OVERSEAS SHIPHOLDING GROUP OSG
April 13, 2022 - 7:18pm EST by
DO EM GO
2022 2023
Price: 2.20 EPS 0 0
Shares Out. (in M): 87 P/E 0 0
Market Cap (in $M): 191 P/FCF 0 0
Net Debt (in $M): 370 EBIT 0 0
TEV ($): 561 TEV/EBIT 0 0

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Description

 

OSG is a sub-scale Jones Act Shipping firm with a concentrated shareholder base.   The company was written up on VIC pre COVID but I believe it merits another look as much has changed since the initial write up.  For background on the Jones Act and the industry, I think Vincent1975’s excellent write up provides necessary background and as such I will focus on the current state of the company and the Jones Act Market.

 

The company operates 23 vessels in total in a few niches within the Jones Act and one international flagged product tanker.  COVID caused a variety of disruptions to Jones Act shipping routes which led to a lack of employment for some of its tankers throughout 2021 and forced the company to place as many as 7 tankers in lay up at one point.  Some of these tankers were leased from AMSC and the company was on the hook for $20K a day in lease costs during the lay up periods while generating no revenues.  As of this write up there are only two ships in lay up currently and both are expected to come into service in the next 3-6 months (OSG Tampa in late Q2 and OSG Vision in 2H of ‘22).  

 

The company breaks out its results in 4 segments in its quarterly reports:



NICHE MARKET ACTIVITIES

 

This business encompasses the company’s 2 lightering vessels, 3 Non Jones Act tankers, and its 3 shuttle tankers.  Within this business the 3 shuttle tankers provide the majority of the revenue (~$14M avg last 4 qtrs) while the lightering has averaged $7M in revenue per qtr and the Non Jones Act  business has averaged $7-$8M in revenues per qtr over the past year.  These ships have more or less provided steady returns with the pre overhead profit contribution of ~$15-$18M per qtr over the last year.  This business has been operating with one lightering ATB(OSG Vision) in lay up while the two newer ATB’s have been operating consistently generating healthy profits.  The OSG Vision was financed using US government backed loans under the MARAD program and there are restrictions on its use outside of lightering.  However, there are options for it to haul crude from LOOP in Louisiana to other US ports as that is outside other coastwise trade restrictions.



ATB (Articulated TUB Barge)

 

The business has generated ~$7M in revenue per qtr and $4M of pre overhead profits per qtr over the last year.  It comprised the two new ATB’s that were delivered in 2019.  Both enjoy steady employment and have helped the company survive COCID demand destruction.



ALASKAN TANKERS 

 

The company has 3 tankers chartered to BP operating in Alaska to West Coast trade routes.  This business has been very stable over the past 4 qtrs and has averaged $17M in revenues and $7-$8M in pre overhead profit contribution.  The outlook here is steady for the foreseeable future as Alaskan Oil volumes are remarkably consistent and in high demand on the West Coast.  There is a 4th tanker, the Alaskan Frontier, which has been in cold layup and is fully owned by OSG and therefore an asset that can be sold at some point.  It could potentially come into use if Alaskan North Slope (ANS) crude production were to expand to the Willow Field which is currently held up in court.  This would be added upside as I don’t include this tanker in any of my estimates.  Its current sale value is fairly low and the company has decided to keep it for the time being.



JONES ACT PRODUCT TANKERS

 

This segment has yielded heavy losses over the past year for OSG as the 11 MR handysize tanker ships (one owned and 10 leased from AMSC) operate mostly in this segment.  Due to the COVID related poor demand environment in 2021, as many as 6 of these vessels were laid up at some point over the past year.  Coming into 2022, as demand for petroleum products has normalized, demand for these ships has returned and the company has returned all but one of these product tankers to service.  The remaining vessel in lay up is expected to come out of lay up late in Q2 after it completes a dry dock and ballast water treatment.  Market demand for the vessel currently exists as the market has tightened dramatically over the past 6 months but the company is waiting on a ballast water system ordered from Europe to be installed before it can begin operations.  Due to supply chain issues, the ballast water system delivery has been delayed. 

 

The economics of bringing back all ships out of lay up are fairly dramatic.  In lay up, the company pays $20-$25K in lease costs to AMSC and other costs while earning zero revenues.  Currently spot rates are $70K a day for these tankers and the average for 2-3 month charters is now $60K a day.  At $60K the vessels generate $20K a day in pre overhead profit vs. $20-$25K in losses per day.  On the Q4 conference call, CEO Norton highlighted the earnings power of this unit at full employment. Revenue of $60K on 10 ships with costs of operation estimates at $40K, inclusive of leasing costs, would generate nearly $70M in pre overhead profit contribution.  Over the past year due to lay up costs and resulting loss of revenue this business lost $45M.   



JONES ACT TANKERS - Supply/Demand

 

According to the Q4 call there is a total available supply of Jones Act vessels of 87-88 ships and 85 are currently employed. The OSG Tampa will be coming into employment as soon as the end of May leaving only one ship unemployed that is over 20 years old.  As such the outlook for nearly full employment of the fleet is fairly strong in the next year.  New supply is non-existent as there are zero new ship orders and given a backlog at shipyards, any new ship ordered today would likely be delivered in 3-4 years.  Furthermore, at current ship prices, day rates would need to average $70K a day with a 2-3 year charter to justify the cost of a new ship.  While rates have risen to close to that level in the current spot market, 2-3 year charters are not available and 1 year charters were last executed in the $55-$60K a day range, a healthy discount to current spot rates. 

 

Due to the losses incurred in 2021 and the lack of available long term charters, OSG has notified AMSC that it will not renew the leases on 3 of the MR tankers at the end of 2022.  This certainly reduces the company’s earnings power but lowers financial risk in case the market weakens once again.  If the market remains strong I suspect OSG might try to renew those leases with AMSC, who as a foreign based entity, can't operate those ships on its own in the Jones Act market.  However, they could presumably be leased to competitors such as KMI, Seacor (now Seabulk) etc. if OSG does not renew the leases.  This of course means these ships would still be available for hire if leased by a competitor and would keep overall supply fixed which leads me to believe if the market remains strong OSG will eventually re-lease those ships.

 

Despite the much improved supply/demand picture we can’t assume consistent full employment for all OSG ships in the near term.  For illustrative purposes mgmt has guided to EBITDA of $35M-$40M a qtr if ALL ships were fully employed at current rates.



SALTCHUK RESOURCES

 

Saltchuk Resources is a well managed, family held, private company with a great reputation and a diversified business spanning various transportation sectors.  It employs 5,500 people and OSG would be a great fit for them. Saltchuk owns 15.2% of OSG and tried to buy the company in the summer of 2021 at $3 a share.  The company was in the midst of a relatively difficult refinancing of its debt last summer and the Jones Act shipping market was much weaker last summer as the COVID Delta wave was hitting the US and world transportation markets.  Fast forward to today, the company’s EBITDA has improved dramatically and it now expects significant FCF despite heavy spending on dry docking before bringing ships out of lay up.  Saltchuk has not sold any shares since its bid and it remains a significant possibility they come back with another bid.   I think it is highly reasonable they are able to negotiate a deal with Cyrus Capital who owns 18.8% of the company and the rest of the OSG board at a significantly higher price that recognizes the progress the company has made and the much improved outlook for Jones Act shippers.



RENEWABLE DIESEL (RD)

 

The renewable diesel market is an unexpected tail wind for Jones Act shippers that has the potential to suck a significant amount of tonne mile demand from the already tight market we have today.  Renewable diesel projects are growing in importance in the US and the main market for it currently is California and perhaps Oregon in the near future.  All current RD production is in the Gulf Coast and voyages to the West Coast carrying RD generate 3x the tonne mile demand a Gulf Coast to Florida trip generates.  OSG has already signed a 2 year charter for RD and KMI has as well.  As new RD capacity comes online later this year and in 2023, the market for Jones Act tankers is likely to improve further.  This coupled with ZERO new tanker supply should provide a strong cushion for rates and allow OSG to get back to as high as $140M EBITDA run rate next year.




VALUATION 

 

The company has 82.3M shares outstanding and a market cap of $184M.  It had $83M in cash and $445M in debt at year end.  Its EV is ~$545M at current market prices. LTM EBITDA was only $45M but I believe the company will be on a $120M- $140M EBITDA run rate starting in Q3 as it brings back the last two ships from lay up.  

 

The company has $22M in mandatory debt amortization this year and interest costs will be ~$32M in 2022.  Cap ex going forward will be minimal as the company spent heavily on dry docking and water ballast treatments while its ships were laid up.  I expect maintenance cap ex going forward to be in the $10-$15M range although they have said this year cap ex will be minimal.  

 

FCF Run Rate at  Mid point of estimates is $130M less $50M in interest and cap or $80M.  That is nearly $1 per share if I am correct on EBITDA going forward.  The company plans to focus on deleveraging but will also look to re-invest in growth opportunities according to the CEO.  

 

Recent deals in the sector have been done at 6x EBITDA and I believe that is a fair valuation.  Using $350M in net debt at year end and $130M EBITDA we get a fair price of ~$5.25.  

 

Alternatively if the company doesn’t renew the leases on the 3 ships from AMSC, EBITDA estimates at full employment fall by $25M.  As such the company would generate approximately $115M in EBITDA.  This presumes they can lease the remaining ships which is a reasonable assumption as they are all employed currently.  In addition, the market continues to suffer from COVID related disruptions mainly related to supply chain issues now vs. lack of demand previously.   At a similar 6x EBITDA multiple the upside falls to ~$4.15 a share. 



CONCLUSION 

 

I believe the risk/reward at $2.20 is excellent as a knowledgeable industry buyer was willing to pay $3 when the company was in weaker shape and currently it remains a large shareholder.  The bid clearly illustrated the private market value of its assets last summer and provides a floor under the equity while offering potential upside of more than 100% in a market that has tailwinds behind it.  

 

In addition, the CEO Sam Norton owns 2M shares personally and has bought in the market highlighting his commitment to the equity.



RISKS

 

The number one risk is a potential repeal of the Jones Act.  In the short run, it is difficult to estimate the damage to rates as foreign tankers could enter the market and push rates lower.  I believe this risk is remote and the recent concerns on national security and the desire to onshore US supply chains makes this risk even less likely. 

 

The second risk is another wave of COVID lockdowns that would disrupt liquid fuels demand in the US.  This risk is somewhat mitigated by the supply reduction over the past two years, especially with the bankruptcy of smaller Jones Act player, Bouchard.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

1) Saltchuk Acquisition

2) Deleveraging as FCF builds leading to possible cash returns 

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