Is the Drybulk Rally Real?

Is the Drybulk Rally Real?

Dry bulk shipping companies DryShips , Diana Shipping , and Navios Maritime Holdings rallied strongly at the end of last year as the Baltic Dry Index, which reflects the daily charter rate for vessels carrying cargoes such as iron ore, coal and grain, surged to its highest level in two years.

However, since then the Baltic Dry Index has collapsed nearly 40% from its highs and shipping stocks have followed suit. This collapse was in part due to the Colombian government taking a tougher stance on coal exports from the country. In particular, a new wave of regulation on Colombia's coal industry means that many miners within the country are unable to export coal until they meet these new strict regulations. As a result demand for drybulk ships to export coal has fallen.

Obviously this move has scared some, and shipping stocks across the board took a hit in the wake of this announcement and subsequent collapse in the Baltic Dry Index. Nevertheless, while this collapse in the index has been devastating, over the long term things still look positive.

The long-term outlook is ok
For example, it's not as if Colombia has banned all coal exports. Coal will be exported from Colombia again when miners within the country comply with the new legislation, and dry bulk ships will still be required.

Still, declines in the Baltic Dry Index are not just due to a cessation of coal exports from Colombia. Many analysts consider this time of the year to be a seasonally weak spot for dry bulk rates, as the Chinese New Year is just ahead. In addition, within an interview with the Financial Times, Rui Guo, senior dry freight analyst at ICAP Shipping, said China was running down coal stocks while its iron ore market was also "hugely depressed" in terms of importing activity. Imports of iron ore expanded 10% in China during 2013.

Further to go
But while dry bulk rates are under pressure at present, there are some indications to suggest that the market is in the process of staging a full recovery. According to Clarkson, the world's leading provider of integrated shipping services, during 2013 the total amount of dry bulk cargo shipped around the world jumped 5.4% year on year, while total seaborne trade increased 3.8%. This rate of growth was close to the average annual growth rate of the last 50 years. What's more, Clarkson reported a great improvement (decline) in the number of new builds delivered to the market during 2013.

A chronic oversupply of ships has been one of the reasons that the shipping industry has remained so depressed during the past few years. Hundreds of new ships were purchased with cheap credit in the run up to the financial crisis when the industry was booming, and this overhang has kept the market depressed. However, now it appears that these order books are starting to run dry. In particular, the tanker and bulk carrier fleet grew 4.3% during 2013, roughly in line with the growth of global trade. In comparison, during 2009, 2010, 2011, and 2012, the four years when global trade remained depressed, the fleet expanded 8.4%, 10.7%, 10.4%, and 7.3% respectively.

Better positioned
Of course, some companies are better positioned than others to ride this recovery. DryShips' exposure to the deepwater drilling business via subsidiary, Ocean Rig has kept DryShips afloat during the past few years as the shipping sector struggles to recover, but demand for offshore drilling services remains strong.With the cash flow from the drilling business, a recovery in the dry bulk market is likely to accelerate DryShips' recovery, and this puts it in a better position to ride the recovery than its peers.

That being said, the recent announcement that DryShips was tapping the market for $200 million through the issuance of new shares did spook shareholders; this dilution is bad for long-term investors. In comparison, Diana Shipping has a good track record of not diluting shareholder equity, with only minimal market cash calls during the past three years.

Still, even though Diana has not diluted shareholder equity to the same extent as DryShips, the company's stock has risen 55% during the space of the last year. What's of concern here is the fact that Diana's operational performance has not improved during this period; actually it's gotten worse, as the company swung from a profit to a loss. This means that Diana's valuation is now higher than it has been at any point in the last few years and the market is expecting big things. However, nothing is certain in the shipping industry, and if things go wrong, Diana's investors could be left high and dry.

Foolish summary
So all in all, the dry bulk market is starting to find its feet again, but as of yet the recovery is not fully under way. The volume of cargo being shipped around the world has returned to growth, and the number of new builds hitting the market has declined to a multiyear low. Nevertheless, investors need to be careful where they choose to place their cash in the market as some companies are better positioned than others.

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Fool contributor Rupert Hargreaves owns shares in DryShips as 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.

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Originally published