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DryShips (DRYS) has a lot to prove as it hopes to turn the corner from a disastrous 2016. The dry bulk shipper spent all last year focused on staying afloat, which led it to sell assets and negotiate with lenders to shore up its balance sheet. While these efforts appear to have succeeded in restructuring its finances, it still has plenty to prove.
No. 1: Show that it can make money from its remaining fleet
Driving DryShips' devastating collapse over the past few years is that it had amassed more than $5 billion of debt to grow its fleet, which became a grave issue when shipping rates collapsed. Last year, for example, the company lost money leasing its dry bulk vessels because shipping rates were below its operating costs:
Data source: DryShips. Chart by author.
Suffice it to say; this trend cannot continue. One step the company took to address this problem was to sell off older, less profitable ships, which caused its fleet to sink from an average of 38 in 2015 to less than 20 last year.
What the company must prove is that it can make money from its remaining vessels going forward. That is going to be tough to do if the spot market remains weak, meaning the company likely will need to continue pushing down vessel operating expenses. Another potential option is to seek longer term charters on these vessels. One way or another, DryShips needs to show that its core business can generate sustainable earnings.
No. 2: Demonstrate that its diversification plan is a winner
Another thing DryShips has done to get back to profitability is to diversify away from the volatile dry bulk carrier market. It is doing so by using its recently shored up balance sheet to acquire up to four very large gas carriers (VLGCs) currently under construction. What's important to note about these vessels is that each has already signed long-term time charters with major oil companies and oil traders, which will lock in cash flow. Those contracts currently amount to $390 million, which is more than the company's $334 million acquisition cost.
That said, DryShips attempted a similar diversification strategy in the past to no avail. In 2007 the company acquired offshore driller Ocean Rig (ORIG) in a series of transactions. At the time, Ocean Rig owned two vessels under short-term charters with major oil companies, which DryShips expected to recharter under five-year terms at attractive dayrates. DryShips would subsequently spend billions to expand OceanRig's fleet before eventually selling shares in an IPO. It ultimately cashed out earlier last year, but only after Ocean Rig's stock price cratered because of concerns with its elevated debt amid the oil market downturn:
Given this history, DryShips needs to prove that the past will not repeat with its latest divarication efforts. To do so, the company needs to show investors that it will take a more measured approach to growth and use a high percentage of equity and internally generated cash flow instead of debt to finance growth going forward.
No. 3: Prove that it has the finances to stay afloat
DryShips ended last year with a much stronger balance sheet than it entered. Overall, it had $76.8 million in cash and just $137.5 million in debt. Further, it had $79 million of undrawn capacity on its revolver and access to $200 million of equity capital from an outside investor. That liquidity is crucial as the company works to get its dry bulk fleet back to profitability.
However, the company immediately chose to put its improved liquidity to work by signing an agreement to acquire the VLGCs. In fact, it has already committed to buying one vessel, which required it to hand over $21.9 million last week, with the remaining balance payable in installments until the ship's delivery in June. The concern is that if DryShips exercises its options to acquire all four vessels it could cause its liquidity to dry up completely should the dry bulk market weaken. Because of this, the company needs to do a better job showing investors how it intends to maintain a stable financial footing after seemingly starting another buying binge just days after shoring up its balance sheet.
Investor takeaway
While DryShips made tremendous progress improving its financial situation over the past year, it needs to prove that those efforts were not in vain. To do so, it must clearly show that it can make money in the current environment with its shrunken fleet, while also explicitly demonstrating that it has a plan to deliver sustainable growth that will not blow out its balance sheet again. Until it does that, there's still a real risk that this stock continues to sink.
