When I’m looking at the shipping companies, I have four important factors (you could call them business decisions) that make a big difference in how the stocks will trade.  Let me list them for you and then we will break them out just a bit.

1. Capital Funding – Does the company use debt, equity, or internal cash to bankroll its growth?
2. Customer Contracts – What type of long-term or short-term agreements are in place for each ship owned?
3. Dividends – What are the quarterly payments?  Is this a fixed dividend or does it fluctuate from quarter to quarter?
4. Vessel Type – Does the company own mega freighters? Nimble smaller ships? In-between, or an assortment?

Capital Funding

Now I could bore you to tears with a discussion of debt ratios and funding strategies, but the only thing you really need to know is “how do they pay for their ships?”

For instance, Diana Shipping Inc. (DSX) has committed to shareholders to keep a low debt level.  So while it may draw on a line of credit to initially purchase a new (or used) ship, historically it has very quickly paid down that debt by issuing new shares to the public and using the proceeds to retire debt.

Now this type of strategy periodically dilutes shareholders.  So if you owned 10% of the company and they 1) bought a new ship and 2) sold stock to pay for it, you might now only own 8% of the company.  But it’s a bigger company now that they have another ship so shareholders still do well.

On the other side of the spectrum we have Genco Shipping & Trading Limited (GNK).  The company has huge levels of debt because it has decided not to dilute shareholders by selling additional stock.  Instead, when Genco purchases a new ship it takes out a loan, and then uses the cash flow from that ship to service that debt.

Genco’s approach is much more aggressive, and in a thriving economy that makes a lot of sense.  Genco could enjoy a very attractive revenue stream and after paying the interest on the debt, there was still a large amount of income left over.  But on a percentage basis, this stock has dropped more than some of its peers this summer.  The high debt level increases the risk because if the ships are not able to produce as much income, the huge debt level becomes a problem.

So in this particular environment, a conservative approach (low amounts of debt) have served shippers well.  But if and when we make the turn and shipping rates rebound, then the more leveraged plays will turn out to be the winners again

Customer Contracts

Moving on to the second metric, shippers must decide whether to lock in long-term contracts with their customers, or to take the going rate on a day-by-day basis.  This is sort of like choosing a variable rate savings account or a fixed CD.  If rates go higher, then you will make more money with a variable rate.  But when rates drop as they have with the dry bulk day rates, then it looks much smarter to be holding a fixed rate contract.

There is a particular company that I have been watching closely which has decided against entering into long-term contracts with customers.  It may sound like a stupid decision today with rates at all time lows, but back in October of 2007 and again in May of this year, the stock was a huge winner.  Similar to a gold mining company that doesn’t hedge its production, this stock rises and falls with the prices of shipping rates.

In the publication Death Cross Trader we are looking closely at this company and will likely take a position in the near future.  Even though the stock has been beaten down more than its peers over the last six months, business decisions have put the company in a unique situation that leverages any improvement we see when demand for shipping goods picks back up

Dividends

Imagine picking up a stock that will pay you back your full purchase price every two years.  On top of that, you get to keep the stock which could grow by 30, 50, 100% or much more in the next 12 months.

Just a cursory overview of the stocks in the shipping industry will reveal a couple of names with dividend yields of 50% or more.  If you are willing to take a dividend yield of 35% or more, you have at least a half dozen shipping stocks to choose from.  Now not all of these opportunities will pay off and each of these companies have their own unique set of circumstances.

Many shipping companies have a dividend policy that requires them to pay out a portion of each quarters earnings in the form of a dividend.  I’ve had professors debate the merits of this strategy, and Warren Buffet is notorious for his commitment to NOT paying a dividend.  But we will put all the academics aside for right now and look at the situation from your perspective – the perspective of the investor.

If you own a stock that is paying you a quarterly dividend, you are likely to be a more loyal shareholder.  Sure, you hate to see stocks that you own decline – no one likes that.  But if you are getting paid a nice sum while you wait for the stock to come back around, you are likely to be a little more comfortable.

Many of the shipping stocks that pay a dividend are trading at levels so low, that the dividend is huge compared to the price of the stock.  For kicks and giggles, pull up the following tickers on google finance:  ESEA, DSX, GNK, EXM, EGLE…  You will see that all of these (and more that I haven’t mentioned) pay huge dividends relative to the stock price.

Now before you go buying a bunch of these names, let me tell you there is a REASON that these stocks are so low.  There is a significant amount of fear that these companies will either cut the dividends or go out of business altogether.  So you should certainly do your homework before jumping into any investment, but I can tell you there are some attractive bargains out there.

Vessel Type

The last issue I will point out is a company’s decision as to what type of vessel it will purchase.  While larger ships are typically more efficient per dead weight ton of cargo, smaller ships offer the flexibility of being able to navigate particular passageways and ports.  Some smaller ships also feature their own cranes for loading and unloading cargo.  This is an important feature if the vessel will be accessing remote ports with less equipment.

Eagle Bulk Shipping Inc. (EGLE) has made the decision to concentrate on smaller ships.  While I have issues with other decisions that the managers have made, the decision to stick with a fleet of more flexible vessels has probably kept the company afloat (pardon the pun).  While larger ships are struggling to find customers that can fill the mammoth holds, Eagle is able to take an assortment of smaller commissions and still manage a profit.

Age is another important factor which plays into the mix.  Cargo ships (much like airliners) often have a useful life of 20 years or more before they require expensive refurbishing or are turned to scrap.  With the current global fleet becoming much older as an average, companies are trying to stretch out the service life of each vehicle.

One particular stock that I am watching has made the decision to purchase old decrepit ships from its competition.  Management wagers that they will be able to use their expertise to keep the ship in service longer than peers would be able to – thus creating more value out of an older ship than the seller would have gotten.

One key assumption going into this argument was the price of steel.  Once a ship is no longer efficient to operate, the only option may be to sell it to the scrap-yard which pays based on the value of the metal.  However, now that scrap prices are so low, this stock has been hurt from all sides.  The stock has been driven down to such a level that we are paying pennies on the dollar just for the ships.  The nice thing about owning this company is that a pickup in either the price of steel – or in the shipping rates, would have a dramatically positive effect on the value of this company.  Its nice to have the potential for more than one catalyst to propel the stock.

So in conclusion, there is quite a bit of opportunity in the shipping sector if you know where to look for it.  Low debt levels, long-term contracts and high dividends usually lead to a more stable stock.  But in this topsy turvey market, we might actually find more opportunity by looking on the opposite side of this metric in the coming months.  I will be sure to keep you updated both in ZachStocks discussions as well as through my writing for Taipan and Death Cross Trader.