How to Navigate the Dry-Bulk Crisis

Some ships are designed to weather any storm. However, when it comes to the manmade tempest that has raged against the world's dry-bulk shipping industry since mid-2008, the dry-bulk stocks have virtually been dispatched to Davy Jones’ locker  with seemingly indiscriminate destructive force.

Korea Line, South Korea's second-largest dry-bulk shipping line, officially entered court receivership this week after filing for protection late last month. To an even greater degree than we witnessed following South Korea's prior shipping casualty in 2009 -- Samsun Logix -- Korea Line's fall from solvency has spooked a dry-bulk market that was finally beginning to glimpse some hopeful light at the end of the tunnel.

In familiar fashion, the spillover effect from the Korea Line debacle placed shippers with direct exposure under the market's microscope, and brought broader concerns over the nature of counterparty risk back to the forefront of investors' concerns. Eagle Bulk Shipping (Nasdaq: EGLE  ) bears the brunt of those direct exposures, with more than one-quarter of its ships reportedly chartered by Korea Line at the time. 

As of Tuesday, Eagle reported $7.3 million of total delinquent payments due, but it anticipates some payments forthcoming now that the line has entered court receivership. The newly constructed Supramax vessel Nighthawk, which was slated for imminent delivery to Korea Line, must now be matched with an alternate client or face the specter of idle time in an industry where time is most definitely money.

Providing a welcome counterpoint to counterparty risk, meanwhile, Navios Maritime Partners' (NYSE: NMM  ) own exposure to Korea Line's troubles has been effectively mitigated by insurance contracts designed to protect against just such an occurrence. Without such coverage, Navios Maritime Partners could have seen some 15% of its revenue stream at risk.

Beyond the immediate fallout
Suddenly, the best-case scenario envisioned by Diana Shipping (NYSE: DSX  ) -- in which the breakneck pace of growth in pan-Asian commodity demand seemed almost capable of absorbing the epic oversupply of newly constructed vessels joining the global fleet -- must now be demoted from a feasible forecast to a fantastical fairy tale.

So tenuous was the condition of the industry already, in fact, that the severe flooding in Australia's Queensland state could arguably have been the straw that broke shippers' backs, bringing more sobering scenarios for the industry into play. With massive volumes of coking coal exports by leading producers like BHP Billiton (NYSE: BHP  ) interrupted by the deluge, the unexpected idling of vessels exacerbated a critically oversupplied market condition. Charter rates for the behemoth Capesize carriers plummeted anew, dipping dangerously beneath the cusp of profitability.

Whereas smaller vessel categories provided some relative relief from the subeconomic rate structure that periodically blasted Capesize operators in 2010, anticipated charter rates now appear set to decline across the tonnage continuum. Cantor Fitzgerald expects Panamax daily rates to average $19,000 for 2011 (nearly 10% lower than the 2010 average), before deteriorating another 9.5% to $17,200 for 2012. The Baltic Exchange sees a troublesome 20% decline in average Capesize charter rates between 2011 and 2012. Relative to recent Capesize spot fixings beneath $5,000 per day, even those decidedly grim forecasts would provide some welcome relief.

Dahlman Rose analyst Omar Nokta recently downgraded a slew of dry-bulk operators -- including Genco Shipping and Trading (NYSE: GNK  ) and Eagle Bulk Shipping -- citing an increased likelihood that several will resort to share dilution to offset the group's badly diminished earnings profile and the danger of violating loan covenants. As veteran dry-bulk investors can well attest, prior rounds of dilutive equity offerings have poured sea salt into shareholders' widespread wounds.

3 cheers for a trifecta of stubborn selections
Under normal circumstances, I would close my analysis of a sector this steeped in structural crisis with a vocal plea for Fools to avoid the group entirely. When I renewed my warning against investment exposure to the residential construction industry last month, for example, I conceded that my stubborn refusal to avoid the dry-bulk sector represented something of a special situation (deploy air quotes).

The projected continuity of increasing raw material demand, I reasoned, presents a catalyst for vessel demand that will ultimately hasten the industry's return to relative equilibrium. In the short term, factors like China's stockpile of some 80 million tons of iron ore may pile on additional headwinds, but my long-term Foolish gaze remains fixed upon the "global supertrend" for growing seaborne trade in coal, iron ore, and multiple key commodities.

With that said, this sector presents a range of potential risks to investors that must be well understood, including violation of debt covenants, bankruptcy, counterparty risk, share dilution, distressed asset sales. Because of those risks, I certainly do not advocate oversized bets on the sector. When I recommended a fresh look at DryShips (Nasdaq: DRYS  ) last month as a potential ultrahigh-risk gamble on multiple maritime subsectors, I harbored concern for the 40% of respondents to our Motley Poll who indicated their willingness to "bet the house" on DryShips shares.

I have since initiated a truly miniscule position in DryShips, which now joins Diana Shipping and Baltic Trading (NYSE: BALT  ) as this Fool's personal trifecta of still-modest dry-bulk exposure. In contrast to DryShips, Diana and Baltic are relative powerhouses of financial strength, which I expect will serve them well through the industry's extended bout with tight-to-negative operating margins. Diana employs the fleet through long-term charter contracts that can serve to smooth out the bumps in this extremely volatile price environment, while Baltic Trading offers direct exposure to spot-market pricing with a built-in profit-sharing plan for shareholders.

Now that you know where I stand, it's your turn to sound off. If you hold shares, or are considering acquiring positions in the dry-bulk space, take a moment to join the free CAPS community and place your selections in a CAPS portfolio. Insightful investors are eager to exchange ideas with you, making better investors of us all in the process.

Fool contributor Christopher Barker can hold his breath underwater while a Capesize carrier steams overhead, though he doesn't recommend it for humans without gills. He can be found blogging actively and acting Foolishly within the CAPS community under the username TMFSinchiruna. He tweets. He owns shares of Baltic Trading, Diana Shipping, and DryShips. 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 an unsinkable disclosure policy.


Read/Post Comments (4) | Recommend This Article (23)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 16, 2011, at 7:41 PM, cheap2chuck wrote:

    In general, the article is accurate. However, without exception and including this writing, whenever Dry Ships is mentioned in an someones blog, the writer seems to forget that 82% of the fleet is under charter for all of 2011 at very palatable daily rates averaging $36,000 per day. In addition, three of the four drill ships are are also under charter for an average of $575,000 per day. Dry Ships is very risky, however you have to give George E. some credit for being the first to branch out into oil with the drill ships and tankers. The man knows shipping. I would not bet the farm but certainly will take a modest shot.

  • Report this Comment On February 17, 2011, at 9:07 AM, silverminer wrote:

    cheap2chuck,

    That's not entirely accurate. Current deployment of the drybulk fleet carries an average daily rate of $31,220, with nearly half of the Panamaxes operating in thin-margin territory with rates beneath $20,000 per day. Also, 18 of the 37 charters carry earliest termination dates within calendar 2011, and thus are likely to reset at sharply lower rates unless spot rates rebound in a hurry.

    I give Economou his due credit for ingenuity, but as far as I'm concerned that is more than offset by the injuries he has brought upon shareholders in recent years. That all being said, I obviously agree with your last statement, since I too have initiated a gamble on DryShips with a miniscule position in the shares for a high-risk play on potentially impressive growth. That doesn't mean I have to respect the CEO, who -- based upon both his words and his actions -- sure doesn't appear to hold much concern for the interests of long-term shareholders.

    http://www.fool.com/investing/small-cap/2009/02/02/a-gaping-...

    http://www.forbes.com/forbes/2008/0225/095.html

    "Once you have full disclosure, if you don't like it, don't invest," he says. He does, however, sometimes seem to be disdainful of his shareholders. "Who are my investors? Computer models, hedge funds and some institutions that go in and make $10 and get out."

    .....

    Consider the plight of this poor guy, who thought DRYS shares looked cheap at $84 in June of 2008, before a 94% share price decline was rendered far worse still by a ruthless quintupling of the share count:

    http://seekingalpha.com/article/82135-jim-kingsdale-selling-...

    .....

    http://www.fool.com/investing/international/2009/05/13/drysh...

    http://www.fool.com/investing/general/2010/11/19/surprise-se...

    Although I am now a reluctant shareholder for the reasons discussed in the link below, I certainly don't wish to convey any semblance of trust in the company's enigmatic ringleader.

    http://www.fool.com/investing/general/2011/01/06/the-greates...

    P.S. silverminer = TMFSinchiruna

  • Report this Comment On February 17, 2011, at 10:37 AM, psl8er wrote:

    Dry Bulk Crisis?

    The whole dry bulk shipping industry is grossly overtonnaged because of reckless ordering of new ships by shipowners.

    Freight rates are controlled by the major commodity producers and their customers and not by shipowners.

    China's appetite for bulk cargoes has slowed significantly while they have built large fleets of their own which will keep fright rates down.

    Add to this the fact that the major iron ore and coal suppliers are building their own ships and some of the large commodity traders have taken ships on long charters at very low rates.

    The independant shipowner is unable to compete and many will fail to survive as there are still nore ships to deliver and the market will be overtonnaged for years.

  • Report this Comment On February 17, 2011, at 11:43 AM, XMFSinchiruna wrote:

    psl8er,

    No argument here with any of your comments, save for the observation about Chinese commodity demand, which remains comfortably settled in a trajectory of long-term volume growth.

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