TNK - Ardmore Shipping: Forecasting Favorable Winds In The Market

2023-08-07 21:15:57 ET

Summary

• Ardmore is a buy due to elevated market rates, positive and clear capital allocation, and the status of their fleet.
• Ardmore's capital allocation policy includes deleveraging, dividends, and investments in performance upgrades and environmental technologies.
• The younger fleet provides operational efficiency, reduced maintenance costs, and potential for improved profitability, positioning them well relative to peers.

This will be a continuation of our analysis of the oil tanker industry. You can see our current articles and thoughts on Scorpio Tankers ( STNG ), Teekay Tankers ( TNK ), and Nordic American Tankers ( NAT ).

In this article we will discuss Ardmore Shipping, ASC's, most recent earnings, their strategic positioning, as well as their capital return policy outlined by in their most recent earnings call. Based off of these factors we are placing a conservative rating of Buy with a Price Target of $16.

Ardmore Shipping's Q2 2023 Earnings Call

Ardmore Shipping Corporation, a provider of seaborne transportation of petroleum products and chemicals worldwide. They recently held their Second Quarter 2023 Earnings Conference Call on August 4, 2023.

Despite the challenges posed by the ongoing global economic turmoil, Ardmore has demonstrated remarkable resilience. Like the rest of the Oil Tanker market, the company's medium-range (MR) and chemical tanker time charter equivalent (TCE) rates have remained at elevated levels, significantly above Ardmore's cash breakeven rate of $14,000 per day.

For the second quarter, the company reported adjusted earnings of $23.7 million, or $0.57 per share. The robust market conditions are continuing into the third quarter, with MRs being booked at high rate of $26,100 per day, and chemical tankers, on a capital-adjusted basis, earning $20,400 per day. With 45% and 63% of those dates being booked already.

Ardmore has successfully executed its capital allocation policy, which has included continued delevering to enhance earnings quality. The company declared a quarterly cash dividend of $0.19 per share.

Capital Allocation and Investment Plans

The company's strong financial position and robust operating performance allow it to pursue all of its allocation priorities simultaneously. In their recent earnings call , Anthony Gurnee outlined the playbook targets for their earnings distributions.

1/3 by formula is being paid out to investors; more than 1/3 is going into CapEx, mostly performance upgrades; and then what's left is there to continue delevering.

The current dividend share matches this playbook perfectly with ~31% of the net income being returned to investors this quarter through dividends. The management team also highlighted that as they shore up the balance sheet, the idea of special dividends was not off the table.

In addition to these initiatives, Ardmore plans to install nine second-generation carbon capture-ready scrubbers onboard its vessels in 2023 and early 2024. The company will also install performance-enhancing technologies and ballast water treatment systems during its eight scheduled drydocking periods this year. These investments, which have relatively short payback periods and internal rates of return ranging from 20% to over 100%, will not only reduce Ardmore's carbon footprint but also significantly improve performance and protect it from regulatory risk.

Something of note from this capital allocation strategy is the lack of the tax-efficient share buybacks that other companies are employing in their sector. Also of note is that they have been net sellers of shares with shares growing from 35 Million in Q2 2022 to 40.7 Million in Q2 2023. This is in addition to preferred shares.

Fleet

A deep dive into the fleet status and composition of a shipping company is paramount to understanding its competitive position and operational efficacy. Ardmore Shipping Corporation ( ASC ) is no exception to this rule, with a diversified fleet comprising a mix of leased, time-charter-in (TC-in), and owned vessels.

As of the second quarter of 2023, Ardmore has comparatively young fleet, with an average age of 9.2 years. To put this into perspective, ASC's fleet age compares favorably with competitors such as TNK and NAT. The DWT-weighted average build year for ASC stands at 2013.8 while it is 2009 for TNK, and 2011 for NAT, showcasing Ardmore's relatively youthful fleet.

The advantage of having a younger fleet extends beyond just operational efficiency and environmental compliance. In the current shipping market, which has been described as "frothy" due to high prices, the need for Ardmore to make significant additional capital investments in acquiring new ships is reduced. A younger fleet equates to less immediate pressure to replace aging vessels, allowing the company to avoid paying a premium price for new ships in the heated market.

Furthermore, the younger fleet age contributes to reduced maintenance costs and downtime, lower fuel consumption, and enhanced cargo carrying capabilities, all of which can potentially lead to improved profitability. In essence, Ardmore's strategic commitment to maintaining a younger fleet places it in a strong position to navigate the volatile shipping market while enhancing its operational performance and financial health.

Market Outlook

Ardmore projects a favorable near-term outlook. Currently, the primary force shaping the market is the EU embargo, which is expected to persist. This embargo has set a price ceiling for Russian oil per barrel, resulting in a reshuffling of global trade routes. Consequently, tonne-miles for the entire oil tanker fleet have surged, leading to greater demand and reduced supply for worldwide consumers. The most significant contributors to this tonne-mile trend are the routes from Russia to India and the US to the EU. As the conflict between Ukraine and Russia lingers, coupled with escalation in the Black Sea , these increased tonne-mile patterns, driven by the EU embargo, are anticipated to remain.

With that said, market rates influenced by these circumstances may stay unpredictable, especially if Russian Oil continues trading above the $60 per barrel EU imposed cap. A decline in charter rates is probable if more vessels divert from these longer routes. Nevertheless, considering the minimal global fleet growth and ASC's low daily breakeven, they appear well-equipped to navigate these challenging waters.

Valuation

The Enterprise Value (EV) to Market Capitalization ratio is a particularly valuable metric in the shipping industry, and indeed in any capital-intensive sector. The reason lies primarily in the significant role that debt plays in these industries. Unlike market capitalization, which solely reflects equity value (calculated as the stock price multiplied by the number of shares outstanding), EV incorporates the company's debt and cash levels. This is crucial for sectors like shipping, where companies often leverage substantial debt to finance their fleets.

This ratio enhances comparability between companies, especially those with differing capital structures. For instance, a company heavily laden with debt might appear inexpensive when assessing market cap alone. However, the EV to Market Cap ratio can reveal a different story, indicating the company is actually more costly once debt is factored in. A company with a lower EV to Market Cap ratio might indicate an undervalued entity, given a significant part of its value comprises cash and equivalents. Conversely, a high ratio can serve as a warning sign, suggesting the company has a large amount of debt relative to its equity value, potentially marking it as a riskier investment.

In essence, the EV to Market Cap ratio offers a more comprehensive measure than market cap alone. It provides a holistic view of a company's value and financial health at a quick glance. As we can see ASC is trading among the lower quadrant of their peers with an industry average EV/MKT of ~1.4 they are trading at ~17% discount to that average. In addition to this they are trading around the same valuation of Teekay Tankers. As we have discussed here , Teekay's old fleet puts them in a position where they are going to have to reinvest in their fleet in order to maintain revenue. With their new fleet Ardmore Shipping doesn't have to invest in their fleet as dramatically and is in what we believe is a better position to return capital to investors in these elevated charter rate times.

Conclusion

Given Ardmore Shipping Corporation's distinctive size and balance sheet position, we anticipate that they will continue to return significant capital to investors, particularly as Time Charter Equivalent (TCE) rates remain elevated. The company has outlined a strategy of returning 33% or more of earnings to shareholders. Consequently, we expect higher earnings in Q3 and Q4 to translate directly into increased dividends for investors. This makes Ardmore an appealing option for income-focused investors, as we believe the company will provide solid income over the next several quarters.

While our optimism for Ardmore is slightly tempered compared to our bullishness on Scorpio Tankers, we still recommend adding Ardmore to investment portfolios in modest amounts. We give Ardmore a 'Buy' rating with a price target of $16. While this doesn't represent a massive upside from the current valuation, we believe that the combination of dividend income and anticipated earnings growth will offer downside protection up to that price point.

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