The Maritime Industry is among the most economically sensitive industries that Value Line covers. Within the industry, shippers of dry bulk cargoes (which include commodities such as iron ore, coal, and grain), have been the most volatile over the past ten years, flourishing during the boom years of 2005-2008, and crashing especially hard from 2009 through the present.
The historical movements of the Baltic Dry Index (BDI), a measure designed to indicate the rate for bulk shipping of commodities, demonstrates the volatility of the shipping industry. After reaching a record high of over 11,000 in 2008 due to the boom in raw materials consumption in China, which necessitated rising imports from producers as far away as Brazil, the BDI crashed during the financial crisis and ensuing recession. To make matters worse, capital spending on new ships had risen exponentially during the boom years of the mid-2000s, which led to a flood of new capacity. The growth in demand for bulk-carrying and container ships (used for manufactured goods) has slowed to a relative crawl in the years since. Four years after hitting its peak, the BDI is stuck under 1,200, marking a decline of over 90% from its peak.
Diana Shipping (DSX) has a fleet of 27 dry bulk carriers, consisting mostly of Panamax ships (the label referring to the maximum size for ships allowed to traverse the Panama Canal), which are meant for large-volume cargoes. The company is highly sensitive to the BDI, with earnings per share peaking in 2008 at $2.97, and its stock price hitting a high of around $45 in 2007. By 2011, earnings per share were down by more than half, at $1.33, and the stock price had declined by more than 80% from its all-time high. The company sticks out in the industry for its relatively strong balance sheet, with cash assets outweighing long-term debt. This is largely due to its relatively cautious expansion strategy. While competitors amassed tremendous debt loads during the boom years by ordering new ships, Diana invested far more modestly. The strategy has paid off in recent years, with the company remaining quite profitable while competitors have been pulled under by interest expenses and crashing operating margins. Having no income tax expense due to the favorable tax treatment afforded to international shipping companies, DSX's net profit margins have remained staggeringly high, coming in at almost 42% in 2011, despite a rough year for the industry.
Dryships (DRYS), another dry bulk transporter, owns a fleet of 47 drybulk carriers, 29 of which are Panamax. The company expanded aggressively during the boom years, with capital spending accounting for a multiple of the company’s cash flows from 2005 through 2008. Its aggressive strategy and record earnings sent the stock price up to a high of $131 in 2007. Since then, its stock price is down by over 98%. Indeed, its current stock price is a small fraction of its peak earnings per share of $9.51 in 2007. This makes the appreciation potential highly enticing should business conditions improve. However, the risks here are jaw-dropping, as the company now holds long-term debt of over $3.9 billion and a large working capital deficit, while earnings have dried up in recent years, with share-net coming in at a mere $0.05 last year. While we project that the company will remain slightly in the black this year and next, it will probably take a major rebound in the BDI before profits can recover significantly.
Another dry bulk shipper, Eagle Bulk Shipping (EGLE), which is a leading operator of Supramax ships, meant for smaller volumes than Panamax, has seen an even steeper reversal of fortunes. Adjusting for a recent one-for-four reverse stock split, the stock price is down about 98% from its 2008 high of $145 per share. Indeed, the shares are selling at less than their 2008 earnings alone. However, unlike Diana and Dryships, Eagle has gone deep into the red, with a loss of $0.96 in 2011, and much larger losses projected for this year and next. Further, its balance sheet is a major cause for concern, with a working capital deficit and a long-term debt load of over $1 billion, which far outstrips shareholder equity. With debt repayments coming due and minimal cash assets available, the company is in a precarious position. Having run aground, Eagle’s capital spending is projected to come to a screeching halt, after having taken delivery of 20 ships in 2010 and 2011. This may be good news for the industry as a whole, as such scaling back may eventually heal the capacity glut.
The fate of these three stocks will be determined by the trajectory of the BDI, which is, in turn, heavily influenced by both the state of the global economy and the speed with which the oversupply of shipping capacity is absorbed. A major pickup in global economic growth could lead to exceptional price recovery for these beat-up stocks, while downside surprises could put further pressure on the shares. Of the three, Eagle is the most vulnerable due to its distressed balance sheet and income statement, while shares of Diana may offer the best risk-adjusted returns, as the company has weathered the storm of the last four years far better than its competitors.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.