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Rogue Wave Swamps Dry Bulk Shippers

Christopher Barker
February 23, 2009

Rogue waves come out of nowhere, and have been known to swallow massive ships in the blink of an eye. For mariners and investors alike, it pays to keep a vigilant watch even when conditions appear favorable.

In the wake of a perfect storm, that vigilance must intensify further; and the recent bear-market rally among the dry bulk shippers provides the ultimate cautionary tale. Understandably eager to climb aboard the first available life raft within a sea of uncertainty, buying interest returned to the shipping sector in December when a sudden reversal in the Baltic Dry Index (BDI) set the blogosphere ablaze with bullish sentiment.

Now that a series of dramatic developments have bashed the group like a rogue wave, and fourth-quarter results are beginning to emerge, let's step back and take a comprehensive look at the sector.

Credit running dry
Placing an exclamation mark after the company's epic deterioration from last year's glory, DryShips (Nasdaq: DRYS  ) doused investors last month by slashing its dividend and later revealing that the company had breached debt covenants. I believe that contravention of debt covenants presents a wholly unacceptable level of risk for Fools in this environment, so I held no punches in cautioning Fools to leave this one alone. Hopefully, Fools heeded my caution, since a momentary recovery after two lenders renegotiated debt terms lasted only a matter of days.

How rogue waves are formed
South Korean shipper Samsun Logix has run aground, filing for court receivership and splashing some competitors in the process. With close ties to struggling steelmaker POSCO (NYSE: PKX  ) , Samsun Logix provides a timely reminder that a global downturn of this magnitude will not reverse as easily as the sudden spike in the BDI might have suggested. Consequences will continue to reveal themselves, and Fools are encouraged to proceed cautiously with their precious investment capital.

This development has far-reaching implications for the industry. The failure was precipitated by the cancellation of charter contracts by shippers that themselves became insolvent. Like an airborne virus, the malaise travels through Samsun Logix to the publicly traded shippers. As an integrated ship owner and operator, Samsun Logix inked charter contracts with vessel owners like DryShips and Navios Maritime (NYSE: NM  ) to maintain a more elastic fleet. DryShips was in the process of selling a vessel to Samsun Logix, while Genco Shipping & Trading (NYSE: GNK  ) had only one vessel chartered to Samsun Logix.

Mounting bankruptcies within the sector give charter clients additional bargaining power when it comes to renegotiating long-term charter contracts … many of which were priced at rates substantially higher than present charter rates.

First to report a rogue wave
The ability to rely upon contracts as binding instruments is central to the normal functioning of global commerce, so the news that two charter clients of Excel Maritime Carriers (NYSE: EXM  ) suddenly decided to pay only half the contracted rate caught the industry off guard. Excel Maritime promptly halted its dividend, citing a $107 million hit, and warned that the company "cannot assure that charterers will continue to pay hire at agreed rates, reduced rates, or at all." 

That chilling statement, I believe, speaks