DryShips (NASDAQ: DRYS ) is not a pure play in dry shipping because of its ownership in Ocean Rig UDW (NASDAQ: ORIG ) . By owning shares directly in DryShips, you automatically have an indirect stake in Ocean Rig UDW. Yet, if you ask its CEO, this means you get a "double whammy" -- which may be more lucrative than you think.
DryShips' shipping business
The dry shipping business alone hasn't been quite fortunate. For the first nine months of 2013, dry bulk revenue dropped 26% to $138.0 million because of lower rates. This caused net losses to continue to pile up, though mostly from noncash depreciation expense.
In an interview on CNBC, with CEO George Economou said he thinks the rise in shipping rates is only just getting started, and will continue to rise through 2014 and 2015. He believes shipping rates and the stock are both very much undervalued in the long term. If he's correct, a significant rise in rates should make the dry shipping business profitable again.
Melissa Lee then challenged Economou. She pointed out that a lot of analysts are calling DryShips "not a pure play" because of its exposure to Ocean Rig. To this, he responded: "It's true, but on the other hand, Ocean Rig is very undervalued as well. So you will have a double whammy in a sense -- because you will get both the uplift from the increased rise in the drybulk rates and the index, and also the Ocean Rig stock, which is we believe very undervalued."
DryShips own 78.3 million shares of Ocean Rig or roughly 60% ownership of the company. This means Ocean Rig is essentially controlled by DryShips and is considered a subsidiary for reporting purposes. The performance of Ocean Rig as a company and as a stock directly affects DryShips shareholders; you should follow the separate public company accordingly.
Ocean Rig's last quarter results
Ocean Rig describes itself as "an international offshore drilling contractor providing oilfield services for offshore oil and gas exploration, development and production drilling, and specializing in the ultra-deepwater and harsh-environment segment of the offshore drilling industry." It's quite different from dry shipping, carrying its own risks and opportunities.
Last quarter, Ocean Rig revenue increased 15% to $328.5 million. Adjusted earnings before interest, taxes, depreciation, and amortization or EBITDA climbed 31.8% to $161.4 million. Adjusted net income was $39.6 million or $0.30 per share.
These earnings smashed analyst expectations for EPS of $0.21. For the full years of 2013 and 2014, analysts expect EPS of $0.64 and $1.91 respectively. If achieved, that would put the forward P/E at around 11, with EPS growth of nearly 200%. This suggests a decent value, especially if Ocean Rig can also beat analyst expectations.
Foolish final thoughts
Follow the rate environment. Economou didn't mention that DryShips also offers a bit of diversity; when the drybulk industry goes sour, DryShips still has its Ocean Rig ownership to fall back on. Investors in DryShips get a lot of the potential upside from any improvement in the rate environment, without taking on all of the risk.
The market is actually pricing the drybulk shipping portion of Dryships' stock at zero or negative value, since the market cap of DryShips is actually less than the market value of its Ocean Rig holdings. Fools who are able to closely follow the rate environment and know when rates turn significantly higher, and who closely follow the performance of Ocean Rig, could be rewarded before the crowd figures it all out.