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For a long time, observers of the dry bulk shipping sector have thrown their weight behind conservatively managed Diana Shipping (NYSE: DSX ) . But now, along comes Goldman Sachs analyst Scott Malat with a downgrade for Diana (from buy to neutral), and a buy recommendation for the stock I have offered as the greatest gamble in stocks: DryShips (Nasdaq: DRYS ) .
Like Foghorn Leghorn, perhaps folks with rhyming names are just destined to offer sage advice, but in any event, I agree with Scott Malat ... a lot.
Diana Shipping's executive team will be the first to tell you that the industry will encounter some unthinkably challenging dynamics, which will likely threaten the very survival of some highly leveraged operators. As a matter of fact, Diana's execs were out in front of this with some very vocal warnings more than two years ago, and again last month with a thought-provoking reminder that "the inevitable cannot be indefinitely postponed."
The industry continues to carry the weight of an enormous oversupply within the dry bulk carrier fleet, and the process of clearing that excess capacity likely won't occur without some significant collateral damage to the more vulnerable operators. It seems operating revenues are bound to dip beneath average operating costs for a spell, serving as a catalyst for the ultimate game of survival of the fittest. Since I have routinely highlighted Diana Shipping as the shipper that Charles Darwin himself would have adored for its superior capacity to adapt to these survival challenges, why do I now voice my agreement with the downgrade of Diana by Scott Malat, from hot, to not-so-hot?
It's nothing personal, Diana
I haven't changed my long-term bullish outlook for Diana Shipping as the premiere conservative choice for exposure to greener pastures, once the bulk of the oversupply condition clears. From my perspective, this downgrade simply acknowledges that Diana's previous "best-case scenario" for navigating the oversupply just won't happen. It's going to get ugly at some point here, and even the strong will be deeply challenged. The more optimistic global demand growth forecasts that buoyed the outlook for shippers in recent months have rapidly given way to widespread downward adjustments, exacerbating the projected market impact of the persistent vessel glut. Commodities oracle Joy Global (Nasdaq: JOYG ) still foresees long-term global demand growth in the cards, even if at a moderating pace, but a smoother outlook for shippers required every ounce of demand-related optimism that has since been scaled back.
Not letting his tongue get tied in a knot, Scott Malat explains his downgrade of Diana in the context of "higher than anticipated [vessel] deliveries during the first quarter" and "lower than expected ton-miles" for the industry resulting in part from expanding coal trade from areas closer to the nucleus of demand (principally China). These observations have no unique bearing upon Diana Shipping in particular, so I encourage Fools to interpret the call as a reasonable expectation that superior entry points may be forthcoming for multiple dry bulk shippers.
If Diana Shipping deserves a neutral rating in the context of a deteriorating industry outlook overall, then by extension, the outlook for the more severely leveraged operators warrants greater caution still. Genco Shipping & Trading (NYSE: GNK ) and Navios Maritime Holdings (NYSE: NM ) are both quality operators with strong track records of resilience through this crisis to date, although Navios' shares could conceivably have the most at stake given their peer-leading performance over the past couple of years. At the bottom of the sector's barrel, the likes of Genco and Excel Maritime Carriers (NYSE: EXM ) trade at such distressed valuations already that -- short of an outright-failure scenario for either operator -- downside may be relatively limited.
Curious George cashes in
In contrast to the deteriorating outlook for dry bulk, the business environment for DryShips' state-of-the-art ultra-deepwater drill ships is decidedly more bullish.
DryShips recently announced that the long-anticipated spin-off of its Ocean Rig subsidiary is imminent, and Goldman's Malat sees the listing as an important looming catalyst for the shares. Forecasting average daily charter rates of $530,000 for similar "high-spec" drill ships "for 2012 and later," the bottom line is a steady-looking top line for the stand-alone Ocean Rig entity.
Meanwhile, in seeking to discount the leveraged debt risk upon which CEO George Economou's high-stakes foray into drill ships was predicated, the market may have substantially overlooked the tangible value of DryShips' remaining fleet of 39 dry bulk carriers and 12 existing oil tankers.
I'll take a fresh look at the DryShips and Ocean Rig share valuations and respective balance sheets following the Ocean Rig listing, but for now I agree with Scott Malat that DrysShips can be (forgive me) bought.