This is the second installment in today's two-part series on Diana Shipping. Click here to read Part One.

Diana Shipping ( DSX - Get Report) president Anastassis "Stacey" Margaronis conducted a series of sit-downs in New York during last week's shipping-industry conference. Meeting one-on-one with some 25 institutional investors, he gave them all the same lecture, he said, in an effort to explain Diana's bearishness. (It was almost an anti-sales pitch, except it wasn't; with such candor, the company most likely hopes to win over investors.)

The problem, Margaronis said, is that many people have interpreted the collapse late last year, when shipping rates plunged by some 90% from their all-time highs in May 2008, as the bottom of the natural shipping cycle, which ebbs and flows based on supply and demand -- on dynamics, in other words, internal to the dry bulk industry.

It's an old and familiar story: When demand for shipping is high, ship owners strive to take advantage by ordering whole fleets of "newbuildings," as they say in the industry. But after the Champagne bottles are smashed over all those bowsprits, and the new boats slide into service, a glut forms, crashing shipping rates and the value of the freighters themselves. This is the natural shipping cycle, helped along, of course, by the expansion and retraction of the world economy as a whole.
The Diana Armada

But, according to Diana, last year's collapse in rates resulted from a set of vicious extraneous factors: namely, the most severe credit crunch since the Great Depression. Banks refused to issue credit not only to shippers but the traders who are instrumental in paying for the transport of raw materials between producer and manufacturer. In the case of dry bulk, that mainly means iron ore from Australia and Brazil on its way to the steel foundries of China. (To a large degree the dry-bulk hauling business depends, like modern commerce itself, increasingly, on China.)

The surprise jump in rates in the spring, as measured by the Baltic Dry Index, developed because the Chinese were stockpiling cheap commodities, Diana and many others have argued. This perhaps artificial boost in demand added to the sense that business had in fact plummeted to its bottom before marching straight back up into a nascent recovery.

But if this were a true trough, "It would be the first V-shaped recession in shipping in living memory," Margaronis said at the St. Regis Hotel. "Now, over the next three quarters we will have to cope with the effects of the shipping cycle, per se. The real shipping cycle."

As evidence, he pointed to data from Clarksons, the British ship brokerage. The figures indicated that even if the world's economies recover later this year and into next, the sheer number of new vessels being constructed in shipyards, and slated to come into service in 2010, would create such a surplus of tonnage as to overwhelm even the rosiest predictions for rebounding demand.

Given its bearish outlook, Diana has fallen back onto its core philosophy of carefully considered fleet expansion. Even during the boom years, the company steered clear of leveraging up in order to acquire more ships. Diana went public in 2005 at $17 and, despite some rough going in its first 12 months or so as a public company, used a series of secondary offerings since then to increase its fleet size from nine ships to its current 19. (It also has two ships on order, both of which are due for delivery in the glut year of 2010.)

By contrast, competitors took on massive debt to buy whole armadas. Eagle Bulk ( EGLE - Get Report), for instance, bought 26 middle size carriers in 2007 for $1.1 billion, while Genco Shipping & Trading ( G6S) paid the same amount at the same time (nearly the peak of the market) for nine enormous Capesize vessels -- boats so big that canal locks can't handle them; they must instead round the perilous African and South American capes.

When the market crashed, many shippers that went on such buying sprees saw the value of their assets -- like subprime borrowers in the housing boom and bust -- fall below what they'd paid for them. Loan covenants were breached like boats on a shoal.

Not so Diana. The company has not bought a ship since October 2007, when it paid $135 million for a Capesize. As of late June, Margaronis said, the company's "net debt level is virtually zero," with about $220 million in cash on its balance sheet against $20 million in long-term debt. Long-term debt-to-equity ratios for DryShips ( DRYS) and Eagle, on the other hand, are about 1.72 and 1.66, respectively. The industry standard has been leverage of five times EBITDA.

Still, Diana has been counting its chips in preparation for an eventual wager, if a cautious one. "Toward the end of the year, we intend to start buying ships," Margaronis said. He gave no hard and fast targets, but the "acquisition program," as he called it, will be strung out over 18 months and completed by the middle of 2011 "at the latest." By the program's end, Margaronis said, Diana will have doubled the size of its fleet. But, he added, qualifying carefully, "That's a possibility, not a target."

A few ships will likely come from secondhand purchases, but the company will obtain the majority by picking up orders for newbuildings originally placed by shippers who can no longer afford them, or no longer care to.

Diana will finance its future purchases using cash and, at least at first, by borrowing 50% of the price of each unit, "assuming banks are willing to do so." If the market does turn around, the company will ratchet the leverage to 60% and, if the market really turns around, it will not borrow anything, instead issuing stock to finance the purchases, as it did during the boom period.

The Diana fleet today consists of 13 smaller Panamax ships (those that do fit into the locks) and six of the prized Capesize class. Margaronis notes that, compared to its competitors' fleets, "we are amongst the smallest. But by market cap, we're amongst the largest. So it shows the effect of the policy." With its market value of about $1 billion, based on Tuesday's stock price, Diana lies only behind DryShips, which operates 40 carriers and is worth $1.5 billion.

Diana's expansion strategy is fairly simple: By spreading the purchases out over such a long period, steadily increasing the rate of acquisition as time moves on, Diana hopes to straddle the trough with its series of acquisitions, readying itself to exploit a global economic recovery and an eventual upswing in the natural shipping cycle.

To be sure, Diana's conservatism -- it's fundamental prudence in waiting to go all-in until a recovery has made itself clear for all to see -- has given rise to criticism, for the simple fact that, should the market go gangbusters, the company won't participate in a turnaround as lucratively as its more aggressively levered competitors.

But that doesn't seem to bother Margaronis. "A company like Diana is not going to suffer if we are wrong in our prediction about the downside. We're just going to make less than we would have otherwise. Of course, you could tell me that we're going to make significantly less. Yes, but nobody's going to worry about the company's survival."

And then, anticipating the counterargument once again, Margaronis addressed the notion that investors might grow frustrated, during an upturn, by all this caution. "Yes," he said, "they could lose interest in the stock -- because they would consider it, possibly, management being boringly conservative."

The above is the second installment in a two-part series on Diana Shipping. Click here to read Part One.

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