Ponder Diana Shipping's Best Case Scenario

The dry bulk shipping industry continues to make waves. The Baltic Dry Index has again ebbed mercilessly in recent weeks, and virtually all of the U.S.-traded stocks in the group have underperformed the S&P 500 year-to-date. Shares of both Diana Shipping and DryShips (Nasdaq: DRYS  ) , in fact, are still languishing in negative territory for 2010.

The slipping degree of interest in the industry's stocks among investors is palpable, right at the moment when Diana Shipping's (NYSE: DSX  ) outlook is noticeably shifting from dire warnings into resurgent optimism.

Diana has reason to be optimistic, even in this incredibly difficult business environment for the industry. The seagoing hauler beat estimates for both revenue and earnings, turning in a cozy profit of $33.8 million for the third quarter. Diana's incredible net profit margin of 47% for the quarter floated atop a modest 2.4% slip in the fleet's average daily charter rate. Competitor Genco Shipping & Trading (NYSE: GNK  ) , by contrast, saw its time-charter equivalent (TCE) fall by a more precipitous 12.8%.

Like the mining sector that the company serves, Diana Shipping is keenly focused upon the long-term outlook for growth in commodity demand from places like India and China. For 2011, Diana expects a global increase of about 8% in volumes of iron ore shipped, while the outlook for coking coal is far stronger still. Following a 23% surge in 2010, coking coal shipments may expand a further 14% in 2011. Thermal coal volumes will increase as well in 2011, though likely at a more modest 4% clip.

Looking over the horizon to the longer-term outlook, equipment manufacturers Caterpillar (NYSE: CAT  ) and Joy Global (Nasdaq: JOYG  ) have both signaled their clear expectations for sustained commodity demand growth. Joy Global has conveyed its bullish outlook explicitly, while Caterpillar echoed the case this week through its $8.6 billion takeover bid for Bucyrus (Nasdaq: BUCY  ) .

Thankfully for shipping investors, that demand growth will go a long way toward absorbing a massive influx of new dry bulk vessels presently on order. Whether that demand growth (and the port congestion related thereto) will be sufficient to absorb the increased supply will depend, ultimately, upon the final tally of that incoming supply.

According to Diana Shipping president Anastasios Margaronis, the crux of the issue comes down to slippage and scrapping. If too much of the present order book for new vessels is realized in actual deliveries, and scrapping activity is insufficient, a worst case scenario could see the dry bulk market "collapse under the weight of tonnage joining the fleet."

Fortunately, Diana Shipping considers a best case scenario more likely at this stage, where roughly half of the present orderbook fails to enter the global fleet, and scrapping activity increases to rates seen in 2009. Under those conditions, and assuming those demand predictions materialize, Margaronis believes "the market should comfortably absorb the new tonnage." He discussed multiple caveats to those scenarios, in a conference call that Fools invested in the dry bulk space are encouraged to review. In the final tally, though, I consider a scenario where Diana Shipping's stock reawakens into meaningful strength to be the most likely of all.

The Fool has established a bear put spread position on Caterpillar. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Christopher Barker can be found blogging actively and acting Foolishly within the CAPS community under the username TMFSinchiruna. He tweets. He owns shares of Diana Shipping. 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's disclosure policy can hold its breath underwater while a cargo ship passes overhead.


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