Turns out that we were looking at the wrong chart. We can be forgiven, perhaps, as that two year DRYS chart is a real stunner. But it is driven almost entirely by another chart, one that is more fundamental, it’s like those Russian dolls, there is one inside the other. We did surmise that DRYS performance would be driven by shipping rates, and that turned out to be spot on.
So let’s provide a short overview of this intriguing situation.
What is there to like?
- Huge insider holding (34%)
- Very cheap (although that turns out not to be as meaningful as might appear at first sight)
- Enormous margins (a net margin of 82%, but the same comment holds)
- Healthy balance sheet
What not to like?
- It trades with the very, not to say extremely volatile Baltic Dry Index, the graph of which is what we really should have studied. It’s an index measuring spot prices per day for shipping dry bulk stuff like coal, iron, and grains, the businesses DRYS is in
- This is no surprise, that Baltic Dry index is an index of spot day rate contracts for dry bulk shipping, which are very volatile indeed. This decade, it has roughly fluctuated between 1000 and 11,000, although the trend seems to be up for most of the decade. The correction in shipping rates correlates closely with DRYS stock price.
- It also turns out that DRYS is more dependent on these daily spot rates than most of its competitors
- Turns out, predicting day dry shipping spot rates, the one metric that really matters, is very difficult. Which makes predicting DryShip’s earnings also, well, very, very difficult.
So what drives dry bulk day spot rates?
As always, supply and demand is the best place to start. Demand is basically driven by the growth of the world economy, which neatly explains the sell-off from third-quarter last year, as angst set in about the health of the US economy and whether it’s troubles would spread to the rest of the world.
One can argue that shipping between developing countries is of increasing importance, hence the bounce in those spot rates, and the bounce in DRYS share price. But the fear lingers. And those fears might not seem justified, but wow, these spot rates can fall a lot.
So it boils down to a situation with a low probability, but large consequences, a so called Black Swan. It’s not for the faint hearted, this.
Supply is driven by available shipping, and here is were longer-term problems might lie. There is really a wave of new capacity coming onto the seas from about 2010, most shipbuilders in the world are working at full capacity.
Whether that will turn to a glut in shipping capacity totally depends on, well, the state of the world economy. If that continues to grow at a brisk pace, demand for shipping might just be enough for prices to keep from falling (in fact, they might continue to rise).
But to bet on that in a way as to recommend this company as a long-term buy and hold, no. That’s an ocean too far. It might be cheap now, but if these prices start to fall in ernst, either because the world economy slows down, or, as is to be expected in a couple of years, new capacity outstrips demand.
On the other hand, not much new capacity is not coming until 2010, in the meantime, if the world economy continues to grow at a clipper pace, this company could do pretty well still. But if you must take a position, watch that Baltic Dry Index like a hawk!