Bulk Up With Big Shipping Profits

Nicholas Vardy

Nicholas Vardy has a unique background that has proven his knack for making money in different markets around the world.

Subprime woes notwithstanding, the Baltic Dry Index — a measure of global shipping rates on 40 shipping routes on a time charter and voyage basis — continues to hit new all-time highs. A key index that covers dry-bulk shipping rates — managed by the Baltic Exchange here in London — jumped 140 points on Friday to close at an all-time high of 8,410. That means — thanks in large part to China’s insatiable demand for bulk raw materials — the world’s shipping industry is firing on all cylinders. And the best way to profit from the trend is this week’s Global Bull Market Alert pick, Greece-based DryShips Inc. (DRYS) — a global shipping company specializing in the transportation of dry-bulk cargoes.

The equation is simple: as long as shipping rates are rising, so will DryShips stock. Analysts are unanimous that there are no near-term hurdles to slow soaring dry-bulk charter rates.

On the demand side, the Chinese economy continues to be the most important factor in determining dry-bulk rates. Unprecedented demand for iron ore and coal, and the consequent port congestion in Asia and Australia — have meant ever increasing spot charter rates for dry-bulk vessels in recent months. As a Bear Stearns analyst recently noted, "we could see a 25-year bull market, with some cyclical downturns."

On the supply side, there is a serious global shortage of actual dry-bulk ships. Skyrocketing shipping rates mean that new ships are being built and existing ships are being converted to bulk carriers. But the imbalance can’t be corrected overnight. Broker Cantor Fitzgerald expects the number of ships being built and put into service to finally begin to normalize demand levels at the start of 2010.

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Until then, the sector should continue to experience record rates across all dry-bulk ships. DryShips’ Panamax and Capesize vessels are likely to receive higher-than-previously-expected average daily rates in the remainder of 2007 and in 2008.

All of this has not been lost on DryShips’ financial results. Two weeks ago, the company announced that it swung to a second-quarter net profit of $110.2 million, or $3.11 a share, from a year-ago net loss of $808,000, or three cents a share. Excluding a gain on the sale of five vessels, the company’s earnings came in at $56.4 million, or $1.59 a share — handily beating analysts expectations of $1.34. Voyage revenue for the three months ended June 30 more than doubled to rise to $112.5 million from $54.5 million. Operating income came in at $67.1 million — more than six times higher than last year. As DryShips’ Chairman and Chief Executive George Economou summarized, "The outlook for 2008 remains positive with fewer vessels being delivered from the shipyards and Chinese demand projected to remain strong."

So let’s buy DryShips Inc. (DRYS) at market today. Cantor Fitzgerald just reiterated its "buy" rating on the stock, raising the target price from $71 to $94. Since this is a volatile play, we’re going to give it some room to move and place our initial stop at $44.25. For those willing to accept heightened risk for a chance at greater returns, you can buy the DryShips Jan 2008 $85 call options (DQRAQ.X).

PORTFOLIO UPDATE

Last week — week 36 — lived up to its reputation as one of the worst trading weeks of the year. September is a usually a tough month, but we should be re-entering the market aggressively during the fourth quarter.

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