Just when you thought it was safe to go back in the water transportation sector for dry shipping, predatory pricing smells opportunity. This could benefit dry shippers such as DryShips (NASDAQ:DRYS) and Star Bulk Carriers (NASDAQ:SBLK). The source of this maneuver is not the way that DryShips charges for its voyages or the way that Stalk Bulk Carriers buys new ships. Instead, it's coming from a rather unlikely source, and it has a dry shipping rally written all over it.
What is predatory pricing, anyway?
Predatory pricing is an economic term for when a big fish company, the predator, competes with the little fish companies by increasing output and lowering prices far below the competition in an effort to put the little guy out of business.
Wal-Mart has been accused by some similar predatory practices that drive local businesses out of business so it can take increased market share. In some cases, the larger fish will even temporarily bring prices down below cost in order to execute this strategy successfully.
How predatory pricing affects dry shipping
Neither DryShips nor Star Bulk Carriers participate in this strategy. If for no other reason, they avoid it because neither one is large enough nor powerful enough to be successful at doing so. What does seem to be happening, however, is that within the iron ore market, large iron ore producers are engaging in the practice in order to put Chinese mines out of business.
Simos Spyrou, CFO of Star Bulk Carriers, stated in the most recent conference call, "First of all let's talk about iron ore, perhaps the most important commodity in the drybulk shipping space." If you've been paying attention to the dry shipping market and listening to what players such as DryShips have been saying, you know by now that the shipping of this single commodity to China will make or break the entire dry shipping market over the coming quarters.
George Economou, CEO of DryShips, has pointed out in interviews and conference calls that despite the enormous amount of iron ore imports coming into China, it's not nearly as large as China's domestic iron ore production within its borders which is nearly twice the amount. It stands to reason (according to DryShips) that if production were to fall within China, import volumes would have to jump in order to replace the slack. This spike in import volume demand will then spike rates and cause a dry shipping rate rally and the red hot market DryShips has been expecting.
According to Spyrou in the Star Bulk Carriers conference call, the large miners especially in Brazil and Australia see $100 per ton and less in global iron prices as their prey. If they can ramp up production high enough, even if incurring extra costs to speed it up, the result will be that "the majority of small private Chinese producers are non-competitive."
China will then turn to imports, more of the market will be secured for the foreign miners, and the ripple effect will be more shipping and higher rates for DryShips and Star Bulk Carriers. Spyrou sees "exponential growth" in iron ore purchasing coming online right around the same time as the rain season in South America brings about the large harvests of grains to be exported, and Dryships and Star Bulk Carriers may have a perfect storm "multiplying effect" on their hands in the months ahead.
Both DryShips and Star Bulk Carriers are migrating toward an operating strategy that is based on the daily spot rates to maximize the benefit of an upsurge in shipping rates. While you should take optimistic statements from company executives with a grain of salt, both of these companies are putting themselves in position that is consistent with their statements. And their claims make sense.
As I do more reading and analyzing, it seems like a rate rally at some point in the second half of the year is about as likely as you can get. If and when it does come, you can thank predatory pricing for doing its best to push it over the edge.
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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.