DryShips (DRYS) Remains Underperform

We reiterate our Underperform recommendation on DryShips Inc. (DRYS). The company’s fourth quarter of fiscal 2010 financial results were well below the Zacks Consensus Estimates. The drybulk shipping industry is facing serious challenges, where the vessel rate collapsed even below the rate during the recession. We believe the sole reason for this dismal condition is the sheer increase of ships under operation that resulted in intense price competition.

Due to lack of near-term foresight, most of the vessel operators had ordered large number of newbuild ships in several docks. In 2010, total 210 newbuild ships were delivered and in 2011 another 241 ships are expected to be operational. Glut of ships resulted in severe cut-throat price competition. Major competitors of DryShips are Diana Shipping Inc. (DSX), Genco Shipping & Trading Ltd. (GNK), and Excel Maritime Carriers Ltd. (EXM).

The situation became worse as Korea Line Corp., a major global freight company of South Korea, which hires vessels from shipowners, filed for bankruptcy. DryShips has three drybulk vessels under time charter contract with Korea Line. Estimated loss from these three charter defaults may be around $30 million – $35 million in 2011. Moreover, DryShips will continue face the domino effect of this bankruptcy as other freighters will try to keep their rate low to take advantage of this situation.

The spot rate has fallen to such a low level that even surging commodity prices in the Asian markets failed to offset the loss of the vessel owners. We believe continuation of this pricing trend may significantly jeopardize DryShips’ future financials. The company is highly leveraged with nearly $2.33 billion of net debt at the end of fiscal 2010. We also remain skeptical regarding the long-term growth prospect of the oil tanker market.

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