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We downgrade our recommendation on DryShips Inc. (DRYS - Analyst Report) to Underperform based on current volatile conditions of the shipping industry. The drybulk shipping and oil tanker industry are facing severe challenges as the vessel rate collapsed even below the rate during the recession.

We believe the sole reason for this dismal condition is the sheer increase of vessels under operation that resulted in intense price competition.

Meanwhile, difficulties for DryShips continue with the release of dismal financial results for the third quarter of 2012. Strong performance of the company’s majority-owned deepwater oil drilling unit - Ocean Rig UDW Inc. (ORIG - Snapshot Report) was more than offset by tepid results of DryShips’ drybulk shipping cargo division and oil tanker division.

We believe economic headwinds, a slowdown of the Chinese industrial sector, and fluctuations in oil prices are the major near-term concerns. We do not find any immediate growth catalyst for DryShips.    

Capesize vessels, which are mainly used for drybulk goods, faced the major brunt of this competition. In the spot market, capesize vessel rates fell below the operating costs. In contrast, the capesize vessel rate was a massive $40,000 per day just a couple of years ago when the economy was reeling under recession.

We believe the continuation of the extremely low spot rate may also bring down fixed time charter rates. This may severely impact the overall finances of DryShips.

In the previous quarter, the realized average daily time charter equivalent rate of DryShips in the drybulk segment was a mere $12,727, a stiff reduction of nearly 52.4% year over year. The Oil Tanker segment also follow suite as the realized average daily time charter equivalent rate was down 17.7% to $13,978.

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