DryShips Earnings: Don’t Let the Reported Operating Profit Fool You

During the recent DryShips (NASDAQ: DRYS  ) conference call, CEO George Economou stated, "I would like to clarify for everyone, once again, that DryShips is a pure shipping company with predominantly spot charter market exposure in 2014 and beyond and a majority stake in Ocean Rig, which operates as the deepwater drillships."

Since DryShips has a majority ownership in public company Ocean Rig RDW, DryShips reports the results of the two mixed together as one entity even though they are two distinct separate entities.

Given all this, why he and DryShips don't just simply separate the financials of the "pure shipping company" from Ocean Rig will forever remain a mystery to me.  It seems perhaps keeping them combined puts the stock in a better light and it partially hides the inferior shipping results.

The rather dry results but with some good news
On August 5, DryShips announced fiscal second quarter results.  As a whole, DryShips reported a combined operating profit, but the shipping business alone continues to realize operating losses.

Another quarter, another report, and DryShips forces us once again to perform algebra in order to figure out what's really going on with its shipping business – but I've done some of that for you.

Grand total reported revenue was $527.7 million of which $441.4 million was from Ocean Rig alone. This leaves $86.3 million in revenue remaining for the shipping business.

In total, DryShips reported an operating profit of $130.9 million, but there was $149.0 million in operating profit from Ocean Rig. Since the Ocean Rig contribution was even higher than the grand total, this means the shipping business actually had an $18.1 million operating loss and was overall a financial burden to DryShips -- not a profit.

The $18.1 million operating loss for the shipping business was much worse than the first quarter results, when DryShips shipping operations posted a $4.7 million operating loss.

The good news in the release is several chunks of its pending debt due are in the process of being successfully refinanced, and DryShips appears less in danger of bankruptcy risk now. As CFO Ziad Nakhleh put it in the conference call, it's no longer a question of if, but now a question of how cheap DryShips can refinance the debt.

If DryShips ended up filing bankruptcy, common shareholders likely would have been largely or completely wiped out and the state of the shipping operations would have then become irrelevant to investors who could have been left holding the bag. Now the shipping business at least has a chance to get healthy again and maybe even eventually run profitably some day.

The not-so-great news
Economou acknowledges that the daily spot rate for the dry shipping environment was weak in the second quarter, but he and DryShips believe the global supply of new ships coming online is "tapering off" while demand will continue to be robust. According to Economou this will in turn lead "a sustainable recovery in charter rates."

DryShips in the process of letting its shipping fixed-rate charter contracts expire so that they are available to operate based on floating daily spot rates and earn higher revenue and income as the picture improves. This sounds great except but I'm not sure it will be as impactful as DryShips is leading investors to believe.

If you look at the actual contracts, expiration dates, and rates listed neatly in DryShips' earnings release, you may notice almost every one of its ships operates based on the daily spot rates already except its Capesize ships, the largest and generally most profitable of ships. Of these 13 Capesize ships, 12 of them have rates between $21,500 and $55,000 per day.

This means expiration of these contracts is not going to help DryShips unless Capesize rates run multiples higher than current levels which just over $10,000 per day, as of last week.. This leaves its Panamax fleet which should be the focus of investors. In order for the shipping business to realistically turn an operating profit, look for Panamax daily spot rates specifically make a significant rise.

Foolish takeaway
DryShips has achieved a stay of execution but not a stay of deteriorating results. There will have to be major industrywide improvements just for DryShips' shipping business to turn profitable let alone build real, lasting shareholder value. I will continue to stay on dry land rather than in DryShips.

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