DryShips doesn't hesitate to ride the high waves.
Some call its approach risky, but the Greek dry-bulk carrier won't sit and wait. It has been buying vessels rapidly and puts them on the water while the market is hot.
The company's DRYS business is focused on supplying dry-bulk ships on the spot market. Spot rates are determined purely by supply and demand. It's volatile, but return is much higher than the time-charter business, which offers discounted rates for customers who lock in ships for three to five years. When the number of customers who need vessels for 30- to 40-day voyages declines, spot rates sink quickly. Rates fell recently after Chinese steel producers started negotiating next year's iron ore price with mining giants such as BHP Billiton (NYSE:BHP) BHP and Rio Tinto RTP. Dry-bulk carriers move loads of iron ore, coal and steel. Every move by China, the biggest iron ore importer, seems to affect the industry. China buys its iron ore, a major ingredient for steel, mainly from Australia and Brazil.
China acts as if it doesn't need much iron ore because it doesn't want to overpay, says Urs Dur, an analyst of Lazard Capital Markets.
The rate drop didn't keep DryShips (NASDAQ:DRYS) from posting third-quarter profit of $2.38, ex items, beating views by 4 cents. Revenue shot up 150% to $150 mil.
"As we see the market continue to grow, we will obviously try to stay more spot," George Economou, chief executive of the Greek company, said during an earnings conference call. Iron ore transportation is the biggest revenue source for dry-bulk shippers, and Economou indicated that he was confident China needs more iron ore because "China is not even halfway through the industrial production cycle."
Analysts agree with him.
"Getting Chinese off of iron ore is like getting Americans to stop eating hamburgers,"said Dur. "It's pretty unlikely. They need it badly." Volatility in the spot rate doesn't affect the industry for the long term once negotiation matures, says Doug Mavrinac, an analyst at Jefferies. (NYSE:JEF) He says the impact is minimal, and pointed to a spot rate for capesize that has already recovered quickly to an all-time high of $185,000 per day, from $165,000 two weeks ago. Capesize ships are too large to go through either the Suez (NYSE:SZEZY) Canal or Panama Canal, and the ships are specialized to carry iron ore and coal. Panamax would fit through the Panama Canal and carry grains, coal and iron ore and various commodities. Then, supermax, handymax and handysize follow after those two.
Just four months ago, the rate for capesize ships, which carry iron ore and coal, was $100,000 per day. It has shot up 85% since then. Rates for panamax ships, the second biggest dry-bulk ships after capesize, have risen 70% since July, to $93,000 a day. "You are going to pay record-high levels for vessels," Mavrinac said. "For 2008, steel consumption is to increase significantly and rates will strengthen." He says mining companies adding 72 million tons of iron ore production capacity means increased demand for iron ore shipping. To take maximum advantage of a risky spot market, DryShips' strategy is buying secondhand vessels rapidly. Analyst Omar Nokta of Dahlman Rose said Economou had "recognized the trend" and "while the market is strong, he needs to jump on it because (otherwise) someone else will." The company recently bought four second-hand bulk carriers with an average age of 3.9 years. Since Aug. 2007, it acquired nine vessels and now it has five capesize, 29 panamax, one supermax, one handy max, and 8 new building ships.
Unlike used cars, secondhand dry-bulk vessels cost much more than a brand-new ship.
To build a new panamax costs $53 mil, but a five-year-old panamax would cost $85 mil, Mavrinac says. Once the company buys a used ship, the ship can be put on the water right away to take advantage of strong spot rates, but it will take two to three years for a new ship to be delivered. DryShips didn't want to wait.
As charter rates go up, the asset value of secondhand vessels has been skyrocketing. A five-year-old vessel that cost $81 mil 10 months ago now costs $136 mil, Mavrinac says. Even though DryShips kept spending millions to buy vessels, it was able to get higher returns from spot rates, easily offsetting the costs. "They are generating a tremendous amount of cash," Mavrinac said, adding that the company could be close to debt-free by the end of 2008 if it stops acquiring ships. But it's unlikely the company will stop buying vessels as long as China keeps buying iron ore. "I think (DryShips) loves using debt because they can get very strong return," Nokta said. "They were buying assets like crazy and it worked out for their favor."
Meanwhile, mining giants are starting to build their own vessels to carry iron ore. Rio Tinto said it got its first delivery of post-panamax-size ships in August.
Does this mean a possible threat to DryShips?
The answer is no, many analysts say. It's possible that mining companies "could attempt to use their own fleets as a longer-term bargaining tool," said Tim Tiberio, an analyst at Oppenheimer said. "But not in the near term."
As rates moved higher, shares of DryShips and its peers fell in the last few weeks. Mavrinac says the fall was due to the overall weak market, and that nothing is fundamentally wrong with the company. Dur says dry-bulk shippers are not affected by the U.S. subprime crisis, but DryShips will move up and down with the market, and even though it has the highest return, "dividends are not so big." As China's negotiations continue, the country would agree to a 15% to 30% iron ore price increase compared with last year, Dur predicts. The higher price hike means the higher demand for iron ore, therefore, customers would pay higher prices for vessels at spot market, he said.
But how long can DryShips enjoy higher rates? "It's going to be a while," Nokta said. "For the past year and a half, no matter how much steel was produced, it's not enough. There are people who are willing to pay higher prices to secure ships."
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