PSB Monthly Issue November 2012

| November 1, 2012

November 2012


It’s not every day you see the collapse of a major industry.  But it’s even rarer to have the opportunity to buy what was once a $100 stock, for under $3!

That’s what we have here – a once in a lifetime opportunity, to buy a major industry player for less than $3. Let me explain…

The shipping industry has been through a mountain of change.  I’m talking massive overhaul.  We’ve seen a number of players enter and exit over the past decade.  But nothing was quite like what we witnessed in 2008.

You see, in June of 2008, spot shipping rates for capsize bulkers, the largest bulk carrier, hit an all-time high.  According to Clarksons Shipping Intelligence Network,rates for these ships reached a massive $219,000 per day.

But just three months later, Lehman Brothers collapsed.

That, as you well know, sent the global economy into a deep recession.  Every industry, not just financials and real estate, was affected.

Ever since then, shipping rates have done nothing but fall.  To get a better understanding of how much rates have fallen, simply take a look at the Baltic Dry Index.

If you’re not aware, the Baltic Dry Index tracks the spot rates of major shipping routes across globe.

Here’s the 6-year chart below…


As you can see, rates spiked in early 2008… only to come crashing down to the sub $1,000 level in the very same year.  Since then, shipping rates have attempted to recover – only to continue their struggle to move out of the basement.

Why has that been the case?

It’s simply a matter of supply and demand.  If you think about the long-life cycle that ship builders have, up to five years, you can easily see how an oversupply of available ships continues occuring.

When shipping rates were growing by double digits back in 2006 and 2007, many shipping companies put in orders to expand their fleet.  Thinking in those terms, you can also deduce how shipping rates collapsed.  The combination of a major economic recession and an oversupply of shipping capacity caused rates to simply plummet.

It has become so bad for shippers that many simply could not afford to transport cargo at these low rates.  You see, rates are now so low that shippers continue to operate at a loss.  It costs them money to ship other company’s goods!

The good news is shipping rate look to have bottomed and are finally turning higher…

As a matter of fact, the Baltic Dry Index re-tested support at $650 late in September. See the support line (blue) in the chart below…


As the chart shows, shipping rates have put in a triple bottom.  What’s more, rates have quickly moved back over $1000 in short order.

Now, after shippers have spent years running at a loss, it looks as if shipping rates may finally be on the rise again… enabling them to turn back toward profitability.

And we’ve found a company set to capitalize on this changing trend…

Introducing DryShips (NASDAQ: DRYS)…

Key Investment Data

Name:  DryShips
Ticker Symbol:  DRYS
Market Cap:  $977 million
Recent Price:  $2.28

PSB Rating System 4.7 Stars

Raging Revenue:  (4.9 stars) Revenue jumped in the first 2 quarters of 2012 by more than 35%. And next year, revenue is slated to jump to $1.5 billion from the estimated $1.2 for 2012!

Beautiful Books:  (4.5 stars) While DRYS has a debt to equity ratio larger than we’d like, their quick and current ratios are both strong enough to carry them through to more robust quarters.

Stellar Structure:  (4.7 stars) Institutional ownership is fair at 21.2%.  But combined with insider ownership at 13.33%, more than a third of shares are accounted for. Expect the percentage of institutional ownership to rise as shipping rates recover.

Valuation Verification:  (4.8 stars) The price to book ratio for DRYS is fractional at 0.32x.  You can bet this won’t last long once investors figure out the hidden value of the company’s ORIG stake.

Meaningful Milestones:  (4.8 stars) Ocean Rig signed agreements with 3 major oil players for 3 drill ships, adding an additional backlog of $2.2 billion over 3 years.


DryShips is a Greek shipping company that has global operations worldwide.  DRYS specializes in the transportation of drybulk cargo, but also has a fleet of tankers as well.

The company owns a fleet of 46 drybulk carriers and 12 tankers.  Of the drybulk carriers, the fleet consists of:

  • 5 VLOC (very large ore carrier)
  • 11 Capesize
  • 28 Panamax
  • 2 Supramax

The breakdown on the 12 tankers in DRYS fleet is as follows:

  • 6 Suezmax
  • 6 Aframax

The combined deadweight tonnage for drybulk is a massive 5.1 million tons, while the deadweight tonnage for the tankers comes in at an impressive 1.6 million tons.

This capacity makes DRYS one of the largest shipping companies on the planet.

In addition, DryShips holds a 65% ownership stake in Ocean Rig (ORIG).  ORIG is an offshore drilling business running 9 deepwater drilling units.  Of these, two are ultra deepwater semi-submersible drilling rigs.  The other 7 are ultra deepwater drill ships… 3 of which are set to be delivered to the company in 2013.

Interestingly, ORIG has turned out to be the saving grace for DRYS… which otherwise would have suffered to manage their cash flow and capital expenditures.

As I’ve said above, DRYS is one of the largest shipping companies around.  And as such, the company has a number of new vessels on order through 2014.  That’s where a good portion of their capital expenses are going – to pay for new ships.

Thankfully, DryShips’ stake in Ocean Rig offers the company far more flexibility than many of their competitors.  Most of their competitors are chewing through cash flow as additional new ships come online every quarter.

What’s more, DRYS is managing their shipping business cash flow needs in two ways.

First, the company is scrapping older vessels as new ships come online.  You see, the added capacity is just not needed right now.  Unfortunately on the shipping side, charter coverage is looking like it will fall from 44% for the rest of 2012, to just 32% in 2013.

So the cash generated from scrapping is helping offset the cost of new ships.

Second, DRYS is generating strong revenue from drilling contracts at ORIG.  In fact, over $2.2 billion in potential revenue has been contract over the next three years at Ocean Rig.  As a matter of fact, DryShips stake in ORIG now generates far more revenue than shipping!

That’s right – less than 27% of DRYS income for the first six months of 2012 came from shipping.  And with higher lease rates for drilling rigs in 2013 and beyond, the percentage of income from drilling will rise… that is until shipping rates increase significantly.

Again, the plus side here is all about shipping rates.  If the industry sees rates continue to climb higher, shipping income will rise- even with less of the fleet being chartered.  And with a number of monetary stimulus programs, like QE3, set to cause economic growth… the odds are strong we’ll see a turnaround happen in 2013!

In the dismal shipping industry, that’s what makes DRYS a safer bet than the rest. The company is positioned with dirt cheap assets in shipping, while generating huge revenue through drilling.

Here’s the take away…

ORIG will continue to bring revenues up while the shipping industry recovers.  And once shipping rates rise, we can expect to see DryShips stock really take off!

Now that you know more about DRYS business, let’s take a look at the numbers…


For the first six months of 2012, revenue grew from $431.4 million in 2011, to over $583.6 million.  That’s a pop of more than 35%!  What’s important to note is the change in where revenue is coming from.

In 2011, shipping revenue was $195.4 million and drilling contract revenue was $235.9 million.  This year, the variance is wider.  For the first two quarters of 2012, shipping revenue fell to just $157.1 million, while drilling revenue jumped to $426.5 million!

For the six months ending June 2012, DRYS operating income grew to $68.2 million from $8.8 million in the same period of 2011.  Obviously, the added revenue from drilling is helping out DryShips in a big way.

Jumping all the way to the bottom line…

DRYS posted a loss of $65.6 million for the first 2 quarters this year.  That’s better than 2011’s $88.3 million loss for the same period.  What that tells us is the cost of financing their debt is pretty steep.  In fact, that’s without question the weakest piece of the DryShips puzzle.

As of June 30th, the company had a total of $904 million in current liabilities… and just $776 in current assets.  Even as bad as this looks, the entire industry has been battered over the past five years.  What’s more, DRYS is actually better positioned than most of their peers when it comes to debt.

While the shipping industry average debt to equity ratio is 1.6x, DryShips comes in at just 1.3x.  That’s not something to write home about, but given the competition, DRYS is the best of the bunch.


As with any investment, DRYS does have a few risks.

DryShips operates in a competitive industry.  As such, competition can gain market share in an already challenging shipping market.

Also, a significant drop in shipping rates could trigger covenants in the company’s debt.  This could lead to penalties or other negative changes in the nature of these agreements.

Finally, even as we’re expecting global growth to pick up from these levels, a slowdown in expansion… or a recession– could lower the demand for shipping capacity.


Even with the recent rebound in the stock price, shares of DryShips are undervalued. For starters, their price to book ratio is just 0.32x.  That means if you buy shares of DRYS now, you’re getting them for less than what the company is worth if it were sold off in pieces.  As a comparison, the average S&P 500 stock has a price to book ratio of 2.2x.

Even if shares of DRYS were to trade up to a 1.0x price to book ratio, we could see a gain of 212%.

Now, keep in mind that DRYS has a $1.3 billion share of ORIG’s $2.1 billion market cap. And DryShips own market cap is just $979 million.  Once the market catches on, that’s not going to last much longer.  Either way, we can argue we’re almost getting DRYS assets for free!

Between the low price to book ratio, the lack of ORIG ownership showing up in DRYS share price, and the start of a rebound in shipping rates, we can see shares of DryShips taking off in the very near future.

Based on our analysis, we see DRYS trading up over $4.80 a share.  Buy this shipping company now for potential gains of 212% or more!


BUY DryShips (NASDAQ: DRYS) up to $2.50 per share.

Recent price is $2.26.

Use a stop-loss of $1.80 on this position.

Don’t forget your position sizing and stop-loss rules.



I love getting two for the price of one.  Even when I know I’m paying too much for the one I’m buying – it still feels like a deal.  But what’s even better is when I find something that’s a real steal to begin with.

It’s like I’m getting something for free…

Well, I’ve found a company that gives us just that, a two for one deal.  Right now, we are looking at two sectors that are completely beaten down and many consider well oversold.

First, coal stocks have taken a beating.  As you know, the demand for coal depends on the demand for steel production, energy, cement manufacturing, and as liquid fuel.  Just so you know, there are two different kinds of coal, and they’re used in two different ways.  Steam coal is primarily used in power plants, while coking coal is mainly used in steel production.

Over the past year, the demand for both types of coal has fallen.  For starters, steam coal took a hit as natural gas prices plummeted to record lows.  This prompted a number of power plants to convert to natural gas to produce energy, leaving coal for dead.

Next, coking coal prices have crashed with the decline in global growth.  Most of this has been a direct result of the economic contraction we’ve seen in China over the past two years.  Of course the country is still growing at a very high rate, but it’s fallen well off the pace that drove the demand for coal in the first place.

What’s more, there are a number of reports that stock piles of both coal and steel exist in China right now.  That may sound worrisome, but understand that many of the “rumors” out of China are just that… rumors.

The second part of our two for one deal comes directly from China.  Chinese stocks are trading near multi-year lows.  Simply look at the chart of the Shanghai Stock Index to see how badly they’ve performed…


Clearly, Chinese stocks are trading much lower than they should.  Some of the reasons are directly related to the Chinese economy and their currency, the Yuan.  But a good portion of this drop has to do with accounting “irregularities” that have plagued many Chinese companies.

While Chinese stocks look like a super buy right now, trusting the books at many of these companies is an issue for understandably skeptical investors.

Well, we’ve got a great solution to that problem…

What’s more, we’ve found a US-based company that’s fully integrated China’s coal market right now.  So not only do we get access to a coal company, but we have the safety of a US-based company doing business in China, that’s complying with SEC accounting regulations.

Introducing L&L Energy (NASDAQ: LLEN).

Key Investment Data

Name:  L&L Energy
Ticker Symbol:  LLEN
Market Cap:  $81.7 million
Recent Price:  $2.13

PSB Rating System 4.9 Stars

Raging Revenue:  (4.8 stars) LLEN posted year over year revenue growth of 26% in their latest quarter… and double digit growth from last quarter.  That’s exactly what we see continuing with L&L.

Beautiful Books:  (4.8 stars) With a very low long-term debt to equity ratio, and a current ratio of 1.4x, its smooth sailing for LLEN.

Stellar Structure:  (4.9 stars) We’d like to see more institutional ownership, with levels at just 4.3%. What’s more, insiders own a mere 1.25%.  As revenues and earnings continue to rise, you can bet the big names will be piling into this forgotten sector.

Valuation Verification:  (5.0 stars) Every measure shows LLEN shares are well undervalued by the market… P/E, price to sales, price to book, and even price to free cash flow. This won’t last long once the market catches on.

Meaningful Milestones:  (5.0 stars) LLEN is set to acquire two new mines in the next 30 days. These are newly developed mines with lots of long-term potential.  In addition, L&L signed a new coal sales agreement with Datang Power for 360,000 tons of coal.


Founded in 1995, L&L Energy produces, processes, and sells coal in China.  LLEN is made up of coal mines, clean coal washing facilities, coking plants, and coal wholesale operations.  In addition, LLEN has an interest in the Bowie mine… a thermal coal mine located in Panola, CO.

The company mainly operates in the Yunnan and Guizhou provinces of Southwest China. As of July 31st, the company operates the following Chinese subsidiaries:

    • Kunming Biaoyu Industrial Boiler– Owns coal wholesale operations and is the headquarters for the company in China.


    • L&L Coal Partners– Owns two coal mining operations, the DaPuAn Mine and the SuTsong Mine.  Also, this entity operates the DaPuAn Mine’s coal washing facility.


    • L&L Yunnan Tianneng Industry– owns ZoneLin Coal Coking Factory.


    • Yunnan L&L Tai Fung Energy– Owns SeZone County Hong Xing Coal Washing Factory.  In addition, they operate a coal wholesale and distribution operation.


    • Da Ping Coal Mine– This mine was acquired in 2011 and is expected to produce 15 million tons of coal in the next 26 years.


    • Wei She Coal Mine– In February of 2012, LLEN purchased a 51% ownership stake in this mine from Guizhou Union Energy.


    • DaXing L&L Coal– A new coal wholesale operation established by L&L.  With Chinese government approval, is developing additional coal storage space and building out a distribution network.  The company currently has two joint sales agreements with regional strategic partners.


    • Guizhou LiWei Coal– Established in 2011 to enhance communications between L&L and the local Guizhou Province mines.


In addition to these subsidiaries, L&L Energy announced on October 22nd they’d be finalizing the acquisition of two new mines in the next 30 days.  LLEN will then own theLuoZhou Mine and the LaShu Mine.  These are both newly constructed mines in the HeZhang county of Guizhou Province.  The two mines combined are estimated to hold 34.2 million tons of low sulfur anthracite coal.

As you can clearly see, L&L Energy has a well structured business model using subsidiaries that are involved in virtually all aspects of the coal mining and production business.  The big question is, how do the numbers look?  Let’s find out…


In their most recent quarter, LLEN saw quarterly revenues jump by 26% year-over-year from $36.1 million to $45.3 million.  In addition, wholesale revenues increased a massive 174% to $12.2 million in the most recent quarter.  What’s more, wholesale revenue jumped by roughly 94% from just last quarter.

I’d say there’s no question L&L knows how to grow the top line!

While LLEN has revenues gaining traction, net income is what really stands out.  In their most recent quarter, L&L had net income surge by 159% from the same quarter last year up to $6.2 million.  This also represents an increase of 48% from last quarter’s $4.2 million!

That’s pretty impressive growth of both revenue and income… exactly what we like to see in our investments.

With sales and income well in line with what we’re looking for, LLEN’s books stack up just as nicely.  In fact, LLEN has operating cash flow of $23.5 million, with just $2.7 million in long-term debt.  And with a current ratio of 1.39x, L&L doesn’t have a problem turning over inventory… an issue for some commodity companies.

Now, keep in mind LLEN has a market cap of just $81.67 million.  With sales over $152 million a year, we’re looking at a price to sales ratio of 0.54x.  Investors are getting a steal right now for the revenue this company generates!

We’ll get more into valuation in just a bit, but first let’s discuss the risks associated with L&L Energy…


While most of L&L Energy’s top management is well entrenched in China, political uncertainty poses potential regulatory issues.  A final roster of officials will be released this month, and its impact on the current local regimes is unknown.

As with any mining operation, delays and increased expenses and/or labor issues could cause a decrease in revenues or income.  This can also impact market share if existing customers leave L&L.

Finally, the price of coal could have a negative impact on revenues and margins at L&L.  While recently prices have shown strength, changes in global growth rates could potentially force coal prices back to recent lows.


Right now, shares of LLEN are overwhelmingly mispriced by the market.  Currently, share are trading at just $2.13.  As of July 31st, L&L had a tangible book value of $4.78.

Some quick math tells us the price to book ratio is 0.45x.  That means, if LLEN were sold off in pieces, share holders could get more than double what they paid for the shares right now!

And, if we value the shares at 100% book value, the P/E ratio would rise from a mere 3.71x to 8.31x.  At $4.78, LLEN would be trading at 8.3x earnings… and exactly for its tangible book value.

What’s really interesting is the industry P/E ratio is 14.4x (in fact, most S&P 500 stocks also have a similar P/E ratio right now).  So if shares were to trade in line with the industry P/E and at tangible book value, we could see a share price of $8.26… giving us a gain of 387.8%!

Given the current revenue growth happening at LLEN and the ongoing recovery of both coal prices and the Chinese economy… even this valuation could be low.

Remember, at $8.26, shares of L&L would only be trading in line with book value and industry P/E… that’s not a stretch to say the least.

Based on our analysis, we could see shares trade near $9.00 once properly valued.That would give us a gain of more than 421%.  Buy shares of LLEN for gains of 421% or more!


BUY L&L Energy (NASDAQ: LLEN) up to $2.55 per share.

Recent price is $2.13.

Use a stop-loss of $1.50 on this position.

Don’t forget your position sizing and stop-loss rules.


Portfolio Update

With seven stocks down and thirteen stocks up in our portfolio right now, we’re showing a solid profit overall.  Consider this, our worst three stocks are down by 12%, 13%, and 14%… that’s really not too bad for penny stocks.

More importantly, our top three performers easily make up for them with gains of 29%, 41%, and a massive 112%!

So who’s the big triple-digit winner?  None other than Carriage Services (CSV) of course.  You see, CSV has consistantly peformed both fundamentally and technically. And with their latest round of earnings just released after the close of business today, this stock is poised to move even higher.

CSV posted a record $49.5 million in revenue for the past quarter, up 14%… and aneven more impressive EPS growth of 60% giving them another record of $0.16 per share.  And get this – it was in their weakest quarter traditionally!  Since we blew through our price target, and things still look up – I’m moving the price target to $15!  Hold on tight to those shares…

Other stocks hitting new highs for us include Culp (CFI) at $12.70, and Aceto (ACET) at $10.05 – both of which occurred just yesterday.  That’s good news given the recent pullback in the markets, so let’s keep holding both CFI and ACET.

Speaking of the recent pullback…

It appears the selloff in the overall markets may have been overdone.  Economic data continues to improve on a global basis, indicating stocks should continue to head higher.  The damage from earnings season seems to be over with for now, and focus will move to Q4 earnings and the continuing stream of economic data.

The wild card, however, will be the damage caused by Hurricane Sandy.  How the markets interpret the losses (estimated near $50 billion) is anyone’s guess… it could go either way.

Category: PSB Monthly Issues

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