Ship Owners Are in for a Long Haul

Conditions have gotten to the point of no return in the dry bulk shipping market. Rates are at multi-year lows and trade doesn't appear to be returning at a rapid rate any time soon. Sure, stocks popped on quantitative easing and European bond buying news last week, but that rally will be short lived. Just look at the Baltic Dry Index below, which is a composite of Baltic Capesize, Panamax, Handysize, and Supramax indexes, to see where rates are trending. There's no upside with rates this low.

^BDIY Chart
^BDIY Chart

^BDIY data by YCharts

Rates like these leave little in the way of profits for ship owners. Eagle Bulk Shipping (NAS: EGLE) and DryShips (NAS: DRYS) are posting consistent losses while Paragon Shipping and Navios Maritime (NYS: NM) are clinging to minuscule profits. The only company with a consistently profitable business is Safe Bulkers (NYS: SB) and that's due in large part to its balance sheet (which I'll get to in a minute).

DRYS Net Income Chart
DRYS Net Income Chart

DRYS Net Income data by YCharts

All of these losses have led to not only lower stock prices, but increased debt levels. Take a look at the market cap and long-term-debt levels of DryShips, Safe Bulkers, and Navios Maritime over the last five years. Stock prices have fallen and debt is up in every single case. This means that even when rates start to rise, these companies will be digging themselves out of a deep hole.

DRYS Market Cap Chart
DRYS Market Cap Chart

DRYS Market Cap data by YCharts

The biggest thing keeping controversial shipper DryShips afloat with its huge debt level is its ownership stake in Ocean Rig (NAS: ORIG) , an ultra-deepwater drilling company it spun off, which doesn't have anything to do with shipping.

Structural changes in dry bulk
The challenge for shippers has a lot to do with the recession and struggles in Europe, but there are structural changes as well. Thermal coal is a major export to Europe and Asia, but their energy demands will continue to evolve in coming years and I wouldn't expect growth in this area to continue. China is restricting the use of thermal coal and is matching production with demand. In Europe, countries are focusing on renewable energy sources like wind and solar over coal. There's also a likely expansion of natural gas drilling in both regions as fracking grows, which has been the driver of coal's downfall in the U.S.

On the trade front, companies are focusing more of their efforts on local production than they have in the past few decades. China, India, and Malaysia are no longer the extreme low-cost labor sources they once were, which will slowly lead companies to focus more on local production. This is a long-term trend taking place; it will continue to put pressure on dry bulk shipping companies.

Oversupply in dry bulk
Long-term supply trends are working against ship owners, yet it is also true that oversupply of ships will keep rates low as well. Moody's estimates that the market has 30% more supply than it needs -- pressure will continue through 2013.

After that time, Moody's expects conditions to continue because new builds are slowing down and the economy is expected to recover, but that's a long way off to be buying now.

A risky proposition
Moody's may be right that the dry bulk market will pick up eventually, but with rates extremely low, few companies reporting profits, and market trends working against the industry I think caution is in order. Safe Bulkers has the best balance sheet of the bunch; if you're going to jump into this market that is the safest bet, but it is still risky.

I don't think any of these stocks are a good deal right now, and think that we'll see more local manufacturing production and a focus on domestic energy in China, the U.S., and Europe going forward. If the economy does recover there are good buys in other areas, like the three ETFs our analysts have identified. Which ETFs are the best bets for a recovery? To find out, click here for our free report.

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Fool contributor Travis Hoium does not have a position in any company mentioned. You can follow Travis on Twitter at @FlushDrawFool, check out his personal stock holdings or follow his CAPS picks at TMFFlushDraw.The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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