|Shares Out. (in M):||89||P/E||14||NA|
|Market Cap (in $M):||1,481||P/FCF||17.7||NA|
|Net Debt (in $M):||168||EBIT||115||11|
|Borrow Cost:||Available 0-15% cost|
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Misconception and Opportunity
Crude tanker rates have increased since September 2014 after remaining near cash costs for most of the past 4-5 years. The most common explanation seems to be that y/y supply growth is slower than demand for first time since mid-2000’s and that recent demand has been strong because of low oil prices. Both those comments are true; but, I think overall utilization is still low and that there are some other “one-time” bumps that have probably supported stronger tanker pricing:
Floating Storage – based on data from Bloomberg, it looks like ~90 vessels (up from the average of 50 vessels from 2010-2014) are being tied up as floating storage. This adds ~4% to industry utilization and might include Iranian vessels (10-12) sitting in water and waiting to unload.
Refinery Utilization / Inventory – Any short term increase in inventories – at refineries or storage tanks (not real end demand) could have a temporary positive impact on demand for crude oil tankers. According to ISI, global oil inventory builds have been an average of 2m barrels per day since 4Q14. That would be the equivalent of ~5% of extra seaborne demand (typical seaborne demand is 40m barrels per day). That trend could reverse in the second half of 2015.
Port Delays – Bloomberg article (6/23) says ships need to wait 4 days to unload at Houston (versus 0.5 days normal [average trip takes ~60 days]) because of inefficiencies. “There’s a lot more oil on water” – Head of Tanker Research at Poten, a ship broker.
Overall, capacity utilization still seems low and another 10% of supply is expected to be delivered over the next 18 months (excluding scrapping – though no scrapping is currently taking place). I think rates will slip back towards cash cost over that time period.
The biggest disagreement that I have with the consensus is that what matters is the supply of ships on the water that influences rates, not the year-over-year change in supply. In 2009, there were 284m dwt of supply on the water (on a VLCC equivalent basis, that's 886 VLCC ships). Demand, according to Clarksons was 251m dwt (equivalent to 783 VLCC's) – that’s 90% utilization and VLCC spot rates that year averaged $32,000 – roughly in-line with the last 25-year average, so I think it’s reasonable to say that was about normal.
Fast forward to 2015 and Clarksons estimates that demand is 276m dwt. Over that time seaborne crude trade per day has increased from just 36.4m barrels per day to 36.9m barrels per day. So the increase in dwt demand is from longer hauls - that makes sense and if you look at the demand by trade route you can calculate a similar increase in ton-miles as Clarkson's estimate for demand increase (in dwt).
The bottom line is that for utilization to be 90% in 2015 (which I think is necessary to support sustainably strong rates), supply would need to shrink by 35m dwt. In terms of VLCCs that's 110 less VLCC's. The crux of the variant perception is that I think there are still the equivalent of ~100 too many VLCC’s floating in the water.
As I mentioned earlier I still struggle to reconcile this view with the currently unseasonably strong rates, but I think the temporary factors mentioned above are creating an artificially strong rate environment that will weaken once/if these factors recede. And if I'm wrong, then the supply coming over the next 18 months will imbalance the market causing rates to slip back towards cash costs.
Timing – if we’re right about temporary factors boosting crude tanker demand, could be next few months. Otherwise, rates could suffer once supply comes into market over next 18 months.
Nordic American Tanker
NAT has a fleet of 22 Suezmax vessels (plus two newbuilds on order) that all participate in the spot market. The short thesis takes a view on crude tanker rates weakening as capacity comes on over the next 18 months. Investors are attracted to the high dividend yield (they pay out earnings through a variable dividend – currently at 10%).
The average age of NAT’s fleet is 13 years. Based on current market asset prices, the company could be recreated for $7.00 per share. At newbuild prices of $65m per vessel, the company would be worth $15. So, you could recreate NAT with new ships for $15 or buy it on the open market for $16.50. (Admittedly, if you placed new orders, you wouldn’t get them for two years – however, the point is that this stock is trading rich compared to its aging fleet asset value).
As supply comes back into tanker market, we think NAT EPS will suffer – our EPS forecast for 2016 is $0.00 v. FC at $0.80 (0.86 on 5 most recent estimates).
NAT Summarized Financial Statements
Supply / Demand
The following chart has the key data for why I think the tanker market will deteriorate over the next 18 months. The orderbook (from Clarksons) suggests that 8.5m dwt could be delivered in 2H15 and 26m dwt in 2016 (compared with the current fleet of 340m dwt). That’s 10% cumulative supply coming on, which most analysts (and companies) combat with the view that scrapping will offset most of that gross supply addition.
But, no one is scrapping because rates are so healthy right now! Look at the recent history of orders, deliveries, and scrapping activity. As you would expect, since rates have increased in late 2014, orders have picked up and almost no vessels have been scrapped. So, I’d argue that the only reason scrapping would pick up over the next 18 months is if rates weaken – and thus, the NAT short works.
To the contrary, folks are ordering more ships.
Age Profile: Industry v. NAT
The age profile of the industry doesn’t support higher scrapping either. On a barrel of oil equivalent basis, only 2.5% of the fleet is older than 20 years. A 20-year drydock survey expense might be $3m for a VLCC. So, at a $70,000 day rate and $10,000 opex per day – that’s $60,000 of EBITDA per day for VLCC’s – the payback period in this rate environment is just 50 days. No one’s going to scrap that vessel with rates this high – which is exactly why rates are unlikely to stay this high. When rates are near cash costs – that $3m decision becomes a lot more debatable.
For normal returns, I use an 8% return. Though, I think this may be generous because shipowners seem to think about returns on their equity and with 60-70% debt-to-capital and 4% interest rates, you can achieve an 8% ROE with ~6% ROC. Actually, I think that mentality and the favorable financing environment has been a large part of why all shipping sectors seem to be so oversupplied.
For NAT, as can be seen in the summarized financial statements above, I think their normal, sustainable EPS is ~$0.90 (Using a $2,500 discount to $30,000 normal Suezmax rate because of the age of their fleet.) Though, I think there is more risk that earnings slip back towards $0.00 as rates near cash costs than settling near normal levels.
Nonetheless, I think normal, sustainable earnings is appropriate to evaluate the fair value of the equity and at $0.90 and a 10x multiple, $9.00 seems reasonable.
We can also look at the asset values. NAT gives the carrying value of its fleet, which is $1.04b. In a footnote in the 20F, it says that they believe “the aggregate carrying value of vessels exceeds the market value by $255m” as of 12/31/14. That would result in a NAV of $7.00 v. BV of near $10. I arrive at a similar estimate using estimated market value from Clarksons – I suspect they are using the same data. So, there is some support that you could rebuild this company today for $7.00.
But, the market is not that liquid. Since the beginning of 2014, there have been 42 suezmax sales (500 vessels total in service today). Seem to be 11 comp sales for 15-year old vessels (17 of NAT’s 24 vessels). Three sales have taken place since November 2014 at an average price of $27m (average price for all 11 transactions is $24m). This is probably the data being used to support the estimated market value by NAT. Again, we’re circling around somewhere below $10 for fair value.
Floating Storage Impact and Economics
Bloomberg tracks all ships through its BMAP Function, which ties back to satellite positioning of vessels. One thing they track each day is the number of vessels that haven’t moved in the last 14 days and assumes this is floating storage. Seems reasonable. That figure has increased to 180m barrels (90 VLCC Equivalent) from 100m barrels (50 VLCC Equivalent) average over the past few years. Analysts say this data isn’t reliable and that they “know” there aren’t that many vessels being used as floating storage. But, it’s still vessels that are soaking up capacity and could be supporting market tightness.
The simplest calculation for the cost of floating storage (includes bunker fuel, insurance, port costs, and my normal VLCC rate) is about 70c per barrel per month – at current VLCC spot rates, it’s ~90c. The forward curve is currently ~50c per month going out 6 months, so storing oil isn’t profitable.
Risk From NAT 20F
As I mentioned above, building inventories might be supporting tanker rates. This is what NAT mentions in their risk section:
“Fearnleys is forecasting further improvements in 2015. Continued low fleet growth combined with accelerating oil demand growth and restocking at lower prices are expected to be the key drivers. Further restocking is mainly expected to be driven by China, as both new commercial and SPR storage capacity combined with lower oil prices is believed to be sufficient incentives for incremental purchases. OECD oil stocks have however reached a level that may cause a stock drawing period if energy prices at some point recover substantially. The latter would pose a demand risk as much of the oil consumption growth then will be covered by local stocks, rather than generating new long-haul transportation demand. As the oil market is expected to remain oversupplied short term by the key energy agencies, this risk may be more relevant for 2016 than current year though.”
Impact of US Exports
Hard to dimension the impact that US exports would have on the crude tanker shipping market. There are ~40m barrels per day that are seaborne. Some estimates are that US could export 500k barrels per day, so a ~1% increase in seaborne trade. But, US crude exports wouldn’t result in overall demand increase so those exports should be offset by loss of exports somewhere else. There could be some impact from demand for different types of crude, but should be manageable.
Impact of Iran Exports
If Iran brought on 1m additional barrels per day, that could equate to demand for 30 new VLCC’s (v. our estimate of 100 excess supply today and another 100 (VLCC Equivalent) getting delivered over the next 18 months. With 1m barrels of additional demand you could support demand for 30 VLCC’s (takes 2 days to load a VLCC and 60 day round-trip average to Asia, so you could load 30 VLCC’s before the first ship returns to port).
Here's a sample of what brokers have to say about the supply/demand in the tanker market:
Jefferies: We believe that both the crude oil tanker market should experience YOY improvements in charter rates and asset values over the next 12 months as incremental demand growth in both sectors should outpace incremental supply growth through at least 2015.
Euro Pacific Capital: Over the medium term, we expect crude tanker stocks to continue to benefit from solid pricing into increased global crude oil trade and storage, given the current contango Brent Oil forward structure versus last year, against low single-digit net fleet crude tanker growth.
Morgan Stanley: Tanker rates have been quite strong in 1H15 and incremental demand from refineries and traders as well as a higher number of vessels in transit could tighten the crude tanker market even further over the next several months.
Deutsche Bank: todays spot rates may not carry into 2016 as supply growth accelerates.
Citi: Sustainable growth phase in tanker cycle through 2016 and into 2017
Again, it’s the number of vessels on the water that matter, not the year-over-year change in supply versus demand.
Lower spot rates.
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