DryShips: Look Out for Those Forward PEs

by: The Stalwart posted on: April 08, 2008

Time to reprise a very old, mothballed feature of The 'Wart: Arbitraging Barron's, wherein I look past the Barron's pay wall link to some of the more interesting items of the weekend. With godspeed, I'll try to keep it up every weekend. From this past weekend:

Friendlier Waters Ahead For Cargo Carrier DryShips (DRYS):

Global trade might slow this year, but it will come back eventually, and DryShips' profits -- and shares -- should move up over the long term, even if 2008 growth turns out to be lower than Wall Street expects. At its recent quote of 64, DryShips stock was trading at a price/earnings ratio of 3.5 times consensus analyst earnings estimates of $18.18 a share this year and about 5 times the $12.22 forecast for 2009. DryShips also trades at a more than 50% discount to its peers, although rivals generally seek long-term contracts, which are less volatile. DryShips sports a healthy balance sheet, with net debt equaling about 40% of total capital.

Update: In the comments on the article above mentioning DryShips, commenter Mark leaves a very insightful comment on the global shipping industry. I thought I'd promote it here, as it's more than I could offer.


This article fails to mention that dry bulk spot rates are extremely volatile and forecasting where they will go is subject to massive room for estimation error, even for industry veterans. Thus forward PE can be very deceptive and is a silly way to look at the companies. Last year, Clarksons research surveyed a large collection of readers to forecast where rates would go in 2007 and EVERYONE was wrong by a large margin (they spiked massively). They can also spike massively downward in the same fashion... If forward earnings ends up being 80% lower, which historically isn't a crazy notion at all if you look at a rate chart, your PE will be 5x what you thought it was. Thus using forward PE is pretty silly given its forecast error range is so wide as to be near meaningless.

Also, the capacity for shipbuilding yes is indeed "tight", but for bad reasons. It is fully booked to the max and the industry is about to see the largest supply growth ever, for multiple years, going forward. If demand falters in any way and this supply comes on, it will be a slaughter for these companies as they undercut each other gruesomely as they have in the past, since ships must essentially be utilized at all times else they are losing money, and it's a very fragmented market. Not saying that it's all clear cut as to where things will go, but this Barron's article barely touches on the most important issue/risk of massive supply growth which is basically the entire swing factor. They should do their homework a little better.

Friendlier Waters Ahead For Cargo Carrier DryShips
By VITO J. RACANELLI  
4/7/08


DRYSHIPS, WHOSE 39 VESSELS haul iron ore, coal and grains across the seven seas, has seen its stock chopped by more than half, to the low 60s from a high of 131 late last year, on investor fear of a slowdown in global economic growth.

Because day rates in the volatile spot market for chartered ships are about a third below their highs of last fall, some momentum investors have bailed out. Others, wanting a "pure play" dry-bulk transporter sold DryShips (ticker: DRYS) after it revealed a surprise $405 million investment in late 2007 in deep-sea oil-service firm Ocean Rig (OCR.Norway).


DryShips' 39 vessels carry bulk cargo, such as iron ore or wheat. The company focuses on the volatile spot market, rather than on long-term contracts.
THE SHARE-PRICE COLLAPSE, HOWEVER, PRESENTS an opportunity for patient investors with a stomach for a volatile stock. Global trade might slow this year, but it will come back eventually, and DryShips' profits -- and shares -- should move up over the long term, even if 2008 growth turns out to be lower than Wall Street expects.

At its recent quote of 64, DryShips stock was trading at a price/earnings ratio of 3.5 times consensus analyst earnings estimates of $18.18 a share this year and about 5 times the $12.22 forecast for 2009. DryShips also trades at a more than 50% discount to its peers, although rivals generally seek long-term contracts, which are less volatile. DryShips sports a healthy balance sheet, with net debt equaling about 40% of total capital.

Even if profits somehow fell as much as 50% below their anticipated level, DryShips would sport a still very modest 7 P/E. In the past, the stock has traded as high as 40 times, so the current multiple is minuscule by historical standards. DryShips earned $9.54 a share last year, excluding one-time gains. Even middling growth in 2008-2009 suggests that the stock could rise 25% or more over the next 18 months.


Global economic growth will ease this year to about 3.6% from above 4% over each of the past five years, says Bank of America's chief market strategist, Joseph Quinlan. However, economic activity in developing nations -- whose share of world imports has risen to 41% from 33% -- will drive future gains. "By 2015, if not sooner, it's a safe bet that developing nations will account for over 50%," Quinlan predicts.

For DryShips, the rest of the world already is more important than the U.S, notes CEO George Economou, who controls about 47% of the shares. Roughly 60% of the world's dry-bulk trade is concentrated in Southeast Asia and China, he says. In January, average charter rates dropped to around $90,000 a day from about $190,000 in November, but have since rebounded to $130,000. Economou is "comfortable with 2008 consensus EPS estimates in the current rate environment."

Regardless of whether the U.S. economy grows or contracts, it won't have a big effect on DryShips, maintains Eric Marshall, director of research at Hodges Capital Management, which owns about 145,000 shares. As a play on globalization and trade in iron ore and agricultural commodities, DryShips boasts long-term fundamentals that are strong, he avers. "We like it at these levels."

"It's a very cheap stock," adds Scott Black, president of Delphi Management, who notes that DryShips tends to trade in line with the volatile Baltic Dry Index more than with fundamental earnings changes. The index, a broad measure of the price of moving raw materials across nearly two dozen key sea routes, has dropped sharply, from above 11,000 in November to about 7,700.

"With a P/E of three, DryShips trades as if it were going out of business," says Black, a Barron's Roundtable member whose fund owns about 200,000 of the shares. "It's discounting the total collapse of dry bulk trade and [saying] that trade for India and China is over." Delphi has been buying lately as the stock has fallen.

Comments Chris Armbruster, an analyst at Al Frank Asset Management: "DryShips' growth profile is very underestimated...The world is becoming a much more geographically diverse place...and demand for grain, coal and iron ore will be much higher than it has been." Al Frank has been buying shares again after having sold it at much higher levels last year.

The Bottom Line:

DryShips' stock, now in the low 60s, could fetch 80 within 18 months. In short term, however, seasickness pills are a must; the voyage could be quite choppy.To appreciate DryShips' long-term earnings power, look at the rise in historical day rates caused by increases in global trade. Steve Gordon of Clarkson Research Services, a London-based maritime research outfit, says that the highest day rates hit during the 1990s were about $25,000, while the average was much lower. Today, investors are fretting over about day rates that now hover, as noted, around $130,000. Day rates could fall again, short-term, but a sustained drop would require a big contraction in global trade, which doesn't seem to be in the cards. Clarkson estimates that global dry-bulk trade will rise about 4% in 2008 -- slower than the 5% seen in 2007 and 2006, but by no means shabby.

Some investors fear that many more ships will come on line in 2009, but worldwide ship-building capacity is constrained until 2010. Adjusted for inevitable delivery delays and ship retirements, the growth in ships won't outstrip demand, Economou contends. Moreover, because of the credit crunch, some ship owners simply can't buy new vessels right now.

Undoubtedly, many investors are worried about the global economy. There might be some hiccups, but India, China and other emerging markets will continue to develop, and that will be profitable for DryShips.