DryShips (DRYS +0.00%) started out this year with just 19 vessels, which was well off its peak from just a few years ago because the company jettisoned ships to shore up its financial situation. However, with its balance sheet in a stronger position to start the year, the company set off on a journey to quickly rebuild its fleet so it could capture growth opportunities it saw on the horizon. Here's a look at the three segments of the shipping market that the company believes will lead to healthy earnings growth if everything goes according to plan.
An accelerated entry into the gas carrier market
DryShips' first deal this year was signing an option to buy up to four Very Large Gas Carriers (VLGCs). While the ships were still under construction at the time, the seller had already secured a long-term charter for each vessel to transport liquefied petroleum gas (LPG) for major oil companies and oil traders, which would supply predictable cash flow for the next several years. In fact, if customers exercise all options, the ships will generate $390 million in revenue, which represents excellent near-term earnings potential for vessels that will only cost $334 million.
Image source: Getty Images.
Aside from the cash flow from those contracts, the other reason DryShips chose to make this deal was that it "provides us with a unique opportunity to enter this new segment on a solid footing that can be a stepping stone for further expansion," according to CEO George Economou. It's a market that has tremendous growth ahead of it.
For example, a report by Grand View Research forecasts that global LPG market demand will grow at a 3.6% compound annual rate through 2024. That growth suggests that the market will need more gas carriers in the future to ferry LPG from producing nations to demand centers.
Supporting that view is analysis from LPG tanker company Dorian LPG (LPG +0.57%), which noted that orders for new vessels are expected to fall 44% from last year's peak to just 25 ships this year. Further, Dorian LPG also pointed out that as many as 39 older VLGCs need to be scrapped due to age, while only 11 newbuild orders are on the docket for 2018 and 2019. Because of these dynamics, there could be substantial opportunities for both companies to expand their fleets in the future.
Filling up on oil tankers
The next leg of DryShips' expansion plan was to reenter the oil tanker market, which it exited in 2015 to reduce debt. It did so in late February, buying an Aframax tanker that was still under construction and a Very Large Crude Carrier built in 2011, for a combined $102.5 million. The company would go on to buy another Aframax tanker in April and a Suezmax tanker in May. That last vessel is worth noting because the company signed it up to a five-year charter plus profit share, which, like the VLGC charters, will provide it with a predictable stream of cash flow.
One reason why the company bought all those oil tankers is that prices had been at historic lows. Because of that, the company should be able to earn high returns on these investments in an improving market.
In addition to the fact that oil demand continues to grow, the supply of tankers in the world appears poised to tighten in the future. Last year, for example, the industry only ordered 12 new Suezmax tankers, including three by Nordic American Tankers (NAT 1.61%), which was the lowest number of new orders since the mid-1990s. That could eventually lead to a scarcity of ships, which, as Nordic American Tanker pointed out in its recent market outlook, tends to cause rates to go up. Those rising rates could enable DryShips to earn more money from its boats, as well as order more ships to meet market demand.
Image source: Getty Images.
Bulking up on dry bulk carriers
The final leg of DryShips' growth strategy has been to buy more dry bulk vessels. Overall, the company bought four Newcastlemax and five Kamsarmax vessels to bolster its fleet that already had 13 Panamax vessels. Like the tanker acquisitions, the company made these purchases at historically low rates.
That said, the driver of DryShips' decision to buy more dry bulk vessels wasn't just because the ships were cheap, but because the outlook for the market is finally starting to turn positive after several down years. As a result of modest orders for new ships and the strengthening of China's demand for raw commodities, the spot rate for dry bulk ships has been on the upswing.
One example of this was the company's ability to sign one of its newly acquired Newcastlemax vessels to a one-year contract with a major grain house for a dayrate of $19,450. That's well above last year's rates for this vessel class. For example, Diana Shipping (DSX +0.36%) earned rates as low as $6,450 a day on one of its Newcastlemaxes last year.
Meanwhile, that same ship is making $15,500 per day this year for Diana Shipping under a new charter contract. Because of those soaring rates, DryShips should be able to grow cash flow from its current fleet, as well as take advantage of additional opportunities to build and buy more dry bulk vessels.
Investor takeaway
While DryShips is a dry-bulk shipper at its core, it also sees compelling growth opportunities in the oil tanker and LPG shipping markets. That's why the company quickly went to work this year to rebuild its fleet and position it to capture the growth it sees ahead in all three markets.
If everything goes according to plan, these new vessels have the potential to supply the company with $77 million in earnings before interest, taxes, depreciation, and amortization (EBITDA) per year, which would be a massive improvement given that it had been generating a negative $7 million in EBITDA on a quarterly basis. While the company paid a hefty cost in terms of dilution to chase this growth, its hope is that a continued recovery in shipping rates and additional acquisitions could drive that number even higher in the future.
