The first issue is financing. When companies decide to purchase a new ship, they can finance that purchase with cash on hand by issuing debt or by issuing new equity. Since most companies do not have enough capital lying around for such a large purchase, they have turned to selling bonds or preferred stock to finance such transactions.
Diana Shipping has a unique approach in that management has decided to purchase most of its new vessels using equity, and so when it finds an attractive purchase, it issues a secondary stock offering to fund the purchase. This cuts down on risk as the capital is permanent, and while it may at times be dilutive to current shareholders, most are usually constructive on the opportunity to purchase a new cash generating asset.
A firm must strategically decide whether to operate under the fluctuating daily spot rates or whether to engage in long-term charter rates. While the prices were steadily rising, it seemed to make the most sense to take advantage of the potential revenue increases by accepting the daily rates offered by the market. But in volatile times, it now seems wise to charter a large portion of available shipping days with long-term contracts to stabilize revenue and provide a more reliable earnings stream.
Diana has historically made extensive use of long-term charters, and while that may have caused management to forfeit some opportunity, the stable earnings and more recent new contracts at attractive rates have served the company well.
The last interesting dynamic to point out is that each ship has a definitive useful life before it must undergo extensive repair or be scrapped. New capacity is coming online in the form of new ships being built, but an aging industry fleet will likely have to retire ships, taking a bite out of the new capacity. As scrap rates increase sharply this year, there is more incentive for owners of aging vessels to go ahead and take their ships offline which could throw current assumptions about the shipping supply into transition.
As the industry adapts to the growing need for global shipping, and as the price and demand for commodities continue to rise, shippers are likely to enjoy growth as an industry. The recent market dynamics create an opportune time to look at many of these names like DSX and DRYS as short-term trading vehicles, and a few qualify for long-term investments.
Hedging - Diana has taken a more conservative approach in chartering its vessels. It has set contracts up with fixed rates for 2-5 years. This will allow its earnings to not be affected as much with the BDI sliding.
This issue revolves around the company’s dividend policy. While many management teams have decided to keep earnings in-house to build book value and possibly finance growth initiatives, Diana has decided to pay out the majority of its cash flow to investors, thus keeping its dividend yield very high. In looking carefully at the returns to investors including the past dividends, the stock has a very attractive historical return.
One benefit of a healthy dividend policy is that it often helps to stabilize the stock somewhat as investors are unlikely to sell a holding that pays an attractive cash flow on a regular basis.