|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|
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.