With DryShips (DRYS) flirting with record 52-week lows, it may be tempting to try to catch the falling knife and ride it straight back up. Before you give into that temptation, there are a number of things to consider -- perhaps DryShips stock is falling for good reason.
Settling old scores
Unfortunately, DryShips is short on cash and long on debt. It owes $700 million by Dec. 1 of this year or it goes into default. The company has been trying to score leniency with its debt holders, but their answer to the company's pleas has amounted to saying, "No way; pay us."
Reports from sources are "skeptical" that new financiers will step up to the plate on favorable terms, though DryShips may be able to convince them by putting up its 78.3 million shares of Ocean Rig UDW (ORIG) as collateral.
The problem with that for shareholders is twofold: First, there still is no deal in place yet, so if one doesn't solidify, DryShips could be looking at bankruptcy. Second, putting up its Ocean Rig shares could mean sacrificing its only major liquid asset available, and then it'd be left with no safety net and a questionable-at-best ability to invest in new ships in the future.
Dilution pollution
Another distinct possibility is that DryShips will be executing new and large equity raises at a discount to the market, which the company has a long history of doing. Dilution cuts each share of the pie into thinner and thinner slices, negatively affecting the long-term fundamental value of each.
DryShips held its IPO back in 2005 with 30.4 million shares outstanding. Today, it's ballooning up to near half a billion shares, a 1,500% increase. Shareholders who bought and held in 2005 have seen their slice of the company pulverized. History often repeats itself.
With the stock down in the dumps, it means many more shares would have to be issued to raise the same amount of money as compared to just a few months ago. This could put further negative pressure on the stock in the near term.
The Baltic Dry Index is wet with red ink
The above woes might be easier to deal with if the dry shipping market would cooperate, but instead it is acting like it's sick with the flu, refusing to come out of bed. The fourth quarter is supposed to be the hot season for dry shipping, but instead it's cold as ice.
On a year-over-year basis, daily spot rates for Capesize ships are down by over two-thirds, Panamax rates are down by over half, and even Supramax rates are down by nearly 20%.
Low rates mean low revenue per trip on the seas. Low revenue yet similar costs spells large losses for DryShips. With current rates this low, every day DryShips loses more and more money. There needs to be a dramatic turnaround, and fast.
2015 profits are a mirage
Don't let the analysts fool you. Estimates for fiscal year 2015 call for earnings of $0.38 per diluted share. If that figure were straightforward, then I wouldn't bother writing this article: I'd be too busy buying the stock instead.
The problem is that those figures include Ocean Rig's results, even though Ocean Rig is a completely separate and distinct company that DryShips just owns shares of. I'll spare you the math: If you separate the parts, analysts expect net income of nearly $300 million for Ocean Rig and a net loss of maybe $150 million for DryShips as a stand-alone entity.
You could probably make a case for a valuation based on cash flow instead of earnings, but in the shipping business over the long term they are generally one and the same. You have large capital expenses up front for ships that are depreciating over time for accounting purposes, but then these ships get old and need to be replaced on a rolling basis.
How do you value DryShips over the long term assuming it works out its problems? That's a crapshoot at best, but historically the company has performed very poorly since it went public, and 2014 onward isn't looking much better. In short, with all the risks, uncertainty, and poor near-term prospects to solve its problems, I wouldn't touch DryShips stock with a ten-foot oar.
