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  Diana Shipping

BENJ GALLANDER and BEN STADELMANN

Monday March 9, 2015

Dry bulk shipping has entered turbulent waters. The Baltic Dry Index, which tracks the price of moving goods on the open oceans, fell to 509 in February. It was the lowest point ever recorded, knocking out the 1986 bottom of 632 and the 2008 nadir of 663.

To put these lows into perspective, the index peaked at 11,793 in early 2008 and bounced back to 4,074 in 2011. This industry is cyclical. The 2008 downturn was largely demand driven as economic activity contracted precipitously when credit dried up. The current collapse is quite different as it is largely supply driven. While weaker demand for commodities in Asia is a factor, overall seaborne shipments of dry cargo grew by a solid 5.5 percent in 2013. The simple fact is that too many ships are chasing the same transportation contracts.

There are few barriers to competition so rates are elastic. With operating costs now exceeding market rates, a brutal endgame is underway.

Though the global recovery has been tepid, ship construction has expanded rapidly. Commodity producers such as Vale SA built their own fleets, and private equity firms backed new market entrants. Meanwhile, the rate of ship demolitions did not keep pace with increased capacity. This imbalance is likely to persist as new ships continue to come online. To compound matters, scrap prices have declined, reducing the incentive to take older vessels out of service.

Leverage is also an issue for the sector. Not only do most companies carry enormous debt loads, but some use unrealistic depreciation and amortization schedules and report carrying values of their fleet that do not properly reflect with fair market value. In other words, the debt-equity ratios of many dry bulk shippers are worse than meets the eye.

Although the current outlook is bearish, buying into distressed areas is part of Contra the Heard's modus operandi. One that Ben liked and was added to the vice-president's portfolio in December was Diana Shipping Inc..

While Diana's depreciation and amortization assumptions are conservative, the value of some of its ships on the books is above what could be fetched in the marketplace. This difference between carrying and fair market values isn't an immediate concern as long as management doesn't sell at fire-sale prices.

Encouragingly, its leverage is the lowest in its peer group, cash on hand is high and liquidity is adequate. This balance sheet strength has allowed Diana to expand its fleet at a time when new ship prices are low. In the long run, this should increase market share and benefit shareholders, but it means debt is increasing in the short term. Fortunately, the leverage target discussed in the recent conference call will maintain the balance sheet as one of the cleanest in its sector.

In addition to the fleet of dry bulk carriers, Diana has an equity investment in Diana Containerships Inc., a company it partly spun off in 2010. This provides a welcome balance as the outlook in this area is brighter than for dry bulk. Furthermore, Diana's growing fleet is diversified, relatively new, and largely consists of pairs of identical "sister" ships. These features help the business achieve high utilization rates, flexibility and competitive pricing.

The management team also looks good. They are significant shareholders, and they act like prudent business owners in the way they manage the corporation's portfolio. There isn't any sugar-coating of the problems facing the industry either. They are in for a tough slog and make no bones about saying so. We appreciate this kind of straight talk.

The trend toward gradual trade liberalization and globalization will extend for the foreseeable future. Eventually the supply-demand dynamic will right itself and ship owners will receive a reasonable return on equity.

When such an opportunity is identified, we try to cherry pick an enterprise from the beleaguered candidates. Does Diana Shipping represent the right piece of fruit?

Potential investors should be aware of the risk associated with revenue concentration, high insurance costs and limited shareholder rights associated with its incorporation in the Marshall Islands, a jurisdiction not exactly known for its transparency. This voyage on the high seas is not for the faint of heart.


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