+ Tanker rates are all over the place with the current economic uncertainty
+ This makes it challenging to see the 'wood through the trees'
+ Here we model various scenarios and see which equities offer value, even in the worst case scenarios
The tanker market is renowned for being volatile and stomach wrenching. Late 2019 and early 2020 hasn't disappointed, with tanker rates soaring on IMO2020 hopes, then collapsing with Covid-19 hitting China, to soar once more on the oil contango, only to be met with increasing concerns over oil demand and future near term demand destruction for tankers, and they are now in a gradual decline.
In 2019 there was much talk of the start of the next tanker supercycle. Future new builds are at historic lows, a large portion of the tanker fleet is aging and going to scrap soon. Fleet utilisation should increase sharply as a result, driving rates up and giving tanker owners another historic set of earnings like in the last bull run of 2003-2008.
Add on top of this regulatory uncertainty first with IMO2020, and whether to retrofit scrubbers and scrap older vessels, and now with IMO2030. Without some certainty of what IMO2030 regulations will require, it's hard for shipping executives to press the button on new builds. It creates a lack of desire to buy now, and a willingness to hold off until things become clearer.
Adding yet more on top, the uncertainty with what global demand looks like coming out of lockdown, and we have a supply/demand picture which clearly has some major variables. With rates still high relative to other years at the time of writing (mid May 2020) but the potential for a long road to recovery ahead, tankers have recently been sold off, despite the encouraging fundamentals.
We think this is where numbers come in. We think that with good models, one should be able to assess the potential upside and downside in each equities valuation, comparing across the classes and choosing the best placed equities to perform well. This should hopefully limit downside and increase the upside potential. We have built our own models from the ground up, using publicly available fleet data for each equity, read through numerous 10-Ks and applied industry standard formulae to try and predict the performance of each equity in certain situations. This gives us the chance to model the possible outcomes in our investments, what are we risking versus what can we gain. Selecting a broad basket of shipping equities could be one approach, however as you will see there is a lot of variability and some clear bargains, even in a pessimistic future.
Now there is always more to valuing a business than simply NAV and cash flow, however this can form the crucial foundations for further analysis in to which equities might be investable and where one should focus their efforts.
Bearish Case:
Source: Contrarian Investments
To start with we ran a highly bearish scenario, where rates remain very suppressed from Q3 2020 through to Q3 2021 before a gradual recovery into 2022. The results are shown above. We have calculated our future NAV forecasts by using the Hamburg formula, which is driven by not just the scrap value of the vessel but also its present value of future earnings. We have extrapolated out the 3 year earnings in this model over the remaining life of the vessels. In a low rate environment, remember that a heavy asset really becomes a heavy liability, owing to the fact that the vessel costs the company money to keep on the water. Thus, in this example we see that some forecast NAVs turn negative. That obviously may sound silly, but it gives a flavour of the debt leverage of the company, and whether they could survive an extended period of low rates. That aside, points of note here are that a few examples still show good free cash flow, even with rates terrible. Okeanis $OET never has negative cash flow and Tsakos Energy Nav $TNP only dips negative in 2021 after having an amazing 2020. The debt gearing in Teekay Tankers $TNK is apparent.
Bullish Case:
Source: Contrarian Investments
Here is an example of a bullish scenario of rates playing out, with rates continuing to be strong (though still lower than currently) throughout 2020 and with 2021 and 2022 still being good years, though perhaps not as heady as the last 9 months. There are still people out there who would be more bullish than this scenario paints, so we deem this to be a 'reasonable' bullish forecast. You can see Ardmore $ASC continuing to struggle, even in a supportive rate environment. Other darlings of the tanker space, $TNK and Nordic American $NAT are now positive, albeit less so than others. $TNP and $OET are still the clear winners.
In summary, we felt that with rates being so variable it was easy to get caught up in chasing the spot rates and the volatility in the tankers. Standing back, the macro picture other than Covid-19 remains excellent, and being able to model various rate scenarios has helped us significantly in our portfolio allocations. This gives us the confidence to add when prices dip and hold our positions. The reality is that whilst the uncertainty from Covid-19 is around, nobody is buying a new tanker, yet the existing fleet is getting older each day, so the fundamentals in the space only get better. There are still some great value opportunities out there in the tanker space and we believe this will come to bear fruit over the next 12-24 months.
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