TagTeam: Bulk Shippers on the Rebound?

(Editor's Note: Welcome to an ongoing multi-faceted look at sectors, jointly written by Mark Manning and Dave Sterman. Mark and Dave previously applied a tag-team approach to an assessment of the alternative energy space. In this piece, Mark will be looking at the chart action of major indices and stocks in the bulk shippers, while Dave will examine the fundamental dynamics. Mark and Dave encourage your feedback and any suggestions for future industries to analyze.)

David Sterman: Mark, the maritime shipping business is all about supply, demand and pricing. The global slowdown has sharply cut demand and pricing for these big transoceanic ships, even as the industry has put a lot of new ships on the seas over the past few years. Prices have fallen so far that they now cost more to operate than they can garner in rental income.

In response, a lot of shippers are keeping their fleets in drydock. Roughly 150 out of the 800 "Cape"-size ships have been taken out of commission recently. That still hasn't helped boost rental rates.

You can see why some investors remain hopeful of an industry rebound. When times are good, it's a highly profitable business, as rental rates can surge when demand overwhelms supply. For example, DryShips' (DRYS - commentary - Cramer's Take) operating margins surged from 53.8% in the first quarter of 2007 to 73.3% in the first quarter of 2008, which translated into a four-fold jump in quarterly profits. But in the current quarter, analysts predict that DryShips' operating margins will have plunged below 40%.

Mark Manning: David, one of the reasons DryShips' margins are plunging is not just a slowdown in the economy but companies cannot get letters of credit from banks to get the merchandise that they need. If the sellers can't get confirmation that they will get paid, then the goods aren't going to get shipped. I have sources that tell me even food is sitting on the docks rotting because of this problem. That being said, I really like this area for a rebound because I believe this will get resolved, and I look for a continued bull market in commodities, especially agricultural over the next several years.

Even though margins are dropping for DryShips, the company's sales per quarter are still growing at over 100%. I know its earnings are expected to drop 50% from $12.42 a share in 2008 to $6.14 in 2009. But a P/E of 1? Give me a break! That is way too low. Any easing in the credit markets will help get products moving again, and these companies should definitely benefit.

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At time of publication, Manning and Sterman had no positions in the stocks mentioned.