The shipping industry is nauseatingly volatile. The rates that shipping companies earn can change quickly and dramatically with just a slight shift in market sentiment. As a result, a company can go from making a boatload of money to sinking deep into the red, causing its stock price to plunge.
There's volatility, and then there's this
Last year, DryShips' stock lost a stunning 99.9% of its value. While the continuation of challenging conditions in the shipping industry was one factor, the primary weight on the diversified shipping company's share price was a deluge of dilution after it unleashed several waves of stock sales to raise cash so that it could rebuild its fleet, which it sold off in previous years to repay debt.
Two other factors have contributed to DryShips' volatility over the years. First, the company charters its boats on short-term contracts at spot market rates, which ebb and flow with the shipping market. Those rates can plunge without notice due to slowing global trade or too many ships on the water, which can quickly dry up DryShips' profits. Making matters worse, the company takes on a boatload of debt to buy ships, which weighs it down during turbulent market conditions. Those two factors are a recipe for disaster, which is what DryShips' stock has been over the years.
There's nothing it can do when the bottom falls out
Oil tanker company Nordic American Tankers has tried to take a unique approach to combat the volatility of shipping rates. The company operates just one ship type -- Suezmax oil tankers -- so that it can keep costs low. It also tries to keep debt low, with it currently at $8.9 million per ship, which is less than their scrap value.
However, despite the company's low operating costs and debt level, shares have been incredibly volatile. The stock plunged a jaw-dropping 70.5% last year because of deteriorating market conditions, which forced the company to sell more shares at an inopportune time to bolster its financial situation. That's because like DryShips, Nordic American Tankers charters its ships at spot market rates, which enables it to cash in during up markets but can prove disastrous during rough seas. That has been the case in the last year as shipping rates plunged to $11,200 per day in the first quarter, which is below the company's breakeven level and well under the $30,000 per day they've averaged over the past few decades. The company's direct exposure to such a volatile market is why I'd never buy its stock.
A better business model for the shipping sector
GasLog Partners does things differently. The liquified natural gas (LNG) shipping company secures long-term, fixed-rate charters for all its vessels, with the bulk of them contracted to big oil giant Royal Dutch Shell (NYSE:RDS-A)(NYSE:RDS-B). These charters help insulate GasLog Partners from changes to spot market rates, enabling it to earn a steady stream of cash flow.
Because the company generates stable cash, it's able to consistently distribute money to investors in a dividend that currently yields 8.9%. While the company does send back the bulk of what comes in, it uses the remaining cash, along with new debt and equity capital, to acquire more ships from its parent GasLog (NYSE:GLOG). These vessels come with long-term contracts already in place, enabling them to provide an immediate boost cash flow, which has allowed GasLog Partners to increase its distribution to investors in each of the last six consecutive quarters.
However, one concern I have with GasLog Partners is that it has a boatload of debt -- $1.1 billion at the end of the first quarter for a $2 billion company -- which could weigh it down if market conditions deteriorate significantly. Still, the LNG shipping market is intriguing since global LNG production grew 10% last year and is on pace to increase at a healthy rate in those to come due to several new LNG export facilities coming online. That wave of gas needs carriers to move it to global markets, suggesting that the LNG shipping sector has ample upside ahead, which is why I'd consider investing in GasLog Partners under the right circumstances.
The shipping sector isn't for the faint of heart
Shipping stocks are highly cyclical, which can fuel big-time returns when rates are rising and huge busts when they fall due to the added pressure of debt. That's why I'll never buy most shipping stocks. About the only ones I will consider are those that secure long-term contracts for the bulk of their boats, since that should help mute some of the impacts of shipping rate volatility. Still, even these stocks aren't immune to market downturns, which is why I'm still weighing the risk/reward potential of GasLog Partners.