Houston, we have a problem. Diana Shipping (NYSE:DSX) announced that one of its dozens of charterers has terminated its contract nearly a year early. While one contract of one ship, for one year, doesn't sound like much, it's a harder blow to Diana than you'd think.
Diana Shipping announced on Nov. 27 that the charterers of its third-largest ship, the "Houston," have given notice effective Nov. 26 of cancellation. The original contract was supposed to run until Oct. 3, 2014. The charterer claims it is entitled to cancellation because of a breach of contract by Diana Shipping's subsidiary, but it didn't provide any further information.
Diana Shipping insists that the allegation is nonsense, and says that all its efforts to resolve the dispute have gone nowhere. In the press release, Diana Shipping implies it will sue, if necessary, but that realistically could take years and lots of money to resolve. Even then, there can be no assurance that Diana Shipping is ultimately able to win and collect at all.
The financial damage
While this may be only one ship, it happens to be Diana Shipping's most expensive contracted ship on its fleet, by a long shot -- and, at a contract rate of $55,000 per day, the most profitable.
In its recent third quarter, Diana Shipping generated $41.9 million in revenue from 36 ships, which works out to an average of $14,491 per day. The Houston rakes in nearly four times as much revenue as Diana's average ship. While there's no doubt that Diana Shipping will be able to find a new customer, the current spot rates of Capesize-class ships like the Houston's size run at less than $18,000 per day, more than two-thirds lower.
At $18,000 per day instead of $55,000, Diana Shipping stands to lose $37,000 per day in revenue. For the fourth quarter, that's around a $1.3 million shortfall. Expect an equal amount cut from the company's bottom line, too. For the first quarter next year, if we still use $18,000 per day, Diana's revenue and profit shortfall would be $3.33 million. If the rates get even softer in the first quarter, that gap could grow even wider. By the time you add it all up, Diana Shipping stands to lose around $11.5 million in revenue and profit by Oct. 4 of next year.
Diana didn't indicate any problem during its conference call on Nov. 19. In fact, CEO Simeon P. Palios stated, "Currently, our fixed revenue days are 99% for 2013. The majority of our vessels -- charter for periods rising from 2014 through 2015 and beyond."
The silver lining
The silver lining in all this is twofold. First, Diana Shipping has operated very conservatively for many years and has $316 million in cash as of Sept. 30. It should be able to afford the shortfall. Second, if rates begin to rise, this will reduce the financial damage. If rates unexpectedly skyrocket, Diana Shipping could potentially end up with more revenue than $55,000 per day.
Many other dry shippers are forecasting higher rates in 2014.
Safe Bulkers (NYSE:SB) president, Dr. Loukas Barmparis described the current environment as "an early stage of the forthcoming shipping cycle." He expects rates to "really move higher" in the second half of 2014 and onward. CEO Polys Hajioannou also explained that right now iron ore is cheap, and it's causing an increase in amounts of shipments, which will increase rates. If Safe Bulkers management is correct, the damage to Diana Shipping should be lessened.
DryShips (NASDAQ:DRYS) CEO George Economou had similar commentary. He mentioned that DryShips is "cautiously optimistic, expecting a sustainable recovery in 2014 and beyond." DryShips CFO Ziad Nakhleh is also optimistic about higher rates, and forecasts a "sustainable recovery" for 2014 onward. Nakhleh believes there are simply too many old ships in the industry that will need to be scrapped at an accelerating pace. He forecasts, this reduced supply will raise rates.
Foolish final thoughts
This is a blow to Diana Shipping, but it's far from a death blow. Follow the rate pattern because rising rates for the rest of its fleet could more than make up for the shortfall of this one ship. Look to future announcements and SEC filings from Diana Shipping for any word of a possible legal recovery.
Nickey Friedman has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. 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 has a disclosure policy.