Stock Trade – DryShips Inc. (NASDAQ:DRYS)
Sunday, March 02, 2014

STOCK TRADE: Buy DRYS at market price (approx. $3.66), good for the day. Place a protective stop-loss at $2.50 and a pre-determined sell at $5.50.

by Ian Harvey

March 02, 2014

Introduction

The shipping industry is still suffering from the losses it accumulated over the last decade due to the oversupply of vessels and the financial meltdown of 2008. However, the situation is much better than the last year. The future outlook of the global economy and international trade is also favorable for the shipping industry.

DryShips Inc. (NASDAQ: DRYS) should make a full recovery over the next two years. The stock has already made substantial recovery over the last twelve months, and the favorable economic environment should support the future rise in the stock price.

Things are changing rapidly for DryShips, due to the changing dynamics of the industry. Also, the company has been trying to restructure the huge debt levels. There has been a lot of volatility in the stock price and it has made some wild swings - however, the overall trend has been upward. The stock has gained more than 190% during the last year. However, as the New Year started, a combination of profit taking and an announcement to issue new equity by the company caused the stock to fall. Nevertheless, the stock has started to make a recovery and it has been gaining momentum again. The main reason for an upward movement is the improving conditions of the dry bulk carrier industry and a favorable economic outlook.

Company Details

DryShips Inc. is a holding company engaged in the ocean transportation services of drybulk cargoes and crude oil worldwide through the ownership and operation of drybulk carrier vessels and oil tankers and offshore drilling services through the ownership and operation of ultra-deepwater drilling units.

Through its majority owned subsidiary, Ocean Rig UDW Inc., DryShips owns and operates 10 offshore ultra deepwater drilling units, comprising of 2 ultra deepwater semisubmersible drilling rigs and 8 ultra deepwater drillships, 3 of which remain to be delivered to Ocean Rig during 2013 and 1 during 2015.

DryShips owns a fleet of 42 drybulk carriers (including newbuildings), comprising 10 Capesize, 28 Panamax, 2 Supramax and 2 newbuilding Very Large Ore Carriers (VLOC) with a combined deadweight tonnage of approximately 4.4 million tons, and 10 tankers, comprising 4 Suezmax and 6 Aframax, with a combined deadweight tonnage of over 1.3 million tons.

Key Statistics for DRYS

Current P/E Ratio (ttm) -
Estimated P/E(12/2014) 20.3315
Relative P/E vs. SPX -
Earnings Per Share (USD) (ttm) -0.3700
Est. EPS (USD) (12/2014) 0.1810
Est. PEG Ratio 2.0331
Market Cap (M USD) 1,584.80
Shares Outstanding (M) 430.65
30 Day Average Volume 10,392,757
Price/Book (mrq) 0.4136
Price/Sale (ttm) 0.9477
Dividend Indicated Gross Yield -%
Cash Dividend (USD) -
Dividend Ex-Date 01/22/2009
5 Year Dividend Growth -
Next Earnings Announcement 05/22/2014

Technical Outlook

DryShips (NASDAQ:DRYS) traded up 0.02% on Friday, hitting $3.3.68. The stock had a trading volume of 11,463,604 shares. DryShips has a 1-year low of $1.65 and a 1-year high of $5.00. The stock has a 50-day moving average of $3.77 and a 200-day moving average of $2.88.

The company’s market cap is $1.365 billion.

Earnings

Ocean rig has a market cap of $2.26 billion. The drilling business is performing well and should continue to do well in the future. Over the past few quarters, the company has shown a significant hike in its revenue and adjusted EBITDA. For the third quarter of 2013, Ocean Rig generated revenue of $328.5 million, as compared to $285.7 million for the same period in 2012. It recorded a net loss of $21.5 million. But the loss includes non-cash write offs and breakage costs associated with the full repayment of the $800 million secured term loan agreement and the two $495 million senior secured credit facilities totaling $61.1 million. This is a one-time and non-cash expense. Excluding this expense, the company's net results would turn into a net income of $39.6 million.

Moving Forward

Improved Shipping Rates

The shipping rates depend on the demand and supply of goods transported. They also depend on the number of vessels available - there is an inverse relationship between the number of vessels and the shipping rates. Analysts have predicted that in 2014, the growth in demand for the services of drybulk carriers is expected to be greater than the growth in the number of vessels by 0.1% to 1.1%. This will result in better shipping rates, subsequently, increase the margins of drybulk carrier companies.

Drybulk carrier companies have been increasing the fleets since last year. Mainly, due to the increased demand over the two-three years. The Baltic dry index is also getting better if we look at it on a yearly basis. During 2013, Baltic dry index rose 200%. However, most of this growth was lost as 2014 started. The problem is that Baltic dry index is extremely volatile which effects DryShips' stock almost instantly. So if we were to evaluate this company by shipping rates, the wise thing would be to consider the long-term year-over-year growth of Baltic dry index rather than any short-term movements in the index. The main reason for drop in Baltic dry index is a decline in demand for capsize, which mainly happened due to the decreased demand of ores from china due to its New Year. However, this effect is temporary and is expected to improve as business gets back in the flow.

The value of vessels has also been increasing significantly for both new and used. Value of a used Panamax increased from $25.5 million to $26.5 while capsize value increased from $41 to $49 million. Additionally, the value of huge number of vessels which DryShips owns is also increasing with increased vessel prices. This will not directly affect the company's earnings but may reflect on the company's balance sheet as the assets get revalued. As a result, total assets to total liabilities ratio will improve.

China is the largest importer of coal as the steel production keeps rising and the number of expected coal fired plants continues to increase, the demand for coal in China and India is expected to increase. By 2030, the demand for thermal coal is expected to double as it is a viable option for many due to higher LNG prices. Also, estimates show that India may face a shortage of 350 million tons of coal by 2017. In other words, the demand for coal in India would increase by 20-32%, annually.

Restructuring the Debt: Increased Free Cash Flow

Long-term debt has been a huge problem for the company driving it profits down and leaving the company with negative free cash flow. Fortunately, the company has restructured its $1.8 billion loan to solve solvency problems and increase its cash in hand. The loan restricting is done through the company's subsidiary, Ocean Rig (ORIG). The new loan is not going to mature before the third quarter of 2020. Although the company would still have to pay the interest costs but it will certainly increase the free cash flow of the company for at least 6 years. The amount which would have been taken by debt retirement could now be used to provide short-term solvency for the company. DryShips have used Ocean Rig to get out of jail on a number of occasions as it is a healthier arm of the company.

Global Economic Demand

Performance of DryShips is largely dependent on the global economic conditions. The company operates both drybulk carriers and tankers. Iron ore and coal demand is rapidly growing in China and India, as a result, demand for dry bulk vessels is increasing. Both iron ore and coal are the biggest source of demand for dry bulk vessels.

China is the world's largest iron ore importer. Iron ore demand in China is rising due to increasing steel production. Around 98% of iron ore is used in steel making. China's steel production is forecast to increase 3.8% to a fresh record of 810 million tons from an estimated previous record of 780 million tons for this year. With the growing steel output, China's iron ore imports are expected to rise 6.3% to a record of 850 million tons in 2014.

Iron ore consumption is also increasing in India due to growing steel demand. Steel demand in India is expected to grow by 5.6% this year. Due to lower domestic iron ore output, India's iron ore imports are expected to rise by 67% to around 5 million tons in FY14. Besides iron ore, coal demand is also rising in China and India that will drive the demand for drybulk vessels. Between 2012 and 2017, China's coal imports are forecast to grow at 38.4% from 289 million tons to 400 million tons. During the same period, India's imports of coal will surge from 137 million tons to 165 million tons.

Support

DryShips has a substantial amount of debt which is certainly a risk. The company also has a stake in Ocean Rig UDW Inc. (ORIG) that gives it some flexibility because if things got really bad, they could monetize Ocean Rig to get them out of the slump which is a bit of a competitive advantage against the other pure-play shippers.

Ocean Rig is a long-term catalyst for DryShips. Due to the discovery of several big deep-water oil reservoirs, demand for deep water drilling services will increase in the future. The company has high quality and technologically advanced drillships, that will allow oil explorers to work even under unfavorable condition.

DryShips is expecting to start receiving a dividend from Ocean Rig this year that will help to cover its interest and finance expense in the coming quarters.

Analysts Opinions

Investment analysts at Jefferies Group increased their target price on shares of DryShips from $3.00 to $3.50 in a note issued to investors on Friday, 31st January. The firm currently has a “hold” rating on the stock. Jefferies Group’s price target points to a potential upside of 0.86% from the company’s current price.

Also, the company has been the subject of a number of research reports:-

• Analysts at Nordea Equity Research upgraded shares of DryShips from a “buy” rating to a “strong-buy” rating in a research note to investors on Thursday, January 23rd.

• Separately, analysts at Zacks reiterated a “neutral” rating on shares of DryShips in a research note to investors on Monday, December 16th. They now have a $3.75 price target on the stock.

• Finally, analysts at Deutsche Bank raised their price target on shares of DryShips from $2.00 to $3.00 in a research note to investors on Wednesday, November 6th. They now have a “hold” rating on the stock.

Five analysts have rated the stock with a hold rating, two have given a buy rating and one has issued a strong buy rating to the stock. DryShips has an average rating of “Buy”.

Conclusion

DryShips is well positioned to take advantage of improving economic conditions. Due to increasing iron ore and coal imports from China and India, long-term future of the company looks bright. Although it has a high debt, which indicates some risk, but improving Ocean Rig financials will provide some support to DryShips. In my opinion, DryShips is an attractive long-term investment.

According to estimates, DryShips earnings are expected to improve this year. For Q1 2014, analysts are expecting earnings per share of $0.09 and revenue of $454.11 million. With improvement in the bottom line, the company will be able to strengthen its overall financial profile. DryShips is also working an agreement with some banking groups as it wants to cut down its debt service payments this year and is looking to adjust the financial covenants.

Looking forward, it is believed that the growth opportunity in the sector is real and the company will be able to grow. Furthermore, as mentioned, the company will soon start to benefit from Ocean Rig in terms of cash (a cash dividend from Ocean Rig in May). There is no denying that the company is still going through tough time; however, the market fundamentals and the economic outlook looks in favor of the company and it should continue its journey towards recovery.

Therefore, based on the facts above the following stock trade is recommended…..


**STOCK TRADE: Buy DRYS at market price (approx. $3.66), good for the day. Place a protective stop-loss at $2.50 and a pre-determined sell at $5.50.



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