- Tankers were the trade du jour back in April.
- It was a hit-and-run trade, and now stock prices have corrected heavily.
- However, it seems that, with all the commotion around negative oil prices, investors have neglected a changing narrative in the industry.
Photo: Mark Rain
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Ok, so tankers were the trade du jour a couple of weeks ago when oil prices hit negative levels. Actually, it made sense. At those price levels, the demand for storage options was poised to surge. It is even reported that Carl Icahn got oil at negative prices.
That was a party! Now, the interesting fact is that a couple of weeks later and tankers are tanking, literally. Look at Teekay (TNK):
Source: Seeking Alpha
The company lost 30% in just a matter of weeks. The same thing happened with Scorpio (STNG), this one more exposed to refined fuels.
Source: Seeking Alpha
Scorpio’s case is even more interesting because it is near multi-year lows while the transport rates are trending higher, even if volatile.
Source: Seeking Alpha
What to make of this? I stumbled across this sector while trying to understand how to take advantage of the oil glut. However, two weeks ago, I thought I was too late to the party. Now, the euphory seems to have vanished as fast as it came. Let us try to deconstruct the story for this trade.
The bear case for tankers and Scorpio
The bear case for tankers must be focused on two main points. First, the market is assuming this boom is short-lived and it will fade fast, leaving the terrible economics of the industry exposed once again. Second, global trade will go through a depression and there will be lower demand for maritime transport.
Both reasons seem plausible, and in my opinion, are the dominating force in the market action around these names (just look at the “beautiful” economics below).
Source: Scorpio Tankers filings
After the bonanza, in 2015, the company’s performance went haywire. The company didn’t manage to get a profitable year since then. The revenues have plunged, while years of capacity expansion brought added costs. Both depreciation and interest costs nearly doubled since 2015. Financial debt plus capital leases represent almost 50% of the total assets. You get the picture. Honestly, I don’t think I’ve ever invested in something that bad.
The bull case for tankers and Scorpio
However, all that is more or less priced in, and it is my conviction that investors might be missing an improvement in the industry that was building up well before the oil debacle. The shipping rates were already improving before this year. The industry underwent five though years following the hangover from the 2015 bonanza. The story followed a recognizable script. During the golden years, these companies took on debt, expanded its capacity a lot, and paid generous dividends. When the cycle ended, a long period of adjustment started with low shipping rates and excess capacity. By 2019, things were starting to improve steadily, and the shipping rates seemed to be rising on a sustained track.
Source: Scorpio filings
Part of that might be explained by years of limited new shipbuilding, following the 2015 bust.
Source: Scorpio Investor Presentation
New thesis for the tanking industry and Scorpio
Following years of adjustment, the tanking sector got rid of a lot of deadwood. However, the balance sheets remain bloated with debt and in dire need of cash. April’s oil glut gave an adrenaline shot to the shipping rates, which might just bring some of the cash needed to revitalize these companies. Reducing interest expenses, by paying down debt, and improving liquidity, could be a big catalyst to improve the economics of the industry.
If that materializes, investors will upgrade their views on the shipping industry, and the stock prices might improve significantly. Probably, in a more sustained way than April’s hit-and-run. However, right now, it seems that this sector is being raided by speculators, with little knowledge of the industry (and with little interest to get some) that are just trading based on shipping rates (very volatile) and making a selloff from every lower shipping deal.
Therefore, I’ve added Scorpio to my holdings. Mainly, I see a lot of strength in shipping rates for LR2 product tankers. And, with the stock price trading at a high discount to net asset value, and poised to a strong second quarter, it seems like an asymmetric bet. Additionally, it is outside the overcrowded crude tanker trade, but benefiting from the same trends. Be as it may, I’ll keep this a small bet in a diversified portfolio.
Disclosure: I am/we are long STNG.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
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