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DRYS AT A GLANCE

P/E ► -1.31   EV/EBITDA ► -2.49   ROA ► -20.1% VERY LOW ROE ► -47.4% VERY LOW Debt to Equity ► 1.03 AVG Current Ratio ► 0.407 LOW Interest Coverage Ratio ► -13.8 VERY LOW

 

 

 

 

 

 

DryShips Inc. (NASDAQ:DRYS) is a Greek holding company that charters vessels for shipping dry goods overseas^[1]. The company is the second largest dry bulk shipper listed in the United States, operating 40 ships with an average age of 8 years and a combined capacity of over 3.3 million dead weight tons^[2]. The average useful life of these vessels is 25 years.^[3] Dry bulk vessels deliver commodities such as iron ore (used for steel production), grains and coal throughout the world. Dry bulk shipping accounts for 36% of sea-based trade; in comparison, liquid bulk cargo--such as petroleum--accounts for about 38% of overseas shipping.^[4]

DryShips makes most of its revenues by chartering its vessels to other companies that pay a contracted daily rate to use the ships. The company pursues shorter-term spot contracts as opposed to secured long-term ones, giving DryShips greater exposure to up- and down-swings of daily rates. Its short term strategy is also apparent in its fuel costs, which are paid by DRYS in short-term contracts (and paid by the charterer in long-term contracts). ^[5]

In 2006-2007, China and India's growing appetite for steel, grains, coal and other commodities was the biggest driver of growth for the dry bulk industry. This caused the dry bulk rates to skyrocket, reflected by the industry benchmark Baltic Dry Index (BDI), appreciating nearly 400% in the two year period. DryShips in particular benefited from this short term run up in rates because of their targeted exposure to spot markets. This change led to stock price appreciation of nearly 1000% in the two year period.

During 2008, ocean shipping has been hit hard with soft global consumer demand for discretionary items, a weak housing market, and credit market concerns. Freight rates will likely stay low for several years until trade recovers.Weak demand for U.S. goods due to a strengthening dollar also have hurt the ocean shipping industry.According to a February 2009 analysis by PIERS, U.S. containerized imports and exports in the trans-Pacific trade declined 4.1% in 2009, following a 3.9% drop in 2008.Imports from Asia fell 8% in 2008, and nearly 11% in the fourth quarter.Carriers estimate that housing-related products account for at least 25% of eastbound cargo volume from Asia.Spot rates from Hong Kong to Los Angeles plunged 35% to $1,350 in mid-February from early September 2008. All of these factors led to an approximately 95% drop in the stock price of DRYS, causing the stock price to hover around $5.00 and $7.00 throughout 2009.

Business Overview

Business and Financial Metrics

DryShips revenue and earnings growth has been staggering. This is almost entirely due to the massive appreciation of daily shipping rates for dry bulk cargo. This was reflected in Baltic Dry Index's meteoric rise in 2007. This index is explained in the Trends and Forces section below. Management effectiveness in procuring vessels and maintaining low operating costs was a factor, but the real impact of management is its direction on charter duration. Industry magnate George Economou angled DryShips to be almost entirely exposed to the Spot Market for dry bulk shipping. This was advantageous in a market such as 2007 where demand greatly outstripped supply and short term rates were accelerating.

On the other hand, in the market from October 2007 to January 2008 the BDI shed half of its value. This dragged down expectations of future revenues for DRYS and the stock price fell accordingly. DryShips failed to lock in any of these historically high rates for the long term and operated in the spot market for most of the first quarter of 2008. But the market turned in February and worldwide demand for the commodities dry bulkers move exploded. The BDI recovered all of its value and hit all time highs in May. This time around DryShips locked in 14 vessels to long term contracts from 4-10 years out. This gives DRYS a much less volatile and more secure cash flow structure.

Although Time Charter Equivalent Revenues, a metric used to measure average daily revenue for vessels in the shipping industry, declined by 57.9% in 2Q09 as compared to 2Q08, DRYS was to earn $52.8 million in the quarter, albeit this represents an 82.4% fall in net income.^[8] Yet, when losses related to contract termination fees, gains related to interest rate swaps, and amortization of compensation are removed, DryShips' net income improves slightly, to $55.5 million.^[8] Revenue fell 30.4% overall, to $210 million; yet, the drilling segment benefited from consolidation in 2Q09. This ultimately led to an increase in revenue of $59.8 million and increase of expense of $21.9 million, to $103.6 million and $35.3 million, respectively.^[8] Voyage revenues fell by 58.7%, as average number of vessels declined from 38.5 to 37.3.^[8]

Through three reporting quarters, DryShips a net loss of $16.368 million, almost $700 million lower than the company earned through three quarters in 2008.^[9] Although operating revenue overall fell by 26.4% to $635 million, the company's revenue from drilling contracts did grow by over 135%, to $310 million.^[9] However, this increase is largely due to the segment's inclusion in only 4.5 months of 2008 operations through three quarters.

Hostile Takeover of Ocean Rig ASA

During the 4th quarter of 2007, Dryships began accumulating shares of Norway based Ocean Rig ASA.^[10] The company owns and operates two deep water drilling rigs and has contracted delivery for two more in 2011.^[11] On 22 April 2008, DRYS announced that they possessed a majority of the shares outstanding, and were proceeding with the mandatory tender offer to buy the entire company. ^[12] According to CEO George Economou, the move into a different industry was intended to "capitalize on the shortage of premium ultra deep water drilling assets" and use some of Dryships's substantial excess cash flow.^[13] The acquisition closed on May 14, 2008 and the board of directors at Ocean Rig offered their support for the deal.^[14] Dryships spent approximately $1.4 billion on the acquisition. Economou spun off part of the drilling subsidiary to DRYS shareholders within a year.^[15] The new subsidiary is the only pure ultra deep water drilling company listed on the U.S. exchanges.

Business Segments

DryShips has two main business segments, drybulk carriers and drilling rigs^[16]

Drybulk Carriers (79.70% of revenue^[16])

The operation of a fleet of 40 drybulk carriers with an average age of 8.0 years and a combined deadweight tonnage of 3.3 million dwt is the main business operation of DryShips.^[2] The fleet is used to carry and ship coal, iron ore, and grains, as well as bauxite, phosphate, fertilizers and steel products.^[2] All of the carriers are managed by Cardiff Marine, Inc., an affiliate of DryShips', and the carriers are employed through a variety of leases, such as period time and bareboat charters and in the spot charter market and drybulk carrier pools.^[2] In 2008, DryShips made $861,296 million of revenue and $380,060 million of net income from its Drybulk Carriers segment.^[16]

Drilling Rigs (20.30% of revenue^[16])

In May 2008, DryShips acquired Ocean Rig ASA, which manages two ultra-deep water, harsh environment, semi-submersible drilling rigs that are known as the Leiv Eiriksson and the Eirik Raude.^[2] Also, in April 2008, DryShips, through its subsidiary DrillShips Invesment, Inc., acquired two drillships, which will be delivered July 2011 and September 2011, respectively, and will cost the company $800 million per ship.^[2] During 2008, the Drilling Rig segment had revenue of $219,406 million, but had a net loss of $741,342 million.^[16]

Key Trends and Forces

World Economic, Population, and Infrastructure Growth All Increase Demand for Dry Bulk Commodities

Economic and infrastructure growth often go hand in hand, but populations grow independently of both. Either way, increases in any of these causes increases in dry bulk trade. Economic growth causes demand for all ranges of inputs to increase. Population growth causes demand for food and electricity generation materials to increase. Infrastructure growth causes demand for steel and ore to increase. All three of these are moved over seas by dry bulk carriers. This is clearly a slight oversimplification, but it helps illustrate the absolute necessity of the service dry bulk shippers provide to global commerce. As mentioned above, nearly 40% of all ocean trade is conducted in dry bulk. If there are more buyers (companies who need to move the materials) coming to the market, the sellers (companies like DryShips who possess dry bulk vessels) can demand higher rates to move the necessary cargoes.

Fleet Supply Determines Pricing Power for DryShips

This is determined by the amount of available ships, their capacity, and their utilization rates. Additionally, the average age of the fleets determines where they are in the life cycle. The average ship lasts 25 years, and if a majority of ships approach that number, supply decreases in the short term as replacements are built. Also, supply is heavily influenced by delivery of new vessels. A significant back logged demand for new vessels drives up prices, and in 2008 this situation exists with many new orders that won't be delivered before late 2009. With this backed up supply, BDI prices soared in 2007. With rates for the largest dry bulkers fetching nearly 10x that of a comparable VLCC Oil Tanker, many companies converted tankers into dry bulk carriers.^[17] As conversions and ships contracted to be built at the beginning of the price run up in 2006 come on line, the upward pricing pressure of a fleet in which 41% of its ships are over 20 years old eases.^[18]

Ease of Capital/Financing To Buy New Vessels

The low interest rate environment of 2009 is beneficial for fleet and operations growth. DryShips, and other companies which have significant capital costs associated with growth, find it cheaper to finance bigger expenditures. This translates into less invested capital when a ship is built, and DryShips pays less interest to buy more vessels. The one caveat is that it requires ample liquidity in the credit markets if the company hopes to take advantage of these low interest rates.

Dry Bulk Shipping Rates (reflected in the Baltic Dry Index) Illustrate DryShips Revenues

This index is an average of Spot Market prices for various sizes and routes of shipping dry goods. The "BDI" provides a glimpse of the worldwide demand for DryShips and the rest of the dry bulk shippers' services. DryShips historically has an incredibly short term bias on its contracts, and has operated its entire fleet in the spot market at times. An investment in DRYS is effectively an intrinsic bet on the prices of the BDI. This is evident in the high correlation of the stock price to the BDI this past year. Higher rates directly translate into more income. F Bloomberg BDI Data

Factors Affecting Dry Bulk Charter Rates

• Commodity Demand - This is determined mainly by industrial production and energy demand. If commodity demand is strong, BDI rates increase regardless of spot rates for those commodities. Companies that have contracted out spot rates show increased demand through paying more for shipping of the materials. As more coal and steel are being demanded by China, the rates for dry bulk shipping increase.

• Seasonal Pressures - Weather has a significant impact on both demand and logistics. For demand, cold weather increases the demand for coal and other energy creating raw materials. For logistics, cold weather frequently causes ice to block ports and low rivers to prevent travel. Both of these cause increases in the BDI. Conversely, a mild winter or early ice breakup in cold water parts cause decreased in the BDI.

• Bunker Prices - Bunker oil is the name for the oil a ship uses for fuel. Bunker fuel accounts for between a quarter and a third of vessel operating costs. These higher oil prices are reflected in higher BDI prices. So just as higher oil prices put a damper on Airline company margins, they squeeze margins for dry bulk operators.

• Choke Points Nearly half of the world's oil passes through a few narrow shipping lanes. This includes the straights of Hormuz and Malacca, the Bosporus and the Suez and Panama canals. These choke points cause natural caps in ship supply; i.e.- only a certain amount of ships can pass through them each day. If something disrupts this flow, the BDI increases.

• Market Sentiment - Because of the time lag in forecasting demand for raw materials, market opinion can greatly affect the freight exchange. ^[19] The January 2008 halving of the index's value can be attributed to many companies forecasting lower global growth and cutting their production/demand targets.

• Port Congestion -This acts as another great buffer against supply increases lowering index prices. The actual infrastructure of these ports prevents more ships entering the market. The ports simply cannot handle more traffic. Until changes occur at these vital terminals, there is upward pressure on dry bulk prices. Shipping industry analysts [1] are actually developing an index to standardize and make available this incredibly vital data.^[20]

Competition

References

1. ↑ DRYS 2008 20-F, pg. 39
2. ↑ ^{2.0 2.1 2.2 2.3 2.4 2.5} DRYS 2008 20-F, pg. 39
3. ↑ 2008 DRYS 20-F, pg. 46
4. ↑ RTT News, DryShips - Buoyant Or Ebbing Away?, February 2008
5. ↑ DryShips 20-F Filing, Business Overview, as of December 31, 2006.
6. ↑ Press Release (March 25, 2009). DryShips Inc. Reports Its Financial and Operating Results for the Fourth Quarter and Year Ended December 31, 2008.
7. ↑ DRYS 2008 20-F pg. F-8  
8. ↑ ^{8.0 8.1 8.2 8.3} DRYS 2Q09 6-K
9. ↑ ^{9.0 9.1} DRYS 2009 3Q 6-K
10. ↑ http://www.reuters.com/finance/stocks/keyDevelopments?symbol=DRYS.O&pn=2
11. ↑ http://www.ocean-rig.com/default.asp?fid=1001
12. ↑ http://www.reuters.com/article/rbssIndustryMaterialsUtilitiesNews/idUSOSL00120820080422
13. ↑ Dryships 1Q 2008 Presentation
14. ↑ http://www.rigzone.com/news/article.asp?a_id=62317&rss=true
15. ↑ Dryships 1Q 2008 Presentation
16. ↑ ^{16.0 16.1 16.2 16.3 16.4} 2008 DRYS 20-F, page F-55
17. ↑ http://www.livemint.com/2007/11/06011451/Crude-carrier-to-get-new-lease.html
18. ↑ http://en.wikipedia.org/wiki/Bulk_carrier
19. ↑ http://www.balticexchange.co.uk/default.asp?action=article&ID=3
20. ↑ http://www.g-ports.com/gp_Congestion.aspx
21. ↑ Google Finance: DRYS Income Statement
22. ↑ Google Finance: DSX Income Statement
23. ↑ Google Finance: GNK Income Statement
24. ↑ Google Finance: GNK Income Statement
25. ↑ Google Finance: EGLE Income Statement
26. ↑ Google Finance: NM Income Statement

Notes