Is There Hope for this Struggling Shipper?

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Back in 2008, DryShips (NASDAQ: DRYS) used to be the crown jewel of the shipping industry. With a fleet size second to none, and a market capitalization greater than $3 billion, DryShips dominated the market and held a special place in investors' hearts.

Yet over the past five years, the gloomy demand environment within the dry bulk sector nearly sunk the company. As the Baltic Dry Index kept bumping along the bottom, the stock remained trapped in a steep downtrend. DryShips lost its crown, unable to stanch its cash bleeding or enhance shareholders' value.

Against this backdrop, the shipper found support in the comparably healthy offshore drilling business through its majority ownership stake in Ocean Rig UDW (NASDAQ: ORIG). But just a few days ago, DryShips announced the public offering of 7.5 million Ocean Rig common shares, reducing its stake to 59.4%. Does this latest business decision bode well for the struggling giant's future prospects?

Poor performance set to continue
Shippers evaluate their vessels' average daily revenue performance with a metric called time charter equivalent, or TCE. In the shipping industry, TCE is a commonly used tool for tracking period-to-period changes in a company's net-of-expenses operating performance.

With that in mind, I decided to take a look at how Dryships compares to Navios Maritime Partners (NYSE: NMM) regarding the average change in time charter equivalents for the dry bulk carrier segment:

Time Charter Equivalent, 2008-2012*

<table> <thead> <tr><th> <p> </p> </th><th> <p> </p> <p>2008</p> </th><th> <p> </p> <p>2009</p> </th><th> <p> </p> <p>2010</p> </th><th> <p> </p> <p>2011</p> </th><th> <p> </p> <p>2012</p> </th><th> <p>Average annualized percentage change</p> </th></tr> </thead> <tbody> <tr> <td> <p><strong>DryShips</strong></p> </td> <td> <p>$58,155</p> </td> <td> <p>$30,425</p> </td> <td> <p>$32,184</p> </td> <td> <p>$27,229</p> </td> <td> <p>-</p> </td> <td> <p>-22.35%</p> </td> </tr> <tr> <td> <p><strong>Navios Maritime Partners</strong></p> </td> <td> <p>$24,783</p> </td> <td> <p>$26,071</p> </td> <td> <p>$29,358</p> </td> <td> <p>$29,909</p> </td> <td> <p>$28,907</p> </td> <td> <p><span>4.</span><span>81</span><span>%</span></p> </td> </tr> </tbody> </table>

Source: Companies' financial reports.

*At the time of writing, Dryships had not reported its fourth-quarter and full-year 2012 earnings. For the first nine months of 2012, the company's TCE posted a more than 35% decline compared to the same period in 2011, and stood at approximately $17,719.

Over the past five years, DryShips has failed to deliver satisfying operating results. The tight demand environment in the dry bulk sector negatively impacted the number of revenue-generating days for its fleet. In addition, average charter revenues remained ominously below the cash break-even point. Consequently, the firm's net income slumped. The following chart is worth a thousand words:

<img src="" />

DRYS Net Income TTM data by YCharts

DryShips' contract coverage stands at roughly 33% of calendar days for 2013. This means that with most of its contracts about to expire, DryShips will not be able to generate fruitful cash flows.

Despite positive signs for the future of the dry bulk sector, current market conditions do not present lucrative opportunities for ship owners. 2012 was the slowest contracting year in over a decade, with less than 300 new contracts signed. Most importantly, the prevailing oversupply of vessels prevents time charter rates from flying high.

On the other hand, Navios Maritime Partners achieved a comparably robust performance largely by relying on a conservative business model. Navios Partners' strategy of fixing its vessels under medium to long-term charters when the market is healthy gave the company greater resilience against short-term volatility. Thus, amid a tough market environment, the firm enjoyed a stable base of revenue and was able to augment its cash-generating capacity. In turn, it rewarded its shareholders by increasing its cash distributions.

As of December 2012, roughly 80% of the partnership's contracted revenue was secured by charters running longer than three years. In other words, Navios Partners managed to minimize the charter renewal risk and gain some extra time until a full industry recovery.

Ocean Rig to the rescue?

With dry bulk and tanker spot rates moving around historic low levels, DryShips' cash-generating capacity could not counterbalance its capital expenditures. The firm's efforts to optimize its fleet profile heavily burdened its balance sheet, resulting in a debt-to-equity ratio that crushes the industry's median. So it is no wonder why the shipper decided to sell, via novation, two of its new building tankers.

So far, Ocean Rig is the life jacket that keeps DryShips afloat. Over the years, the company's stake in the offshore driller gave it flexibility in addressing the capital needs of its shipping segment. DryShips acquired a majority stake in Ocean Rig in 2007. Last year, it announced the public offering of 10 million Ocean Rig common shares, reducing its stake to 65%. After the latest public offering, DryShips will receive gross proceeds of over $126 million. 

Above all, as the oil rig business continues to flourish, DryShips benefits from the much-needed cash inflows. Ocean Rig has an overall healthy balance sheet, backed by a solid increase in cash and cash equivalents. For the nine months ended September 2012, Ocean Rig experienced an overwhelming year-over-year growth -- around 54% -- in revenues from drilling contracts. This growth was partially offset by one-time charges associated with the deployment of its fleet. But still, the driller ended the third quarter of 2012 with an order backlog of more than $4 billion. Last month, it signed another contract with an estimated backlog of over $100 million, including mobilization and demobilization. 

Looking ahead

From my point of view, DryShips should convert itself into an ultradeepwater driller, instead of continuing to struggle in a shipping industry well-defined by overcapacity. The fundamentals in the drilling business are considerably favorable, offering unique opportunities. Oil companies' capital expenditures and level of production are projected to remain elevated suggesting strong demand for drilling rigs.

Ocean Rig is well positioned to benefit from this positive outlook and is poised for outstanding growth. EPS this year, as well as over the next five years, is expected to grow at an amazing pace. DryShips should take advantage of the shortage of drilling units worldwide and invest in expanding its operations in the space.

FaniKel has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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