet on China resuming its strong growth, but
also on iron ore demand continuing to drive large dry bulk shipping rates. This will be particularly
challenging considering new supply coming to market via shipbuildings.
Considering how notoriously doctored Chinas growth statistics can be, keeping an eye on the BDI index
and iron ore prices is still ones best bet to monitor the macro environment shippers are working in.
The Feds decision not to proceed with tapering gave dry bulk shipper shares an extra push, in particular
DRYS which is now overextended. GNK is the only stock of the group still far below the initial highs set in
early September.
Waiting for a pullback before entering a long would be the optimal course, especially for DRYS.
On the other hand, GNK (which is up over 100% since early August) could easily drop over 50% if the
progression in dry bulk rates were to reverse.
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8 Responses to Dry Bulk Shippers: Turnaround or Mirage?
1.
Anonymous Jewish Terrorist on September 26, 2013 at 1:16 pm
Wow, fantastic article. I appreciate the explanation of even the dry bulk industry and how these 4
companies function w/i it and the relevance of iron ore shipping. Thank you so much for explaining it
in laymans terms as well. Ive owned DSX since Nov., and have owned DRYS and GNK since July. I
also own 2 oil tanker stocks, both purchased in March, what do you think about that industry? It
seems to be bottoming out as well, though may remain flat for some time.
Reply
2.
Mercenary Research Team on September 30, 2013 at 8:12 am
We do not have any strong views on tanker stocks at the moment. The overall trend for dirty and
clean tanker indices is still downward so a turnaround for the whole industry is hard to predict for
now.
Reply
Harun on January 22, 2014 at 5:27 am
my buy order on EXM was hit today at $52.10 which is a play on dry bulk commodities
shnpiipg. Remember DryShips? Looks like this trend may be back in favor after finding key
support. More on that though
Reply
3.
Roy on September 30, 2013 at 6:28 pm
You mention additional new capacity starting to be delivered: do you know what sort of capacity
increase that will be, percentage wise, in relation to existing total industry capacity? Will it be
significant enough to hurt the shippers if they cant all be efficiently utilized?
Reply
Mercenary Research Team on October 1, 2013 at 9:50 am
While supply growth has been high the past two years, new ships are being added at a
slower pace this year and growth should be even slower next year. Furthermore, the level of
scrapping has been declining this year, implying that shippers are growing in their confidence
Share
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that the worst is over. The following report discusses trends in shipping supply:
http://tinyurl.com/pe8u2gp
Shipping rates price in expectations and the glut in the dry bulk shipping market has played
an important part in the decline of shipping rates since 2008. In other words, shipping rates
have already priced in the extra capacity coming to market and dry bulk carriers are feeling
increasingly confident there will be enough demand to match the increase in shipping supply.
Reply
Gohnny on January 21, 2014 at 8:52 pm
For the bulls this is great news, for the bears unless you sckeud it up you are bleeding
right now. I was one them but thanks for smart management QID was sold for a split.
Now I am vested back in the shipping trend.
Reply
4.
bill arc on October 15, 2013 at 9:58 am
http://seekingalpha.com/article/1745292-3-gamechangers-to-shake-up-2014-metals-markets-part-ii?
source=email_macro_view&ifp=0
seems the author has found information that iron ore prices are set to decline.
Reply
Mercenary Research Team on October 16, 2013 at 7:14 am
According to Reuters this morning, Chinese traders have stated that 10-15% of the iron ore
imported into China this past month has yet to be sold. The idea that low iron ore prices
dragged demand forward is looking more and more plausible. While dry bulk rates may still
have bottomed out long-term, the August-September move was probably overdone in light of
this.
Reply
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