The Week in DRYS

July 6, 2008
Well, quite a week it was, we started the week almost at 85, and after a low in the high 60s, we ended the week at just above $70. If you like volatility, you’ll like this stock. Let’s review some developments and assess the situation.

If you read our articles about DRYS before, you might have realized that we are actually not such fans. Volatility is nice, but it’s all a bit too unpredictable. Why? Because, like we argued before, this stock moves to the beat of that Baltic Dry Index (BDI).

And try to predict that! You might have to creep into the minds of Chinese buyers of Australian iron ore, and when they buy again, when they’re drawing down their inventories, and the like. It’s not easy.

However, having said that, we also have to say that there are things we particularly like in this company. It seems to have excellent management. It is using the boom times to expand and diversify, management is pro-active. They very much seem on top of things. The news this week is an example of that.

Other steps the management has taken in recent times:

  • Deep sea drilling take-over
  • Reducing dependency on very volatile day rates

So there are a couple of forces at work:

  • The short-term volatility of the BDI
  • The longer-term upward trend in the BDI, which is still intact. However, if the world economy keeps cooling, this might very well change, and the margins for error are pretty slim here
  • On the other hand, the credit crisis is something of a boon, as it keeps credit for new players and ships very tight. On the other hand, existing players profit from the good times and use cash-flow for expanding capacity
  • The excellent forward steps DRYS management takes, positioning the company ever better.

And what is the influence of the rising oil price?

  • On the one hand, shipping is transport, so they suffer higher input cost
  • However, high oil prices induce users to switching to coal, which need shipping, so increasing the demand for dry bulk shipping
  • On the other hand, shipping of other low value bulk will suffer from higher energy cost and higher shipping rates.

With respect to the latter, there are those that have even predicted a realignment of global manufacturing as a result of higher energy and hence higher transport cost.

Yes, there is no law that states that globalization cannot slow down, or even go into reverse. The world can also become bigger as a result of increasing transportation cost. Most at risk are those goods that have low value to weight (and/or volume) ratio.

There are few signs that dry-bulk shippers are particularly vulnerable to these risks though. These ship mostly raw materials and commodities (like coal, iron ore, grains), which have the awkward habit that they are location bound, and need shipping to places where they can be put into something useful.

Now, what’s news this week?

DRYS sold three ships for a total of $213M, booking a whopping profit of $108M! Now that’s a deal, these ships were a decade old, which is quite surprising. Ships are not like cars, their life span is supposed to be a lot larger.

The profits surely are a sign of the scarcity in bulk shipping conditions (hence the sky-high BDI)

At the same time it bought four new ships for a total of $400

The Bottom line
To assess the downside risk one must wonder how much of the current problems in the world economy is priced in? We think that because of the very cheap metrics, considerable problems are already priced in.

This doesn’t mean that world economy, BDI, and general market problems will not have further downward influence, what it does mean is that, leaving out extraordinary circumstances like some disaster or market crash, the risk-reward situation of DRYS is actually pretty favourable.

A strategy to deal with the unpredictability is to keep a core position for the long-term (insofar the long-term prospects are still in tact, of course), and trade the rest on the technical picture and BDI movements (and any other info one can lay one’s hands on).