Is the Sky Falling in on Tanker Equities?

Is the Sky Falling in on Tanker Equities?

Is the sky falling in on the tanker market? That seems to be the question of the day. There are certainly those who would assert that it is, or is about to, as rapidly falling tanker stock prices and even more rapidly falling charter rates remind many of the barren shipping landscape of the 80s and parts of the 90s. Then there are those who would disagree and have drawn a very different conclusion based on their view of tanker market fundamentals. We thought it might be useful to take a look at these views and the opinions behind them as investors and operators recover from an ungraceful destruction of the tanker equities.

The Beginning of the End…?

Citigroup Smith Barney analyst John Kartsonas reports that dayrates for all classes of vessels have fallen by an average of more than 60% while Jefferies analyst Ray Wu reports that VLCC spot rates have fallen around 80% over the past eight weeks. JP Morgan analysts note that tanker stocks themselves have correspondingly fallen by 20-35%. An extrapolation of current trends would of course predict future devastation of the tanker industry, but fortunately these trends appear to be more of a temporary correction than an indicator of future rate and stock price falls.

Momentum vs. Value

In the first place, importantly, this sort of gargantuan drop was almost universally anticipated. No one thought the unprecedented rates and stock prices seen in November were sustainable. The question, rather, was when, how far, and how hard they would fall. OSG CEO Morten Arntzen exhibited this philosophy in his explanation to Bloomberg: “I never told anyone that the rates would stand at $200,000 a day. But I enjoyed it.” Savvy investors must have been able to identify with this sentiment in late autumn. JP Morgan analysts Jon Chappell, Gregory Burns and Hassan Malik noted that their 2005 projections, pre-the recent fall, had “already factored in seasonal declines, the impact of an OPEC production cut, and the belief that the November rate levels were not at all sustainable.” The difference between them and the more bearish Citigroup Smith Barney reports appears to have been more along the lines of how to prepare for and del with the dropping tanker market situation than over whether it would occur. So who were the investors that have moved suddenly and in droves to substantially more cautious tanker market positions?

The Chappell-Burns-Malik report argues that the recent massive drop in the tanker stocks represents “the exodus of a vast number of momentum investors,” to which the analysts attribute the tanker stocks’ “meteoric” rise and subsequent fall. Now that the stocks have come back down to earth, the JP Morgan analysts expect a return of the value investors. Indeed, Hibernia, who downgraded Top Tankers to a HOLD just as the stock tumble began in early December, has just upgraded the company back to a BUY, indicating they expected something of the recent fall and seem comfortable that the worst is over.

Citigroup and JP Morgan on Supply & Demand

The supply demand balance, is, naturally, also extremely important in determining the prospects for the tanker market’s health in 2005. The JP Morgan report looks for fleet expansion of 19.2 mdwt, or 5.9% capacity growth, in the coming year while Citigroup reports demonstrate comfort with a slightly higher growth number of around 21.5 mdwt, a growth rate of close to 7%. As the orderbook is a known number, discrepancies revolve more around scrapping expectations, largely involving how tanker companies will deal with the new IMO regulations set to come into effect in April of this year. In the demand arena, Citigroup’s Kartsonas expects growth of around 2% as compared to 7% this past year, with OPEC’s one mbpd production cut to reduce tanker demand by as much as 7-8 mdwt with a shift to less long-haul and more short-haul tonnage. OMI’s Robert Bugbee told Tradewinds that he expects demand to be stronger than this, pointing out factors such as China’s intent to build a strategic petroleum reserve that could easily raise demand by one mbpd. Also on the upside, the JP Morgan analysts used IEA forecasts to estimate tanker demand growth of 13.5 mdwt. This discrepancy seems to be largely geographic with respect to oil supply.

Material Gains

Yet another dispute revolves around whether shipping stocks are cheaply or expensively priced. Kartsonas notes their expense relative to historical levels while the JPM analysts note their cheapness relative to many other industries. You can look for yourself at their P/NAV ratings in the “Fair Value” table. As usual, the truth probably lies somewhere in the middle. While the extraordinary spot rates witnessed in the past few months may have dissipated, current rates are still comfortably above breakeven levels, which are estimated in the low $30Ks for a typical being above mid-cycle and even comparable to annual highs in more typical years as shown in “Rate Comparison” chart. Not only that, but this past boom has seen shipping companies increase transparency, modernize their accounting practices and begin to access whole new pools of capital, all of which contribute to lowering their cost of capital and increasing the opportunities for financing available to owners and operators.

The tanker companies are now seeing that not all their new supporters will stick around when the fad passes, but they have undoubtedly succeeded in raising their profile and increasing the breadth of their long-term support base. Just as importantly, the companies are continuing to demonstrate strong performance, in a far more sustainable fashion than before, and, as the JP Morgan trio pointed out, they offer the potential for share buybacks, dividend increases and consolidation.

Is the sky falling in on the tanker market? That seems to be the question of the day. There are certainly those who would assert that it is, or is about to, as rapidly falling tanker stock prices and even more rapidly falling charter rates remind many of the barren shipping landscape of the 80s and parts of the 90s. Then there are those who would disagree and have drawn a very different conclusion based on their view of tanker market fundamentals. We thought it might be useful to take a look at these views and the opinions behind them as investors and operators recover from an ungraceful destruction of the tanker equities.

Citigroup Smith Barney analyst John Kartsonas reports that dayrates for all classes of vessels have fallen by an average of more than 60% while Jefferies analyst Ray Wu reports that VLCC spot rates have fallen around 80% over the past eight weeks. JP Morgan analysts note that tanker stocks themselves have correspondingly fallen by 20-35%. An extrapolation of current trends would of course predict future devastation of the tanker industry, but fortunately these trends appear to be more of a temporary correction than an indicator of future rate and stock price falls.

In the first place, importantly, this sort of gargantuan drop was almost universally anticipated. No one thought the unprecedented rates and stock prices seen in November were sustainable. The question, rather, was when, how far, and how hard they would fall. OSG CEO Morten Arntzen exhibited this philosophy in his explanation to Bloomberg: “I never told anyone that the rates would stand at $200,000 a day. But I enjoyed it.” Savvy investors must have been able to identify with this sentiment in late autumn. JP Morgan analysts Jon Chappell, Gregory Burns and Hassan Malik noted that their 2005 projections, pre-the recent fall, had “already factored in seasonal declines, the impact of an OPEC production cut, and the belief that the November rate levels were not at all sustainable.” The difference between them and the more bearish Citigroup Smith Barney reports appears to have been more along the lines of how to prepare for and del with the dropping tanker market situation than over whether it would occur. So who were the investors that have moved suddenly and in droves to substantially more cautious tanker market positions?

The Chappell-Burns-Malik report argues that the recent massive drop in the tanker stocks represents “the exodus of a vast number of momentum investors,” to which the analysts attribute the tanker stocks’ “meteoric” rise and subsequent fall. Now that the stocks have come back down to earth, the JP Morgan analysts expect a return of the value investors. Indeed, Hibernia, who downgraded Top Tankers to a HOLD just as the stock tumble began in early December, has just upgraded the company back to a BUY, indicating they expected something of the recent fall and seem comfortable that the worst is over.

The supply demand balance, is, naturally, also extremely important in determining the prospects for the tanker market’s health in 2005. The JP Morgan report looks for fleet expansion of 19.2 mdwt, or 5.9% capacity growth, in the coming year while Citigroup reports demonstrate comfort with a slightly higher growth number of around 21.5 mdwt, a growth rate of close to 7%. As the orderbook is a known number, discrepancies revolve more around scrapping expectations, largely involving how tanker companies will deal with the new IMO regulations set to come into effect in April of this year. In the demand arena, Citigroup’s Kartsonas expects growth of around 2% as compared to 7% this past year, with OPEC’s one mbpd production cut to reduce tanker demand by as much as 7-8 mdwt with a shift to less long-haul and more short-haul tonnage. OMI’s Robert Bugbee told Tradewinds that he expects demand to be stronger than this, pointing out factors such as China’s intent to build a strategic petroleum reserve that could easily raise demand by one mbpd. Also on the upside, the JP Morgan analysts used IEA forecasts to estimate tanker demand growth of 13.5 mdwt. This discrepancy seems to be largely geographic with respect to oil supply.

Yet another dispute revolves around whether shipping stocks are cheaply or expensively priced. Kartsonas notes their expense relative to historical levels while the JPM analysts note their cheapness relative to many other industries. You can look for yourself at their P/NAV ratings in the “Fair Value” table. As usual, the truth probably lies somewhere in the middle. While the extraordinary spot rates witnessed in the past few months may have dissipated, current rates are still comfortably above breakeven levels, which are estimated in the low $30Ks for a typical being above mid-cycle and even comparable to annual highs in more typical years as shown in “Rate Comparison” chart. Not only that, but this past boom has seen shipping companies increase transparency, modernize their accounting practices and begin to access whole new pools of capital, all of which contribute to lowering their cost of capital and increasing the opportunities for financing available to owners and operators.

The tanker companies are now seeing that not all their new supporters will stick around when the fad passes, but they have undoubtedly succeeded in raising their profile and increasing the breadth of their long-term support base. Just as importantly, the companies are continuing to demonstrate strong performance, in a far more sustainable fashion than before, and, as the JP Morgan trio pointed out, they offer the potential for share buybacks, dividend increases and consolidation.