November 09, 2016 - 2:37pm EST by
2016 2017
Price: 3.75 EPS .12 .33
Shares Out. (in M): 166 P/E 33 11
Market Cap (in $M): 622 P/FCF nmn 5
Net Debt (in $M): 1,743 EBIT 253 330
TEV ($): 2,365 TEV/EBIT 9.35 0

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  • tankers
  • Shipping


Scorpio Tankers (STNG) owns and operates a fleet of 77 relatively new finished product tankers (which
primarily transport gasoline and diesel). STNG is a heavily beaten up stock, down by roughly 75% since
its 2015 highs on lower tanker rates and new tanker supply hitting the market this year. What investors
seem to be missing is the fact that finished product tanker supply is about to drop dramatically in the
next 12-24 months. With demand growing steadily year in and year out (even during the Great Recession),
the market is poised to shift from one of oversupply and weakish dayrates, to one of undersupply. 
Dayrates could easily spike in the next 6-12 months.
While these are notoriously volatile stocks based on where dayrates are moving, directionally it is
encouraging and we sense the market has little idea of what real rates are (index rates are quite often
wrong and delayed). Given that Scorpio’s tankers operate primarily in the spot market, the set up could
lead to a doubling of EBITDA in the 2017/2018 time frame, with the stock up similarly. While we could
be early on this name, the 13.5% dividend yield offers a nice paid to wait scenario, while industry
conditions continue to improve.
The tanker business is boom and bust with management teams that often take on too much leverage
and extract too high fees. In the finished product tanker category, the supply and demand dynamics
differ dramatically compared to crude tankers, dry bulk tankers, or containerships. Whereas the supply
of crude tankers has quadrupled in a decade, and continues to be well oversupplied, the finished
product tanker market appears much more rational. Note that crude tankers are not convertible into
finished product tankers, or vice versa.
On the demand side, growth has been fueled by the increased globalization of the refining market, as
well as increasing consumption of gasoline, diesel, naphtha and jet fuel. Annual growth in finished
product demand tends to be steady as seen in this chart.
The 4.5% above refers to “ton miles” of product moved. Lower oil prices in the past 2 years have not
impacted trade either; in fact, the opposite occurs as consumption (and hence demand) tends to
increase with lower gasoline/diesel prices. Refinery expansion/growth in places like the Middle East and
China have also added to demand to move finished products. There will likely be 12 new refiners
completed in the Middle East by 2020, with only 2 planned closures. That means demand shifting from
crude carriers to finished product tankers to some extent too.
On the supply side, there are approximately 2100 tankers operating in the finished product space.
Scorpio is the biggest owner/operator of both smaller tankers (the MR or Medium Range boats, as well
as the LRs, the Long Range, biggest tankers). The MR boats cost typically $35-40mm to build, with LRs
costing $50-60mm today.
Scorpio’s LR2s are an average of 1.3 years old, against industry average age of 8 years. Their MRs are
2.2 years old today on average, against industry average age of 8.5 years. Scorpio expects to have 10
more vessels delivered (1 in 2H 2016, 8 in 2017, and 1 in 2018), at which point management intends to
harvest cash flow.
The crux of the thesis is the lack of new orders for tankers. The data from Clarksons Research
below shows a dramatic drop this year, with only 8 orders year to date through September. It takes
18-24 months for tankers to be built, meaning that in the next 6-12 months, new supply will virtually halt.
On top of that, some 5-7% of the existing fleet will “age out” each year over the next 4-5 years. That is
around between 110-150 tankers/year that need replacing. Throw in 3-4% demand growth, and the
2017-2019 picture looks like there should be solid demand for 400+ tankers in that 3 year period
(cumulatively). Supply clearly looks well below that unless orders ramp up very quickly.  New regulations
for ballast water treatment systems (BWTS) also kick in in September 2017, and further sulphur emission
standards in January 2020 will also likely increase retirements of older, non-compliant tankers.
It is also worth noting that the financing market for tankers also has been a constraint. With 20% of the
world’s shipyards likely to close over the next 2 years, there could be further delays and higher costs
associated with new orders too. Shipyards generally have the ability to deliver tankers with some
allowed delays, and Scorpio has one tanker delivery that has slipped already into 2018. More of these
industry-wide are likely.
From the last conference call:
Through this first quarter, we've had lower -- bloated inventories, lower refining margins
coinciding with a growing fleet, and distillate refinery capacity additions. This is what's been
driving these rates lower.
However, the demand for refined products, that's the headline demand, continues to remain
robust. We've had delayed refinery maintenance that should have been happening in 2015.
It's been happening in Q1 and the end of Q2 2016, lower refinery margins, the high
inventory levels. And, we've been, most importantly as well, digesting the last bulge of big
supply. There's been a 4.1% fleet growth in the first half of 2016. That will not be repeated
going forward.
The order book is declining very fast and is probably declining further than most analysts
will look in their research because we ourselves know, in our own order book, the shipyards
are delaying vessels


For 2017, fleet growth should work out to 2% net of retirements (according to competitor Ardmore). 

For 2018, Scorpio and Ardmore management teams expects net fleet growth to be flat to negative.

From Scorpio’s perspective, they have not ordered a new vessel since October 2015 (4 MRs for $36mm each),

and allowed an option to build 4 more vessels expire in December 2015.

In terms of valuation, Scorpio trades at only 44% of book, and at a 20% forward FCF yield. I have
assumed growth in dayrates given the supply demand picture. EBITDA could easily double from current
runrate figures.
On a forward FCF basis, STNG could be a double should the company hit these numbers and assuming a
10% FCF yield. While it is unclear if they can hit $450mm of EBITDA next year, or not until 2018, the
dayrate picture looks very promising at some point in 2017. In fact, last month when the Colonial
pipeline (running gasoline from Houston to NY) shut down for 12 days, MR2 rates doubled.
On a marked to market basis, one sale in October of an MR2 boat (the Ardmore Centurion) was
completed at $16mm, around 85% of book. This was a 10 year old tanker and sold into a weak market.
Applying a similar 15% discount to the book of Scorpio’s fleet would imply a valuation of $5.67 per
share, up 50% excluding dividends.
From a seasonal perspective, Q3-Q4 is the worst quarter given refinery shutdowns and it comes after the
summer driving demand. Q4-Q1 looks stronger seasonally, and Scorpio stock appears to have priced in the
worst at this point.

While an argument can be made that the company is overpaying its dividend, the reality is that once
newbuilds are complete, cash maintenance capex will be virtually nil. Their fleet is new, and that means
even should dayrates stay flat at today’s low levels, in 2018, EBITDA at $275mm (with new boats), less
interest of $120mm, and some maintenance capex of say $20mm implies FCF of $135mm. That is $0.81
in FCF / share.
While in 2017 Scorpio will spend $200mm on new tankers, beyond that FCF should be strong as we point
out even at current type rates. In total STNG has $280mm of newbuild capex to be paid from now until
Q1 2018.
Industry sources suggest there are 70 LR vessels available for supply today, and that demand for MR’s is
low in North Asia and Singapore. This is the shoulder season however which typically means refiners
don’t run due to seasonal maintenance, so volumes tend to fall along with rates. Management has
indicated that rates could rebound as early as Thanksgiving, although we are betting on a 2017
Liquidity is fine. The company has $184mm of cash plus $360mm of bank availability. That said, the
company is levered with total net debt of $1.7BB.
The orderbook for finished product tankers could rebound should dayrates improve.  
Dayrates could continue to suffer.
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.


The company has $150mm remaining on its securities buyback plan, which includes their 2017 & 2020
bonds, converts as well as the equity. They seem to be focused on paying down debt, and buying back a
few shares. We like how management thinks, and when Robert Bugbee (President) says things like,
“why would I build new ships when I can buy my stock in the open market at a huge discount” we tend
to agree.


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