Description

A non-traditional VIC idea... a busted convert at 90% for a 10-14% 1YR IRR/low MOIC.  Boring, but I like it, so here it goes:

About The Company:
Scorpio Tankers is the largest publicly traded, shipping company focused on product tankers.  It has over 100 different vessels across LR2, LR1, MR and H1A vessel classes.  It was aggressively capitalized by hedge funds in the shipping bubble of 2010-2016, which leaves it with a very young aged fleet (average ~3 years old vs. a useful life of 20-25 years).

Capitalization:
Cash                                    $(282)
Vessel Debt                             2,379
Newbuild Debt Needs               42
Priority Debt                            $2,421
  Net Priority                          $2,201

Senior Notes due 2019             58        100%  
Senior Notes due 2020             54        96%
Convertibles @ $10.19             349      91%  <--- Target security price
  Total Net Debt                     $2,661                            

Equity Cap                               $725
  TEV                                       $3,386

Valuation of Unsecured Notes:
1) 77% LTV on a market basis ($2,661/$3,386)
2) 75% LTV on a vessel valuation basis
3) 93% LTV if vessel values contracted 20%

Valuation of Equity:
I value the entity on a DCF basis.  If I assume depressed rates for 2-3 years and median dayrates thereafter  (MR tankers going back to $17K/day), I think the stock offers 7% equity IRR. That isn't compelling to me, but suggests there is equity value behind the bonds on a cash flow valuation.  Importantly, the market is willing to ascribe more optionality to dayrates than me, and that option has value for a very young fleet.  The rate assumption for 2018 and 2019 is $13K-14K/day, which assumes no market recovery.  I assume $17K for 2020+ (50% percentile).  Rates have been as high as $20K (75% percentile) or $30K (100% percentile) for context.

Thoughts on Day Rates:
Product tankers should have a positive Dayrate outlook.  I say this because the global economy chugs along and demand growth for product tanker miles is a GDP+ business.  More importantly, supply growth is limited in the market, < 2%/YR.  So we should be looking at supply shrinkage on real terms, which should be supportive of day rates (FWIW, shipping bulls think this outlook means rates will re-rack to 75% percentile levels well ahead of 2020, vs. the 50% in 2020 that I assume)

Thoughts on Asset Values:
Asset values are no longer at historic lows, but remain well below replacement cost and below average values.  Given a stable-to-positive rate environment view, I think asset values have more upside than downside from here.  That said, I think asset values should be a little lower (say 10%) to reflect current dayrates, so I think asset values are pricing in some forward gains.

2019 Maturities a Play On Liquidity:
I think the 2019 notes are refinanceable through a few paths.

• LTV on current vessel values is 75%.  This means STNG could simply sell off assets to pay off debt with cash.
• Even if vessel values declined 20% (which would take asset values to historic lows), LTV would be 93%.  If you liquidated the fleet maybe LTV would be 100%.
• The majority of 2019 maturities are convertible notes that can roll into a new convertible note or 2nd Lien note.

 Most importantly

• Management is more aligned with creditors than equity holders. They have and will dilute equity to raise cash to repay debt.  Most notably they raised $100MM in November 2017 without a stated purpose at the time, but clarified later as a desire to shore up their balance sheet to get ahead of 2019 maturities.

Why Management Will Raise Equity:
Management has always been incented to run the business for their own pockets, not maximizing shareholder value.  The shareholders who capitalized the company gave away absurd economics to be associated with this management team.  For example, management would get paid bonuses for ordering vessels even if it made no economic sense to order that vessel.  Management also owns a separate management company that runs STNG on an outsourced basis. 

Consequently, management has been a serial issuer of equity, at ever declining stock prices, if it meant growth-for-growth sake or balance sheet stability:

IPO      3/30/10                       $13.00
ADDTL 11/16/10                      $9.80
ADDTL 5/13/11                        $10.50
ADDTL 12/1/11                        $5.50
ADDTL 4/12/12                        $6.75
ADDTL 5/8/13                          $8.30
ADDTL 7/31/13                        $9.50
ADDTL 4/30/15                        $9.30
ADDTL 5/24/17                        $4.00
ADDTL 5/24/17                        $4.00
ADDTL 11/29/17                      $3.00

Recent equity raises have fixed some of the misaligned incentives, but the G&A remains bloated by millions of dollars, and there are still multiple shared service contracts with a separate management company owned/run by management.

More notably, management had no stated use for the November 2017 share raise at $3/share.  Equity markets were blind-sided by this $3/share equity raise, because "it made no sense" to raise this money given depressed asset values and a positive outlook.  However, the raise makes perfect sense when you think about $460MM of unsecured debt maturities coming due in 2019-20.

To make it clear, I think this management would issue stock at 50 cents a share if it means keeping the going concern active.

Management Comments on Q4 2017 Call
Management referenced its debt maturities implicitly for raising the equity, and even patted themselves on the back for doing so.

·         They aren’t worried

o    We're not naive to the overall situation but at the same time, we do have time.

o    we have a board meeting next week and it's not on that agenda

·         They want to see if asset values can rise further

o    With the asset values going up…. that gives you more of an optionality.  You have more optionality in terms of the values in the ships themselves to create liquidity

·         But they are ready to move

o    mean we were criticized in December for doing an equity transaction below the net asset value in December at $3, but we did it in order to create time and stability in the company

o    We’ve had as I said unsolicited offers from various people, we've had people in the convert market saying trying to say well, reverse inquiry

o    We’ve had as I said unsolicited offers from various people, we've had people in the convert market saying trying to say well, reverse inquiry

o    We’ve had as I said unsolicited offers from various people, we've had people in the convert market saying trying to say well, reverse inquiry

IRRs
YTM to on the 2019 converts is 10% @ 91% dollar price
They’ll get addressed at least a few months before maturity, say 3 months = 12% IRR
If they take them out in December 2018 (to avoid letting them go current) = 14% IRR

Risks
Vessel values decline by over 20% over the next 12 months and Company loses market access at any price/structure (no access to secured, 2L, unsecured or equity markets).  Risk is mitigated because you can exit position if asset values were to suddenly fall 10% if you were so inclined, with I suspect not much MTM impact on trading securities.

On my slightly conservatrive dayrate forecast I estimate STNG generates $50-100MM/FCF per year.  However, net of principal repayment (required in the case of vessel debt), I forecast -$100MM/YR.  Since repaying vessel debt should free up additional debt capacity, I am not concerned about the negative change in cash net of debt repayment.  Said another way, I think they can bridge the gap with additional debt incurrence on undrawn lines. 

Catalyst

Refi in Q4 2018 or Q1 2019