Why China Has Less of an Effect on the Fortunes of DryShips and Navios Maritime Partners Than Imagined

Whenever DryShips (NASDAQ: DRYS  ) or Navios Maritime Partners (NYSE: NMM  ) talk dry shipping demand, the mantra is always, "China, China, China." While it's likely true for global shipping rates as a whole, for DryShips and Navios Maritime Partners, specifically, it's actually more noise than signal.


Source:  Navios Maritime Partners

Red-hot China
Navios Maritime Partners agrees with DryShips that increasing iron ore demand from China will raise daily global market spot rates for Capesize ships. Angeliki Frangou, CEO of Navios Maritime Partners, has stated in its last two conference calls that "the drybulk environment has brightened significantly." She is so confident in the environment through the end of 2015, that she has pledged for Navios Maritime Partners to continue to pay its generous quarterly dividend over the next two years, and is prepared to possibly raise it.

George Achniotis, executive vice president of Navios Maritime Partners, adds that experts expect global iron ore prices to fall under $100 per ton due to substantial new supply coming onto the market this year. Market prices below $100, according to Navios Maritime Partners, will make it more economical for China to import iron ore, as it costs more than that just to mine it domestically. This means higher demand for Capesize ships, higher rates, and higher profits. Great news, right? Sort of. Keep reading.

George Economou, CEO of DryShips, outlined much of the same thinking in a recent interview. He pointed out that, as robust as imports of iron ore have been to China, two out of three tons of usage were still produced domestically last year. On top of that, domestic Chinese iron ore has less than half the actual iron content and is a greater pollutant than imported ore. Pollution is becoming a serious concern in China, and is being regulated more and more, so there is still ample potential opportunity for higher-quality imports to take market share.

For these reasons, DryShips believes, in the words of Economou: "The fundamentals for the dry bulk market are quite clear and point to a stronger market ahead." DryShips is calling for a "hot" market during the next three months, a "red hot" market in the calendar fourth quarter, and for 2015 to "explode." Whoa! Big profits ahead for DryShips and Navios Maritime Partners, no? Not necessarily.

The big problem
There's one thing that should be an obvious requirement for any dry shipping company to have during times of hot, red-hot, or explosive demand. A dry shipping company must have its fleet available to take advantage of a booming market.

Navios Maritime Partners owns eight Capesize vessels. Seven are currently locked in long-term fixed-rate contacts that don't expire for quite a while. The good news is that the eighth expires sometime this year, and happens to be the one locked at the cheapest rate of the bunch. The bad news is that the rate for this particular ship is still nearly $15,000 per day, or several thousand dollars higher than the current spot rates.

Out of Navios Maritime Partners' other seven Capesize ships, the next contract expiration won't happen until September 2015. Even then, that ship is contracted for more than $50,000 per day, or multitudes higher than the current spot rates, so even that expiration, at least for now, would be nothing to celebrate.

So how will Navios Maritime Partners benefit from increasing Capesize rates over the next two years? The answer is little to none, except for maybe some indirect benefit from Capesize rates rising and causing the rates for smaller Panamax ships to rise through a domino effect. Maybe.

For DryShips, it's a similar situation. DryShips has 12 Capesize ships, most of which are locked in contracts that don't expire for several years and are garnering higher rates anyway. For the only two Capesize ships that will definitely see their contracts expire this year, both of their current rates are near the daily spot rates. DryShips will see a benefit with these two Capesize ships if rates rise significantly, but probably not much of a benefit at all, if any, on the other 10 for quite some time.

DryShips' smaller ships, which are mostly Panamax size, do operate based on spot rates, unlike its Capesize fleet. Just like Navios Maritime Partners, the main way DryShips would benefit from a rise in Capesize rates would be if cargo shipments were split into two Panamax orders instead of one Capesize, causing Panamax rates to rise somewhat as a spillover effect. China does utilize Panamax ships for coal, grain, and other goods, but its demand for those doesn't dominate the global shipping traffic the way its iron ore shipments currently do.

Foolish final thoughts
The bottom line is that Panamax demand, rather than Capesize demand, is the single biggest factor affecting the fortunes (or lack of) for DryShips and Navios Maritime Partners. At the moment, the Panamax rates are terrible due to a weaker than hoped harvest in South America, which has sunk rates lower than the already low rates of a year ago -- many Panamax ships are operating at a loss. Investors would be wise to focus on Panamax rates more closely, rather than Capesize. Perhaps a "red hot" market or "explosion" in Capesize rates due to China demand could spill over and save DryShips' and Navios Maritime Partners' Panamax rates. They're going to need it to see a meaningful benefit from China.

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