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Dry Bulkers Brace for Brutal Impact

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Ever since the very first wave of destruction that tossed a buoyant dry bulk shipping industry to its tipping point back in 2008, always-opportunistic Foolish investors have maintained a disciplined vigil for signs of calmer seas on the horizon.

In no uncertain terms, unfortunately, Diana Shipping (NYSE: DSX  ) resurrected a troubling, two-year-old warning during its first-quarter conference call last week. Fools may recall that Diana's president, Anastasios Margaronis, issued an alert to investors in May of 2009 that stated "the challenge for most shipping companies will be to survive over the next two years or so."

According to Mr. Margaronis' seasoned perspective, it seems, surprisingly strong business conditions in 2010 forestalled some of the more frightful market scenarios that nonetheless remained on the company's long-term radar screen. Citing newly revised global economic forecasts and shipping industry projections -- and a persistently excessive slate of new vessel construction overhanging the battered industry -- he offers the somber reminder that "the inevitable cannot be indefinitely postponed".

Dry bulk's unavoidable days of reckoning
Indeed, atop the already acutely oversupplied condition of the dry bulk industry today -- which is reflected in the 38% sequential decline in the average daily charter rate realized by spot-market tracker Baltic Trading (NYSE: BALT  ) -- new vessels presently on order would add an astounding 47.3% to the size of the current global fleet. Even accounting for projections of delayed and canceled orders, the Capesize fleet is expected to expand by 14% in 2011, and the Panamax fleet may grow by 12%. The corresponding forecast for only 5% growth in global demand for dry bulk haulage, meanwhile, is nowhere near sufficient to absorb the projected capacity increase in an orderly manner.

I have been concerned about the long-term survival prospects of heavily indebted dry bulk shippers for some time; though admittedly, as time passed, and none of the U.S.-traded shippers that I follow sank to the ocean floor, I grew increasingly complacent about those failure risks. Sure, a pair of defaults by major Korean shipping lines sent shockwaves through the industry, but they caused no semblance of the "wave of destruction for banks to rival the subprime crisis" that Margaronis warned of in 2009.

Following Mr. Margaronis' pointed reminder, however, this Fool's complacency has been abruptly obliterated, and replaced by reactivated scrutiny of the sector's leading failure risks. Within that context, Navios Maritime's (NYSE: NM  ) practice of mitigating counterparty risk -- by insuring charter contracts -- becomes an important factor for Fools to consider. When Korea Line entered receivership last February, that insurance spared Navios from the lasting damage that competitor Eagle Bulk Shipping (Nasdaq: EGLE  ) has suffered. Eagle turned in a $5.8 million net loss for the first quarter of 2011.

A rate collapse takes its toll
Under the intensifying strain of painfully weak charter rates, Eagle was not the sole carrier to post a loss for the first quarter. Excel Maritime Carriers (NYSE: EXM  ) lost a million bucks as its realized average daily charter rate slipped 20% from the prior-year period. The aforementioned Baltic Trading lost $1.7 million. Genco Shipping & Trading (NYSE: GNK  ) managed to eke a $13.4 million profit, but only because the company added 13 new vessels the fleet. Without that substantial expansion of scale, the 37% decline in Genco's average charter rate would have decimated profitability.

Diana Shipping benefited from some counter-cyclical fleet expansion of its own, but the savvy operator experienced only a 1% decline in its average daily charter rate. At $31,592, that average stands among the best in the industry, and the vast majority of Diana's fleet remains locked into long-term contracts at rates well above the prevailing spot market. In addition, Diana achieved an 11% drop in vessel operating expenses for the first quarter. Not only did Diana record a profit during a quarter marked by crumbling market fundamentals, but the company managed to improve upon the prior-year mark by 15% to take home $33.1 million.

Diana Shipping continues to shine as the ultimate relative safe haven amid a sea of dry bulk uncertainty, due to a solid relative profitability profile, an astute executive team with its finger correctly on the pulse of the ongoing dry bulk industry crisis, and a pristine balance sheet that positions the company for transformative, opportunistic growth near the eventual bottom of the business cycle.  As a long-term investor, patiently awaiting the inevitable reversal of this extended downward spiral, I routinely feel as though I am catching a falling knife. With steadfast positions in Diana Shipping and Baltic Trading, however -- plus a miniscule, ultra-high-risk, and ultra-speculative bet on a miraculous turnaround for DryShips (Nasdaq: DRYS  ) -- I trust the resulting wounds will prove limited in both scale and duration.

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 (3) | Recommend This Article (16)

Comments from our Foolish Readers

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 May 10, 2011, at 8:04 PM, imacg5 wrote:

    The worst news for dry bulk companies is the Chinamax effect.

    VALE is going to do to the dry bulkers, what they did to VALE when the cost of leasing a Cape went to $200,000 a day.


  • Report this Comment On May 11, 2011, at 3:19 PM, psl8er wrote:

    Your concerns are well expressed but not as deep as mine.The dry bulk fleet is due to increase by 46% capacity by the end of 2013 but this could be even larger as the shipyard capacity in 2013 is only 1/3rd filled.

    460 Capesizes, 650 each of Panamaxes,large Handimaxes and small Handimaxes all delivering.

    Freight rates in the Capesizes are way below breakeven and set to stay there as the huge Chinamaxes (400,000dwt) deliver over the next 2 years.

    The charter insurance you refer to that Navios claims to have is unclear. It appears to be issued by the Belgian Export Credit Agency ONDD but the sheer size of the risks and the fact that the premiums that Navios pays are not declared raises questions about its structure.

    EAGLE cancelled its insurance in 2010.

    China are also building an undisclosed number of bulkcarriers for its domestic owners.

  • Report this Comment On May 11, 2011, at 5:33 PM, psl8er wrote:

    The Dryships bet is that the rig company gets floated but meanwhile DRYS is guaranteeing all the debt of the newbuilding rigs. How are they accounting for that risk?

    Genco is in better shape and may refinance its debt with one of its friendly PE investors as did Genmar.

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