DryShips Sailing Against a Downgrade Current

There are few industries more tied to global growth than dry bulk shipping, as these ships are responsible for carrying the materials required in economic expansion.  DryShips (DRYS), a key player in this industry, was downgraded today by Greg Lewis shipping analyst at Credit Suisse (CS) because on near-term uncertainty in its Drillships business, geared towards transporting deepwater drilling rigs.  Obviously, the future of this business is in question as the BP debacle continues to leak crude into the Gulf of Mexico at an alarming rate.  This would not be such a huge headwind if DryShips had not already committed to pursuing growth in this business by investing in 4 new drillships.  Furthermore, the company is still seeking about $1 billion in financing for the rigs currently being built in South Korea, and perhaps more troubling is that the company does not yet have long-term contracts for any of the four drillships.

There is reason to believe that global shipping could continue its improvement after slowing dramatically during the Great Recession.  Recent data on Chinese exports showed resiliency against a perceived slowdown, and even European goods will now become more competitive on the global market as the Euro has declined in value precipitously of late.  Indeed, Lewis estimates the value of that portion of DryShips to be worth about $4 per share, while the stock is currently trading for just $4.05 as of the time of writing.  In total, Lewis has lowered his price target for the firm from $8 to $5, implying he thinks uncertainty in the drillships business has brought its value down to just $1 per share.  DryShips does have operating contracts for its two existing drillships transporting drilling rigs in the Black Sea and the other off the coast of West Africa, and these two vessels are responsible for more than 40% of DRYS revenues in the first quarter.  However, since the Deepwater Horizon rates on such rigs have weakened considerably.

This company is certainly in a difficult position as management has been outspoken about its ambition to expand its deepwater drilling business over the last two years since acquiring its original two rigs.  They had even discussed the possibility of spinning out the drillships division in an IPO, but with the rigs in production still needing financing and contracts that idea is on hold indefinitely.  DryShips has been dealt a significant setback, but the stock has gotten cheap falling nearly 40% since the BP rig exploded.  The best thing for DryShips would be continued global recovery that would have the dual benefit of improving its traditional shipping business, as well as likely enhancing oil companies’ risk appetite for energy exploration.

This is clearly a high risk, high reward business right now due to their aggressive expansion into deepwater drilling.  At Ockham, we have a Fairly Valued rating on DRYS at this time, and interestingly we have a price expectation of just a shade over $5 per share as well, in-line with Credit Suisse’s analyst.  The median Wall Street analyst estimate is still right around $8 per share, but with the amount of uncertainty present we would not be surprised to see further price target cuts and downgrades.  The stock may be pulled down by this type of analyst action, as it was today, but we have to wonder how much worse can the news get for DryShips?  A six month moratorium on new deepwater drilling in the gulf has already been issued, but the rest of the world is unaffected and should oil prices rise global demand for rigs would likely rise as well.  We believe much of the uncertainty has been effectively priced in and any good news on contracts or rising day-rates would be enough to lift the stock.  Based on the fundamentals, we think DryShips may be starting to look attractive to a value investor with a contrarian streak, and we may be inclined to upgrade at Ockham in upcoming weeks.

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Ockham Research is an independent equity research provider based in Atlanta, Georgia. Security analysis at Ockham Research is based upon the principle known as Ockham's Razor, named for the 14th- century Franciscan friar, William of Ockham. The principle states that a useful theory should utilize as few elements as possible, because efficiency is valuable. In this spirit, our goal is to make the investing environment as simple and understandable as possible, yet no simpler than is necessary.

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