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Salvaging the Wreckage From Dry Bulk Shipping

Christopher Barker
June 8, 2011

For a long time, observers of the dry bulk shipping sector have thrown their weight behind conservatively managed Diana Shipping (NYSE: DSX  ) . But now, along comes Goldman Sachs analyst Scott Malat with a downgrade for Diana (from buy to neutral), and a buy recommendation for the stock I have offered as the greatest gamble in stocks: DryShips (Nasdaq: DRYS  ) .

Like Foghorn Leghorn, perhaps folks with rhyming names are just destined to offer sage advice, but in any event, I agree with Scott Malat ... a lot.

Diana Shipping's executive team will be the first to tell you that the industry will encounter some unthinkably challenging dynamics, which will likely threaten the very survival of some highly leveraged operators. As a matter of fact, Diana's execs were out in front of this with some very vocal warnings more than two years ago, and again last month with a thought-provoking reminder that "the inevitable cannot be indefinitely postponed."

The industry continues to carry the weight of an enormous oversupply within the dry bulk carrier fleet, and the process of clearing that excess capacity likely won't occur without some significant collateral damage to the more vulnerable operators. It seems operating revenues are bound to dip beneath average operating costs for a spell, serving as a catalyst for the ultimate game of survival of the fittest. Since I have routinely highlighted Diana Shipping as the shipper that Charles Darwin himself would have adored for its superior capacity to adapt to these survival challenges, why do I now voice my agreement with the downgrade of Diana by Scott Malat, from hot, to not-so-hot?

It's nothing personal, Diana
I haven't changed my long-term bullish outlook for Diana Shipping as the premiere conservative choice for exposure to greener pastures, once the bulk of the oversupply condition clears. From my perspective, this downgrade simply acknowledges that Diana's previous "best-case scenario" for navigating the oversupply just won't happen. It's going to get ugly at some point here, and even the strong will be deeply challenged. The more optimistic global demand growth forecasts that buoyed the outlook for shippers in recent months have rapidly given way to widespread downward adjustments, exacerbating the projected market impact of the persistent vessel glut. Commodities oracle Joy Global (Nasdaq: JOYG  ) still foresees long-term global demand growth in the cards, even if at a moderating pace, but a smoother outlook for shippers required every ounce of demand-related optimism that has since been scaled back.

Not letting his tongue get tied in a knot, Scott Malat explains his downgrade of Diana in the context of "higher than anticipated [vessel] deliveries during the first quarter" and "lower than expected ton-miles" for the industry resulting in part from expanding coal trade from areas closer to the nucleus of demand (principally China). These observations have no unique bearing upon Diana Shipping in particular, so I encourage Fools to interpret the call as a reasonable expectation that superior entry points may be forthcoming for multiple dry bulk shippers.

If Diana Shipping deserves a neutral rating in the context of a deteriorating industry outlook overall, then by extension, the outlook for the more severely leveraged operators warrants greater caution still. Genco Shipping & Trading (NYSE: GNK