Fight between the bulls and bears of oil tanker stocks continues

The daily movements in the stock prices of oil tanker companies are pretty wild. It seems like they can’t decide which way to go. This just shows you that there is a tremendous battle between the bulls and bears.

The bulls say, “Look at how much money these companies are making.” The bears say, “Who cares? The rates will collapse so it does not matter how much money these companies are making.” This goes on every day. A piece of information comes out saying that storage is in short supply, the bulls say, “See I told you so.” The next day, another piece of information comes out saying that less oil glut was created, and the bears say, “No you were wrong. I told you so.”

Today, April 29, 2020, was a brutal day. The bears had their day and some definitely took some victory laps.

Ok, let’s step back and think about what the entire thesis for the oil tankers is about. Is it to make $300k per day on VLCC rates? No. Is it to have all the ships storing oil? No. Is it to have oil contango for years? No. It is about making respectable rates for a sustained period of time in order to reward shareholders.

Look at the following income statement for Frontline from 1997 to 2008. The first six years represent a bear market in shipping and the second six years represent a fantastic bull market.

Look at the average rates for VLCC and Suezmax. The rates during the bull market were not 10 times the rates during the bear market. Yes, they are higher but they were not ridiculously higher. Now, look at the difference in net income. The rates of between $33,900 and $78,000 during the good years allowed Frontline to earn between $400 million and $1 billion per year.

This fundamental improvement caused the stock price of Frontline to go up 50x. I am going to say this again. 50x. This is not counting dividends.

In 2002, the average market cap was about $650 million. Frontline paid $340 million, $1 billion, $910 million, $655 million, $650 million, and $640 million of dividends in 2003, 2004, 2005, 2006, 2007, and 2008, respectively.

So this is what was possible with average rates for VLCC and Suezmax of between $33,900 and $78,000. Can you imagine what kind of net income and dividends are possible with rates between $100,000 and $300,000. This is mind boggling.

But the market does not care. The bears say that the rates this high are unsustainable. It is not about that. Take the rates between $100,000 and $300,000 for as long as you can, Then, hopefully, rates can go to back to respectable levels like the ones that brought bonanza between 2003 and 2008. The oil tanker companies do not need to make $100,000 or $300,000 per day in order to be hugely profitable. They just need to make rates high enough to have sizeable bottom lines. You might ask “Why would they have sizeable bottom lines if they are nothing but professional capital destroyers evidenced by the last 11 years?”

Look at the following income statement from 2009 to 2019.

After the bull market party ended in 2008, the average rates for VLCC and Suezmax went down. There was a spike in 2015, but for the most part, the rates were very low. In 2018, they hit rock bottom. (By the way, the spectacular analysts covering these stocks were extremely bullish in 2016). The low rates translated into very weak bottom line and pretty much non-existent dividends because you can’t pay dividends with losses.

You might ask why did the rates go down? One uneducated bear said that it is because it is a dying business. If he took some time to study the situation, he would have learned otherwise.

The reason why the rates were so weak from 2009 to 2018 was because the oil tanker industry ordered too many ships during the good times (2003 to 2008). That’s what cyclical industries do. They shoot themselves in the foot.

It took 10 years to work through that oversupply of vessels. During that time, older vessels were scrapped and banks stopped financing new orders. It was just matter of time before another cycle was going to start. Cyclical industries go through booms and busts. They don’t just have booms and they also don’t just have busts. The problem is that when these industries are going through busts, no one believes that they could ever experience another boom. When you get yourself high on heroin, you will come down for sure, but if you take another shot, you won’t stay down either.

In 2019, the cycle started turning. As you can see from the previous chart, the average rates for VLCC in 2019 was $39,400 versus $18,800 in 2018. The rate for Suezmax was $25,100 in 2019 versus $11,000 in 2018.

In 2019, when the market realized that the turn was happening, the stock prices of the oil tankers soared. Frontine went from $5 to $13 per shares. Teekay Tankers went from $8 to $25 per share. Euronav went from $7 to $13 per share. DHT Holdings went from $4 to $9 per shares. Scorpio Tankers went from $18 to $40 per share.

So all of this happened because the average rates on VLCCs went from $18,800 to $39,400 and Suezmax from $11,000 to $25,100. That’s it.

Now the rates for VLCC are between $100,000 and $300,000 and Suezmax between $50,000 and $115,000 but the stock prices are lower. A logical person would say that higher rates are better than lower rate. Nope. Too much of a good thing is a bad thing.

The bears are bearish. They say that the rates are not sustainable at these sky high levels and will collapse. Do the bears have some kind of mental disorder? They are selling these stocks because the companies are making too much money and when the rates collapse, they will be just making good money.

The rates between $100,000 and $300,000 are a once in a generation opportunity. But much lower rates are still fantastic. Rates were much lower between 2003 and 2008 and this did not stop Frontline from going up 50x.

I can already hear some bears saying “What makes you think that rates are not going to collapse to $11,000 for Suezmax and $18,000 for VLCCs?” This is where the supply and demand of ships come into play.

I already said that nobody is financing new ships especially when everybody thinks that the sky high rates are unsustainable. The order book is historically low. The ships that were ordered and delivered as a result of 2003 – 2008 bull market are becoming grandpas and grandmas. There are regulations that do not allow these grandparents transporting oil. They will be scrapped. The only reason why some of them are still around is because they can make a lot of money storing oil. So why not? Store the oil for 3 to 12 months and then go get scrapped afterwards.

Then, we also have the beautiful oil contango. Every day that there is more production than demand for oil, more and more ships are being taken out of the fleet to store oil. This pushes rates higher for vessels that are moving the oil. This also pushes rates higher for the vessels that are storing it.

When the quarantines end, the demand for oil will soar from the currently depressed levels and it will keep soaring as the economy recovers. The vessel fleet will stay reduced because a bunch of them will still be storing oil for months. The demand will likely be increasing at a faster rate than the vessels being released from storage. This should support vessel rates at reasonable levels especially if oil production stays higher than demand. And when everything returns back to normal, why can’t the cycle resume to what it already started in 2019?

I know this is oversimplified. A lot of you have a much better understanding of the situation than I do. The point that I am trying to make is that the current rates are fantastic. Such fantastic levels are not necessary for the oil tanker companies to make a lot of money. Therefore, the current rates should be enjoyed as long as they last whether this means a few weeks, months, quarters, or years. They should not be feared.

Disclosure: Long FRO, DHT, EURN, TNK, STNG

Oil tanker companies were also included in my book, How to Profit from the Coronavirus Recession.

About Mariusz Skonieczny 333 Articles
Mariusz Skonieczny is the founder of Classic Value Investors.