DHT - International Seaways: Smooth And Profitable Sailing

2023-08-10 11:23:02 ET

Summary

• International Seaways is well-positioned to thrive in the low global oil inventory environment due to their new fleet and barriers to entry in high-interest rate environments.
• INSW operates in both the spot market and fixed-rate time charter contracts, providing a diversified business model.
• The company's financial stability and profitability are supported by its breakeven analysis and competitive edge in regional imbalances and limited fleet growth.

This report delves into the company's operations, financial stability, profitability, competitive edge, risks, and a strategic trade proposition for investors. We believe that the low oil inventories around the world will allow Oil Tankers and specifically International Seaways ( INSW ) to thrive in this environment due to the newness of their fleet and the barriers that high interest rate environments provide.

About International Seaways

International Seaways, Inc., a titan in the global tanker industry, offers energy transportation services for crude oil and petroleum products. The company's operations span both the spot market and fixed-rate time charter contracts, providing a diversified business model that caters to the dynamic needs of the global shipping market.

In the spot market, INSW operates through single voyage charters, where the charterer pays a one-time freight rate for a specified voyage. The shipowner, in this case INSW, bears the vessel's operating expenses. Spot market rates are subject to the ebb and flow of global shipping market dynamics, primarily driven by supply and demand. According to their Q2 earnings presentation they have an average SPOT TCE of $38,000/day for Q3.

Conversely, under a time charter contract, the charterer leases the vessel for a predetermined period, assuming the costs of fuel and port charges. The shipowner, however, continues to manage the vessel's operating expenses. This arrangement offers the shipowner a consistent and predictable revenue stream, as the charter rate remains fixed throughout the contract duration. While time charters provide fixed revenues they do limit the upside if spots prices are higher than booked time charters.

As of July 31, 2023, INSW's fleet boasted 75 vessels, including 13 Very Large Crude Carriers (VLCCs), 13 Suezmaxes, 5 Aframaxes/LR2s, 7 Panamaxes/LR1s, and 37 Medium Range (MR) tankers. These vessels serve the crude oil and petroleum product shipping markets. The larger VLCC and Suezmax vessels primarily transport crude oil, while the LR1, LR2, and MR tankers carry refined petroleum products like gasoline, diesel, and jet fuel. Aframax vessels, due to their size, offer the flexibility of transporting either crude oil or refined products.

INSW's strategic focus lies in owning and operating a diversified fleet of crude and product tankers under medium to long-term charters, supplemented by spot tanker market trading. The company leverages its scale, customer relationships, and industry knowledge to generate stable cash flows and deliver competitive long-term returns for shareholders.

The Sales Story

INSW has demonstrated resilience and adaptability. The company's Q2 2023 results indicate a significant improvement over the previous year with revenue jumping from $188.2 Million to $292.2 Million with a fleet utilization rate of 99.5%. The company projects a strengthening product tanker market in the second half of 2023, driven by increased oil consumption, normalization of oil inventories, limited fleet growth, and the potential return of Iranian barrels. Think of the fleet as an arbitrage market mover, where significant geographic price differences incentive higher prices for those products to be shipped globally.

INSW's strengths come from their ability to have high degrees of operational leverage allowing them to benefit from the current elevated spot market prices of Oil Charters. This leverage allows them to generate strong cash flows to not only pay off their debts but also to deleverage, purchase back shares and issue special dividends all while maintaining a solid balance sheet.

Fleet Analysis

INSW's financial stability and profitability are further underscored by its breakeven analysis. The "All-in 12 Month" estimate of breakeven costs represents the average daily revenue that the company needs to cover all its expenses, including operating expenses, administrative costs, interest expenses, and capital expenditures. The "Effect of Fixed Revenue" represents the contribution from fixed-rate time charter contracts to the company's overall revenue. These contracts provide a steady and predictable revenue stream, regardless of market conditions.

Subtracting the "Effect of Fixed Revenue" from the "All-in 12 Month" breakeven costs results in a lower breakeven point. The guaranteed revenue from fixed-rate contracts reduces the amount of revenue that the company needs to generate from other sources (like spot market charters) to cover its costs. In simple terms, the fixed revenue acts as a "safety net," lowering the company's breakeven point.

However, it's crucial to note that this is a simplified explanation and calculation. The actual profits can vary based on several factors like fluctuating spot rates, the specific route and cargo, and various costs such as fuel prices, maintenance, and administrative expenses. Another key point is that not all the company's vessels may be available to charter on the spot market at all times due to existing time charter contracts or necessary maintenance and repairs. Therefore, the company's actual profits could be higher or lower than this calculation suggests.

INSW's competitive edge or "moat" comes from the regional imbalances of crude oil and refined products and limited fleet growth. The company's market is protected by low worldwide inventories and oil reserves which causes an increasing distance between oil producers, refineries, and end-user oil demand. In addition, the order book for oil ships stands at less than 4% of the current fleet, with asset prices at 15-year highs and shipyards at capacity with other shipping sector.

Risks

However, the company faces some significant risks. The oil tanker industry is highly competitive, similar to airlines, with many players vying for business. This competition can lead to price wars and thin profit margins, especially during oversupply periods. The industry also faces high fixed costs, including vessels, maintenance, crew, and fuel, and heavy regulations to ensure safety and environmental protection.

Oil tanker industries are sensitive to global economic conditions and events. For oil tankers, fluctuations in oil prices, changes in global oil demand, and geopolitical events can significantly impact business. Around 64% of the company's interest is fixed or hedged, leaving 35% on a floating rate, adding another layer of risk. However, Oil tankers hold significant inherent value as hard assets, providing a floor for asset values even in a worst-case scenario. In addition, the current trading rates for tankers are in elevated territory relative to a few years ago. The oil tanker industry operates in a cyclical market, which provides opportunities for companies like INSW that can effectively manage these cycles. Additionally, oil tanker companies often have a mix of long-term charter contracts and spot market operations, allowing them to capture upside during periods of high rates.

Other risks include global fleet expansion and geopolitical risks. With this said fleet growth is limited to 4% due to shipyards being full and high interest rates causing some concern around the breakeven analysis of these capital intensive ships.

A Strategic Trade

Investors seeking to hedge their bets in the volatile crude oil shipping industry might consider a strategic position that involves going long on International Seaways while simultaneously shorting DHT Holdings ( DHT ). This strategy could offer a protective shield against potential downside risks in the crude market, while still leaving room to capitalize on the upside potential of INSW.

Currently, DHT is trading at a forward price-to-earnings (P/E) ratio of 8.6X, which is more than twice the forward P/E ratio of INSW, which stands at 4.0X. This disparity is intriguing, given that both companies operate in the same industry and exhibit similar financial ratios and metrics.

However, a closer look reveals that INSW outperforms DHT on several efficiency and valuation metrics. For instance, INSW's operating margin and return on equity have consistently outpaced those of DHT, indicating superior operational efficiency and profitability. Furthermore, INSW's lower P/E ratio suggests that its stock is undervalued relative to its earnings, making it a potentially attractive investment.

By going long on INSW, investors can take advantage of this undervaluation and the company's strong performance metrics. At the same time, shorting DHT allows investors to profit from any potential overvaluation of the stock, thereby creating a hedge against industry-wide risks.

This spread trade strategy-long INSW, short DHT-could provide a balanced approach to navigating the crude oil shipping industry. It offers protection against downside risks while maintaining exposure to the upside potential of a company that has demonstrated robust efficiency and attractive valuation metrics.

Conclusion

In summary, International Seaways, Inc. presents a compelling investment proposition in the global tanker industry. The company's diversified business model, robust operational track record, and strategic focus on owning and operating a diversified fleet of crude and product tankers under medium to long-term charters, supplemented by spot tanker market trading, make it a strong player in the industry. In addition, their balance sheet allows them flexibility to the downside as well as to the upside. Despite the risks associated with the highly competitive and regulated industry, INSW's financial stability, profitability, and strategic trade proposition offer a balanced approach for investors to navigate the crude oil shipping industry.

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