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We reiterate our long-term Neutral recommendation on DryShips Inc. (DRYS - Analyst Report). We believe that DryShips is currently fairly valued as the stock price plummeted 43.2% in the last year.

Why Kept at Neutral?

DryShips declared disappointing financial results for the fourth quarter of 2012, missing the Zacks Consensus Estimates. Solid performance by the company’s majority owned Ocean Rig UDW Inc. (ORIG - Snapshot Report) deepwater oil drilling unit was more than offset by the tepid results of its drybulk shipping cargo division and oil tanker division. We believe that the situation will not improve before mid-2013.

A major problem for DryShips is that a large part of its shipping contracts are currently under the volatile spot rate market. Management declared that two-thirds of the company’s fleet are exposed to the spot market in 2013. Such a huge exposure on the spot market will definitely generate severe top-line fluctuations going forward. The company may not be able to employ its vessels upon the termination of their existing charters at their current charter hire rates. DryShips currently has a Zacks Rank #4 (Sell).  

Risk/Reward Virtually Balanced

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 the reported quarter, the realized average daily time charter equivalent rate of DryShips in the drybulk segment was a mere $10,547, a steep reduction of nearly 58.3% year over year. The Oil Tanker segment also follows suite as the realized average daily time charter equivalent rate was down by 0.2% to $10,062.

Nevertheless, the offshore drilling division continues to flourish buoyed by rising expenditures from oil companies and success in ultra deep water oil field discoveries. The deepwater oil drilling segment is currently witnessing shortages of rigs worldwide, as the energy companies have raised the level of production.  At the end of 2012, Ocean Rig had approximately $5.1 billion of order backlog over the next three years. Furthermore, an expected growth of commodity demand in the emerging markets, especially in China and India may help the drybulk shipping market to recover in 2013.

Other Stocks to Consider

Other stocks to consider in the shipping industry are Kirby Corp. (KEX - Snapshot Report) and Tsakos Energy Navigation Ltd. (TNP - Snapshot Report). Both the companies handily beat the Zacks Consensus Estimates in the most recent quarter. These stocks currently have a Zacks Rank #2 (Buy).

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