We downgrade our recommendation for DryShips Inc. (DRYS) to Underperform, ahead of its fourth quarter 2010 financial results. Drybulk shipping industry is going through an extreme depressive situation. Despite improving global macroeconomic scenario, the financial condition of this industry is worse than what it was a year or two ago. This is solely attributable to non-economic decision taken by the shipping companies in 2008 just before the beginning of worldwide decisions. Due to lack of near-term foresight, most of the vessel operators had ordered a large number of newbuild ships in several docks. Glut of ships are resulting in severe cut-throat price competition.
Capesize vessels, which are mainly used for drybulk goods, faced a major brunt of this competition. In the spot market, capesize vessel rate fell below $7,000 per day. This is a below break-even situation since these companies incur operating costs of $7,000-$10,000 per day. In contrast, capesize vessel rate was a massive $40,000 per day just a year-ago when the economy was reeling under recession. We believe continuation of this extreme low spot rate may also bring down fixed time charter rate. This will severely impact the overall finances of DryShips.
DryShips entered into an agreement with a first class Korean shipyard to purchase 12 oil tankers for a total consideration of about $770 million. Oil tanker market is highly cyclical in nature and is currently going through low freight rate. We believe the recent upsurge in oil tanker rate is due to political disturbances in Northern Africa region, which will be a short-term phenomenon. Several industry analysts predicted that the depressive situation of the tanker market may continue to be up at the end of 2012.
DryShips mainly compete with Diana Shipping Inc. (DSX), Genco Shipping & Trading Ltd. (GNK), and Excel Maritime Carriers Ltd. (EXM). The drybulk shipping industry is also cyclical coupled with volatility in charterhire rates and profitability. Moreover, the business is strongly capital-intensive and its future success will depend on DryShips ability to maintain a high-quality fleet through the acquisition of newer drybulk carriers and the selective sale of older drybulk carriers. The company may not be able to employ its vessels upon the termination of their existing charters at their current rates.