According to Ziad Nakhleh, CFO of DryShips (NASDAQ:DRYS), "The bull market is just around the corner." It's DryShips' position that the global market for shipping rates is poised to escalate in 2014 and 2015. Diana Shipping (NYSE:DSX) appears to feel the same way. When the much more conservatively operated Diana Shipping agrees with anything optimistic reported by DryShips, investors should listen.
Why it even matters
According to Nakhleh, DryShips is "well positioned" to take advantage of rising rates by allowing its fleet to operate based on the daily fluctuating spot rates. For this reason, it's obvious why the volatile short-term rates matter to DryShips. DryShips gives as an example the scenario that if rates were to rise by $20,000 per day, it would increase its earnings by $195 million and $216 million in 2014 and 2015, respectively.
Diana Shipping's strategy is very different than DryShips, as it prides itself on having a "predictable" revenue stream. Its entire fleet operates based on fixed-rate contracts. However, many of those contracts are expiring and coming up for renewal. According to Simeon Palios, CEO of Diana Shipping, 27% of its ship operating days are open for 2014 and 79% for 2015. A short-term rise in rates is not only beneficial to Diana Shipping but it's actually vital for its new contracts.
Diana Shipping is still less optimistic about the future than DryShips is. Palios cautions that the coming upswing in the rates of Capesize vessels, the largest and generally most profitable ships, will be tempered by low Panamax rates. The reason for this balance is that, except for very short periods of time, Capesize and Panamax rates tend to move in the same direction.
For example, if Panamax rates are too cheap when compared to Capesize rates, then demand for Capesize vessels starts to fall off as companies would simply split their cargoes into two cheaper Panamax voyages instead of one costlier Capesize. Anastasios Margaronis, President of Diana Shipping, added, "Low Panamax rates can [cap] any upward movement in Capesize earnings."
Demand is coming
According to DryShips, growth for shipping demand is expected to be 7.4%, yet supply growth is expected to be 5%. DryShips believes that fears about an oversupply have been unfounded and that the real problem has been a lack of demand, which is starting to rebalance. The company cites a delay in the South American grain season for a temporary drop in Panamax rates, which are expected to rise again, and won't hold back a rise in Capesize rates.
Diana Shipping cites analysts at Clarkson Capital who are forecasting a 9% rise in total world iron ore imports to 1.3 billion tons. From Australia alone, iron ore exports are expected to reach 687 million tons this year and 749 million next year. China, which eats up the vast majority of the world's iron ore supply, has a large stockpile at a hair over 100 million tons (which bears are usually quick to point out).
However, considering how much iron ore the country goes through, 100 million tons really isn't as big of a stockpile as it sounds. Last year, for example, China produced over 1.4 billion tons domestically and imported over 800 million tons. A "stockpile" of 100 million is, on average, only barely a two-week supply in total consumption, or maybe six weeks' worth of imports. Meanwhile, Diana Shipping notes that Commodore Research stated that steel stockpiles made from iron ore are down 16% in China, which tends to be a leading indicator that more importation, and thus shipping, of iron ore will be needed..
Foolish final thoughts
Rising short-term rates will benefit both DryShips and Diana Shipping, but if contracted rates rise with the daily spot rates then the result will be more profits at safer predictable levels for Diana Shipping, a win-win for the company and its shareholders. It will be interesting to see if the higher rates materialize as both companies expect, and if Diana Shipping is able to lock in those new rates for its contracts. If so, it could mean a lasting new boom for Diana Shipping.
Nickey Friedman has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. 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 a disclosure policy.