Tuesday, December 14, 2010

Dividend Dud

A year ago as the U.S. equity market appeared to crumble around our ears I recommended investors rotate to dividend paying stocks. The strategy was based on the view that U.S. stocks would continue to be volatile to the downside as the financial markets sorted out the unprecedented mortgage securitization debacle. A dividend yield would pay investors for waiting out the storm. That part of the investment thesis was sound and all but one of our dividend yield plays proved out.

Only one turned out to be a dividend dud. Just two weeks after I recommended DryShips, Inc. (DRYS: Nasdaq) the company suspended its entire dividend. (See the post Dividend Love on January 6, 2010). Management cited uncertainty in future international trading activities that were the primary driver for DryShips ocean-going container ships.

I had been careful to consider the impact of a protracted slump in revenue and earnings and determined that cash resources available at the time would be adequate to support operations as well as payment of at least part if not all of the dividend.

What was missing from the picture at the time was extent of management’s interest the market for deep water oil drilling. Of course, this was ahead of BP’s oil rig disaster in the Gulf of Mexico. At the time deep off-shore oil drilling was still considered fashionable. DryShips cash resources were diverted from its shipping operations and dividend to investment in ultra deepwater oil drilling. In 2008, DryShips had acquired a Norwegian off-shore drilling company, Ocean Rig, and was planning a major expansion of its ultra-deep water capabilities.

It is no use crying over spilled milk, yet anyone who made the trade has not been on a pleasure cruise. DryShips shares were trading in the low teens at the time of my recommendation and within two months had fallen to a 52-week low of $2.99. The stock has since recovered largely on the slow economic recovery. There is also discussion that DryShips is selling an equity stake in Ocean Rig to raise money for expansion.

DryShips has managed to make good with its off-shore drilling enterprise with a total of five rigs that are seeing increasing utilization in recent months. Rates for deepwater oil drilling appear to have bottomed in Fall 2010 and are now trending upwards. The phone has been ringing at Ocean Rig and we expect risings sales and earnings. In 2008, DryShips took a draconian $700.5 million write-off of goodwill generated by the Ocean Rig so incremental profits should drive the bottom line.

Despite improving prospects, do not expect a resumption of the dividend anytime soon. This management team has got a taste for capital resources and is not likely to let even a few pennies go to shareholders until its zest for oil drill rigs has been sated. That said, investors who held DRYS for better days, may get a chance to exit without a loss if fundamentals hold up in 2011.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.

1 comment:

Anonymous said...

Management has no interest in shareholders or share price. Maybe, (big maybe), that will be good for the price in the long term.