Is it Time to Buy Dry Bulk Shippers?

December 29, 2008

The dry bulk industry may be on the decline with lower asset valuations and tumbling freight prices, but some investors believe that the record-low valuations may spur some positive action. Dry bulk shipping rates have plummeted more than 90 percent since last summery while the net asset values of the ships have dropped 70 percent in some cases. The result has been record low valuations for the owners of those ships – those companies operating in the dry bulk industry.

The Baltic Dry Index, which measures day rates for dry shipments, recently moved below 800, signaling the worst pricing since around 2002. These lower day rates are the result of reduced demand due to slowing economies around the world. Less iron ore shipments need to be made given the slower construction in both the United States and growing economies like China. However, many important players in the market are predicting a recovery.

DryShips (DRYS) is one stock that has nearly tripled from its 52-week lows on speculation that things will improve. Chief executive and 34% owner George Economou believes that the company will be able to weather the storm over the long-term. These sentiments have even led to speculation that the billionaire shipping mogul would take the firm private at its cheap valuation and take it public in a few years to yield several times the return.

Many experts believe that the current Chinese iron ore negotiations are moving in favor of dry bulk shippers. Jefferies & Co. said in a research note that a successful downward adjustment to iron ore prices in China could spur demand for the dry bulk market by increasing the number of shipments. Meanwhile, much of the capacity expected to go online has been canceled and fuel / labor prices have also decreased over the past several months.

Unfortunately, many dry shippers are highly leveraged. The risk is that dry bulk owners will simply default on their payments, go into bankruptcy, and emerge under a new name after cleaning out shareholders. It wouldn’t be anything new for DryShips, which was created from the bankruptcy of predecessor Alpha Shipping. That entity was also owned by Economou and went bankrupt in 1998 and resulted in 37 cents on the dollar being paid to creditors and most of the fleet under his ownership.

Safe bets within the sector may be those dry bulk carriers with low debt, few new builds, and limited spot market exposure. These companies include names like Eagle Bulk Shipping (EGLE), Genco Shipping & Trading (GNK), and Star Bulk Carriers (SBLK). Unfortunately, even some of these companies are struggling with Star Bulk already defaulting on a $106,500 a day long-term contract after its client filed for bankruptcy and killed the contract.

So, how can investors get involved with these companies with limited risk? One way may be through long-term options call LEAPS – or long-term equity anticipation securities. These options provide investors with the upside of stock ownership without the risk of owning the stock. Investors can purchase the right to a set number of shares at a fraction of the cost of owning the underlying shares.

Hg