DryShips (DRYS) trades at a significant discount to book value and offers major upside potential because of its earnings and financial leverage. The stock gives value investors an opportunity to buy a cyclical company at a low point and one of the few remaining ways to play China and commodities at a very attractive price. The Company has just over 30 million shares outstanding, a market capitalization of approximately $320 million and net debt of approximately $550 million (proforma for the recent acquisition of two additional ships). DRYS also offers a very attractive dividend of $.20 per quarter / $.80 per year which implies a yield of almost 8%. The Company operates 29 dry-bulk ships (primarily medium sized Panamax class) that transport raw materials such as iron and coal to China and other markets. It shares have traded sharply lower to roughly $10.50 over recent months as shipping day rates have declined.
Asset Valuation / Downside Protection
DRYS has book value as of 3/31/06 of $368.5m or $12.14 per share. Based on its current share price, the Company trades at an approximately 15% discount to book value. However, the balance sheet likely understates the Company¡¦s actual book value based on market prices for ships. Scott Black of Delphi Management in a recent Barron¡¦s roundtable estimated the Company¡¦s NAV at approximately $18 per share, which implies DRYS trades at an approximately 40% discount to NAV. Investors can track the value of the Company¡¦s fleet using industry magazines (such as TradeWinds) which report vessel sales. In addition to trading at a discount to asset value, the stock also trades significantly lower than its February 2005 IPO price of $18 and it all-time high price of just under $24. The high yield on the stock also provides downside protection. The Company¡¦s free cash flow breakeven (which includes debt service and full dividend payment) is approximately $16,000. Since the Company¡¦s has chartered over half its fleet and locked in prices and cash flow, it requires a spot price for its ships of just $11,500. The latest rates for panamax ships was $20,750 and for capsize (larger ships, which the Company owns 4) is approximately $37,500, giving the Company cushion in meeting its dividend payments. On its latest conference call, management was adamant that it intends to continue paying its $.80 dividend.
DRYS trades at an extremely attractive valuation relative to its historic earnings and earnings potential. During 1Q 2006, DRYS earned $.60. The company trades at a P/E of 4.4x the annualized 1Q 2006 rate which is arguably a depressed rate. For 2005, DRYS reported EPS of $3.85. While day rates have decline, if they simply returned to levels from last year it is easy to see the stock trading in the $30-40 range (assuming a 8-10x multiple and earnings of $3.85). If day rates returned to peak levels, the stock could be worth $60-70 per share (based on 8-10x multiple of earnings of approximately $7.20 per share, not arguing they get there, but gives a sense for the potential).
The Company¡¦s earnings are highly sensitive to changes in day rates both because of the firm¡¦s high exposure to the spot rate and the cost structure of the business. Every $1,000 increase in day rates adds approximately $.19 to the company¡¦s EPS. The costs associated with operating dry ships, which are among the simplest of transport vessels, are minimal. For the most recent quarter, daily vessel operating expenses (crew costs, insurance, maintenance, etc). were $4,330 versus $19,698 in revenue per voyage day for the Panamax class ship. The company also has only a small amount of corporate overhead as it outsources fleet management. For the most recent quarter, fleet management and other general and administrative costs totaled $2.4m versus $50.8m in net revenues. Incremental revenue falls to the bottom line. The sensitivity section summarized the Company¡¦s earnings under various scenarios.
DRYS is a highly leveraged company so returns to equity are further enhanced by the significant debt paydown in high earnings years. The Company has the financial structure of a public LBO. It uses non-recourse, low interest rate secured debt to finance its ship purchases (it has a minimal amount of subordinated debt). The Company¡¦s net debt is approximately 2/3 of TEV and equity is 1/3. The sensitivity sections shows the Company¡¦s free cash flow capabilities. Even in difficult EPS scenarios, the Company still produces EBITDA sufficient to make significant debt paydown (as non-cash depreciation represents a significant portion of operating costs) and support a valuation not far from current levels.
These sensitivities analyze the DRYS¡¦s 2006 revenues, EPS and EBITDA under various scenarios based on the Company¡¦s current contracts and the spot rate. The model assumes all non-contract ships immediately get priced at the spot rates and assumes a 98.0% fleet utilization rate (the 1Q 06 rate). It holds vessel operating costs and Company overhead at 1Q 2006 levels (adjusted for additional ships). It includes the results for 1Q 2006. The table below summarizes the results of the sensitivity:
Case Current Peak Rates Historic Avg.
Panamax Day Rate $20,750 $46,000 $10,400
Revenue $226.5m $358.7m $170.1m
EPS $2.77 $7.20 $.88
P/E @ $10.50 price 3.8x 1.5x 12.0x
EBITDA $171.7m $303.8m $115.3m
Net Debt $464.2m $329.8m $521.6m
TEV EBITDA* 4.6x 2.1x 7.3x
* For valuation, the model adjust current TEV based on debt paydown. It assumes dividend payments.
The table below provides the data by ship for the sensitivities:
DRYS Fleet Summary as of 5/31/06
Ship Class Spot / Contract Day Rate Earliest Redelivery Latest Redelivery
Manasota Capesize Contract $46,000 9/06 11/06
Alameda Capesize Contract $28,000 2/07 4/07
Shibumi Capesize Spot $20,000
Netadola Capesize Spot $29,250
Conrad Panamax Contract $42,000 11/06 2/07
Coronado Panamax Spot $16,750
Waikiki Panamax Spot $15,500
Mostoles Panamax Baumarine* $11,576
Linda Panamax Contract $43,250 7/06 10/06
Sonoma Panamax Baumarine $15,905
Catalina Panamax Contract $18,100 9/06 10/06
Ocean Panamax Contract $17,900 7/06 7/06
Padre Panamax Contract $17,800 7/06 7/06
Toro Panamax Baumarine $15,739
Xanadu Panamax Contract $35,000 6/06 9/06
La Jolla Panamax Spot $17,500
Lacerta Panamax Baumarine $15,646
Panormos Panamax Baumarine $16,237
Paragon Panamax Contract $30,000 8/06 10/06
Iguana Panamax Contract $16,500 7/06 7/06
Daytona Panamax Baumarine $13,683
Lanikai Panamax Baumarine $13,881
Tonga Panamax Baumarine $11,016
Flecha Panamax Baumarine $11,571
Striggla Panamax Baumarine $12,037
Maganari Panamax Contract $29,000 2/07 5/07
$18,400 2/08 7/08
Alona Handymax Contract $19,900 9/06 11/06
Matira Handymax Contract $15,800 9/06 11/06
Hille Old. Handymax Contract $20,020 1/07 5/07
* Baumarine is a trading pool of ships
An increase in day rates could drive DRYS stock materially higher. The day rates for Panamax ships are currently approximately $20,750, 55% below peak levels of $46,000. There is ample room for rate increases. The macro forces that drove rates to ever high levels from 2002 through the first half of 2005 continue unabated and represent catalysts for day rates and the stock:
„X Continued economic growth and high commodity demand from China and India
„X High coal use
„X High iron use
„X Continued growth in grain consumption based on new demand patterns in emerging markets
„X Port congestion issues: requires major capital expenditures, time commitment and availability of suitable locations limited
The downside risk primarily relates to possible increases in the supply of vessels that could put pressure on day rates. While capacity has increased, the medium / long term growth in capacity should be limited by increased scrapping of older vessels and the decision by ship builders to focus on higher margin and more expensive construction projects such as LNG tankers. There is also the risk of share dilution, as the Company has stated in may issue up to 5 million additional shares to fund more ship acquisitions.
DRYS is compelling long based on 1) asset valuation, 2) earnings potential, 3) yield, 4) LBO capital structure that further amplifies returns to equity holders and 5) macro economic forces that serve as catalysts for day rates and earnings. It is not hard to envision scenarios where day rates rebound from their current low levels and DRYS¡¦s EPS return to levels that support a stock price of $30-40 and perhaps higher. The stock is trading at cyclical lows with the macro forces that drive demand strongly in its favor.