Economists love to run a series of experiments based on "
," testing whether individuals rationally account for the actions
of others before making their own moves. When it comes to companies
in the dry-bulk shipping industry, only one player has been acting
rationally. The rest have been making foolish moves, making life
brutal for investors -- except for those who have been smart enough
to own that one rational player.
After the economic downturn in 2008, the industry was suddenly
beset by too many ships chasing too few customers. The
Baltic Dry Index
(BDI), which is a handy
for the rates these companies can charge to lease their fleets,
plunged sharply, from around 11,500 in the spring of 2008 to just
2,000 18 months later.
That kind of drop turned the industry on its head, as daily lease
rates for these massive ships that carry iron ore, coal and other
dry goods were suddenly so low, that profits turned into big
Faced with such a sea change, you'd think these companies would
show restraint and wait for demand to rebound and profits to rise
back up before ordering new ships. Instead, almost all of them kept
ordering new ships, and now they're paying the piper. The fleet of
dry-bulk ships is set to expand 13% in 2011 and another 11% in
2012, according to research firm Sterne Agee. Faced with a glut of
new ships, customers are able to work out sweet deals, while the
BDI now sits at just 1,500.
Is it any wonder share prices are once again falling for the
industry's key players?
It would be awfully tempting to look at these stocks as bargains,
despite the foolish expansion moves by key players in recent
months. Companies like
Dry Ships (Nasdaq:
Navios Maritime (NYSE:
, for example, sport price-to-earnings (
) ratios in the mid-single digits. Stocks like
Eagle Bulk Shipping (Nasdaq:
Excel Maritime (NYSE:
trade for half their 52-week high, a typical level that attracts
interest for those seeking deep value plays.
But every one of these stocks carries the same risk. If the
globaleconomy cools, then lease rates for these massive ships might
fall even further, turning current forecasts of decent profits or
small losses into massive losses. This would spell real trouble for
these firms, each of which carry too much debt. In most instances,
big payments will need to be made against that
in the next few years. A lousy
could conceivably force these companies into bankruptcy.
The wise player
As the table above shows, one dry-shipping firm chose to follow the
rules laid out in "Game Theory." Seeing that the industry was
embarking on an ill-conceived expansion,
Diana Shipping (NYSE:
decided to step aside and hoard its cash, assuming it may
eventually be able to buy ships at fire-sale prices from distressed
rivals if the industry hit another rough patch.
Analysts at Sterne Agee laid out a bold prediction back in January:
"DSX's financial flexibility, ample cash balance and debt capacity
put the company in a pole position to capitalize on the coming
weakness in the dry-bulk market." That time is now at hand. Diana
now has $373 million in cash and can borrow up to $87 million,
according to ClarksonCapital Markets . This gives the company $460
million in fire power. Goldman Sachs believes "Diana has the
cash/debt capacity to roughly double the fleet size."
Even before making any big moves, Diana is already nicely sheltered
from the industry price pressures. Its fleet is already mostly
booked at pre-negotiated prices, which are higher than the current
Action to Take -->
Even as Diana Shipping has held up better than peers, it's still a
Net Asset Value
) of $12.60 a share. In coming quarters, Diana may well acquire
more assets for $0.50 or $0.60 on the dollar, pushing the ultimate
long-term value of itsasset base even higher.
Shares also trade for just 6.5 times projected 2011
before interest, taxes,
(EBITDA). It's not a cheap multiple in an industry that is
suffering, but it's a nice entry point when you consider Diana's
rivals are increasingly likely to retrench and take ships out of
the water if the hard times continue. Picking up ships on the cheap
now will boost EBITDA later when the industry re-strengthens. As a
third leg to value, shares sport a free cash-flow
of about 12%, based on Goldman Sach's 2011 free cash-flow
-- David Sterman
P.S. -- If you're an income investor, why would you buy a stock
yielding 2% when you can find one paying 26% right here? Watch this
presentation for more.
Disclosure: Neither David Sterman nor StreetAuthority, LLC hold
positions in any securities mentioned in this article.