Rising demand before the Great Recession led the shipping sector to overbuild. Now, a falloff in business has created a glut of vessels, and rates have predictably plunged. Unfortunately, there is little hope for the short term, as more stormy years await the shipping sector. Which companies should Foolish investors expect to stay afloat and return freighter-sized, long-term gains after the industry recovers -- if it ever does?

Ship Finance International , which owns and charters vessels and drilling rigs, just beat analyst expectations for earnings per share, or EPS, for the third quarter. Formerly a unit of tanker company Frontline , Ship Finance International has performed well compared to rivals in the shipping sector. While it's trading barely above its initial public offering price from 2004, many other stocks in the shipping sector have sunk underwater, or remain barely afloat in the low single digits.

Through chartering ships, Ship Finance has managed to avoid much of the carnage ravaged upon others such as Frontline. Chartering gives Ship Finance much more flexibility in pricing to respond to changes in the market. It also lets the company offload the operation expenses and risks on the client; if business falls, the client still has to pay the charter fee. As the chart below shows, Ship Finance International stock has risen during the Great Recession, while Frontline has sunk below its former price in that same time.


SFL Chart

SFL data by YCharts

Frontline is hardly the only shipping group stock to be treading water furiously at low levels, however. DryShips , Nordic American Tankers , and Teekay Tankers are all off greatly from pre-recession prices, as revealed by the following chart. Don't expect improvements for DryShips anytime soon; it just reported disappointing earnings, prompting speculation that it will be the next shipper to sink into "Davey Jones' locker."

NAT Chart

NAT data by YCharts

To survive the next few years, these companies will have to generate high EPS growth with low debt burdens. But according to the table below, EPS growth for this year won't salvage any of these stocks. That makes each of these companies' cash positions even more critical, particularly for those with such heavy debt loads as Frontline, Ship Finance, Teekay Tankers, and Dryships.

Metric

Ship Finance International

Frontline

DryShips

Nordic American Tankers

Teekay Tankers

Industry Average

5-Year EPS Growth Rate

(5.95%)

n/a

n/a

n/a

n/a

(39.26%)

EPS Growth Rate Year

(20.91%)

(428.85%)

(134.46%)

(8720.83%)

(140.58%)

 

Projected EPS Growth Rate Next Year

(22.63%)

70.40%

44.40%

19.40%

0.00%

 

Debt-to-Equity Ratio

2.09

10.70

1.11

0.29

1.11

1.39

Sources: Motley Fool CAPS and FINVIZ

Earnings are horrible
To see which companies have the cash they need to survive, we need to look at three critical components: cash flow, cash on hand, and the interest coverage ratio. The cash flow is important to see how well the company converts its earnings into the funds needed to operate the enterprise. With so much debt and falling EPS growth, plenty of cash on hand is crucial. Also critical is the interest coverage ratio, which shows how many times the operating income can make the interest payments (the higher the better). Combined, these indicators reveal how much a company has booked to meet its expenses, how well it turns its earnings into the cash needed to run the business, and how onerous the debt burden is in terms of the interest due.

Based on the following chart, Teekay Tankers, and DryShips seem to occupy a particularly precarious position. The operating income of each can't even come close to covering the interest payments on the debt they owe, much less the full debt itself. In contrast, Ship Finance International's ability to pay interest on its debt is twice as strong as the industry average. Given the debt-to-equity ratios from the previous chart, Foolish investors should be very wary of DryShips and Teekay Tankers' ability to continue operating without bankruptcy protection.

Metric

Ship Finance International

Frontline

DryShips

Nordic American Tankers

Teekay Tankers

Industry Average

Price to Free Cash Flow

(13.10)

1.40

(0.80)

(4.80)

(16.80)

(3.80)

Price to Cash on Hand

12.95

1.44

0.74

4.57

9.18

n/a

Interest Coverage Ratio

2.60

n/a

0.60

n/a

0.10

1.30

Sources: Motley Fool CAPS and FINVIZ

Which company should Fools look for floating to the top?
Clearly, this is not an industry for the weak of heart or faint of purse. It would seem plausible, however, that one or more of the companies should remain upright. Ship Finance has the best chances, thanks to its solid cash position, net profit margin of over 50%, and strongest gross and operating margins in the sector. If things in the industry get even more turbulent, it can reduce its double-digit dividend to bolster its cash position.

Foolish investors should monitor Ship Finance's cash hoard, and particularly its interest coverage ratio. If it remains stable, Ship Finance could be a welcome sight for Foolish investors scouting for survivors in this shipwreck of a sector.

It's pretty obvious that shipping companies will not be dominating the world in the near future. If you are looking for that type of strength and ingenuity to invest in, you should check out this free report: "3 American Companies Set to Dominate the World." Click here to get your free copy before it's gone from all the others who grabbed so they can buy into companies that are set to dominate the world.

The article Can These 5 Shipping Stocks Survive More Troubled Waters? originally appeared on Fool.com.

Jonathan Yates has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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