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Why DryShips, Inc. Stock's Crash Today Should Leave You Cold

By Neha Chamaria – Jan 10, 2014 at 3:20PM

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Beware: DryShips could be headed for rough waters as the Baltic Dry Index tanks.

Although we don't believe in timing the market or panicking over market movements, we do like to keep an eye on big changes -- just in case they're material to our investing thesis.

What: Shares of dry bulk shipping company, DryShips (DRYS) sank nearly 7% this morning after the Baltic Dry Index dropped a nerve-wracking 11% to 1,706 overnight. The index is a key indicator of shipping activity, measured by the cost to transport goods through various fleet classes.

So what: After a sharp rebound in 2013, which also sent shares of dry bulk shippers soaring, the Baltic Dry Index is losing steam at a pace faster than you could imagine. After Friday's double-digit fall, the index has already shed 19% since the beginning of the year on weak sentiments backed by several factors.

One, it's a seasonally weak period for iron ore demand from China, which in turn means lower demand for vessels to ship the commodities. In fact, shares of leading iron ore mining companies too are feeling the pressure as worries about China's slowdown continue to loom large. Two, unpredictable weather in key markets, such as Australia, is also playing spoilsport.

Now what: Stifel's Ben Nolan sees further downside in the spot shipping rates as iron ore inventories in China continue to remain high. That's terrible news for DryShips, especially since the index's drop is being led by the largest and otherwise high-margin capesize ships. Spot capesize shipping rates crashed a staggering 27.5% on Friday alone, taking its total year-to-date drop to 33%. Since several of DryShips' capesize contracts are near expiry and will have to be renewed at spot rates, any further drop in rates could put the company in trouble.

DryShips is struggling with huge debt and losses, so any potential hurdle to its top-line growth is nothing but dangerous. The market applauded when the company suspended an equity offering in early December last year, but the excitement fizzled out even before the new year as DryShips resumed the offering.

Why does the situation appear bleaker today? Here's a simple equation: Contracts at low rates will mean lower revenue and greater losses, leaving DryShips high and dry with negligible free cash flow. With debt and interest payments mounting, the shipper will then have no option but to issue more shares to raise capital, and that's a double whammy for existing investors -- zero earnings growth and constant dilution of wealth.

Now that's a scary picture, and now you know why today's slump in the Baltic Dry Index should leave you scurrying for cover if you're a DryShips investor.

Fool contributor Neha Chamaria has no position in any stocks mentioned, and neither does The Motley Fool. 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.

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