STNG - Scorpio Tankers Should Benefit From Rising Dayrates

2023-12-22 23:24:13 ET

Summary

• Scorpio Tankers is set to benefit from the tailwinds in the product tanker market and rising dayrates.
• The fallout from two wars and a drought impacting the Panama Canal are leading to longer routes and less effective capacity.
• STNG is well positioned to benefit from the current market dynamics unfolding.

As the largest pure play product tanker company in the world, Scorpio Tankers ( STNG ) is set to benefit from the tailwinds in the product tanker market and rising dayrates.

Company Profile

STNG is the world’s largest owner of clean product tankers. Its fleet consists of 59 MR tankers, 39 LR2 vessels, and 14 Handymax ships, although it is in the process of selling 1 MR vessel for $33.7 million. LR2 are the largest of the vessel classes, with DWT between 80,000-120,000. They are designed for longer voyages between 40-60 days. MR tankers, meanwhile, are smaller at 40,000-54,999 DTW and generally have voyage lengths between 20-35 days. Handymaxes are the smallest vessels at 25,000-39,999 DWT and have typical voyage lengths of 15-20 days.

The average age of STNG’s fleet is under 8 years old. Nearly 90% are fitted with scrubbers. Most of the company’s fleet operates on the spot market, although it has 15 vessels chartered out on medium term contracts (mostly 3 years in duration and one with a 5-year duration) that expire between June 2025 and July 2027.

Opportunities and Risks

With over 85% of STNG’s vessels currently operating on the spot market, spot dayrates for transporting refined products is the biggest driver for the stock. While dayrates for product tankers has been volatile the last couple of years, there are currently a number of tailwinds in the industry.

The Ukraine-Russia conflict and subsequent Russian oil price cap has played a big role in the maritime shipping markets, including for product tankers. With Russia now shipping refined products to new markets such as Brazil and the U.S. shipping more to Europe, routes lengths have increased greatly. Longer routes, in turn, create less overall effective cargo capacity in the market.

Meanwhile, the crucial Panama Canal has had drought issues this year that has limited the number of vessels that can transverse the waterway. The Canal handles about 5% of global seaborne trade and this has caused a major disruption. This has led to some companies paying huge premiums to jump the line in special auctions, while others have opted to avoid the canal and take longer routes. This has led to some outsized dayrates, with STNG getting a rate of $166,000 a day for its STI ESLEs II on a route from the Gulf to the west coast of Ecuador. Its average dayrate in Q3 on a MR vessel was $28,587.

More recently, Yemeni Houthis rebels began attacking shipping vessels in the Red Sea as a response to the Israel-Gaza war. While the U.S. and other nations are creating a force to protect ships in the area, many shippers have begun to divert ships from the Red Sea and take the longer Cape of Good Hope route.

All of these international issues are leading to longer routes and less effective capacity, which should drive up spots rates and in turn benefit STNG. The company notes that $10,000 increase in dayrates is equal to about $350 million in annualized cash flow. The company has generated about $680 million in operating cash flow the first nine months of this year.

In addition to spot rates being a driver, the company has also been unwinding expensive lease financing on its vessels. The company has repaid the outstanding debt on 56 vessels since August of 2022. Meanwhile, it expects to repurchase 22 vessels under lease financing in Q4, of which 8 had already been repurchased as of early November. Ultimately, the company is looking to bring its debt down to about the scrap value of its ships. In addition to lowering leverage, this will also bring down STNG’s breakeven from about $17,000 a day to under $13,000 a day.

In addition to reducing debt, the company has also been buying back shares and increasing its dividend. It will look to continue to repurchase shares as long as the price is below its current net asset value ((NAV)). It could also look to issue some special or enhanced dividends like others in the space have issued.

When it comes to risks, the spot market can also reverse course. Currently dayrates have benefited from the fallout of two wars, and those wars will presumably eventually end. The Panama Canal, meanwhile, will increase daily transits starting in January , although be below normal levels. Refined oil demand can also play a role in dayrates, and if the global economy collapses into a recession, demand for refined products would move lower, as would likely dayrates.

In addition to geopolitical and economic issues, the supply of ships is another factor that plays a role in dayrates. Historically, much of the shipping industry has seen boon and bust cycles, where strong periods are followed by a jump in newbuilds, which is turn increases the supply side of the equation and sees dayrates tank. On the product tanker side, the order book currently looks manageable, while the number of vessels over 20 years old is pretty higher over the next five years. Under normal circumstance, scrapping typically occurs between 20-25 years, although when the market is strong, owners do try to extend the life of these older vessels.

Valuation

STNG trades at 4.7x the 2023 EBITDA of $929.8 million and 5.2x the 2024 EBITDA consensus of $853 million.

On a PE basis, it trades at 6x 2023 EPS estimates of $10.32. Based on the 2024 consensus for EPS of $10.22, it trades at 6.1x.

STNG stock trades towards the lower end of other marine shipping companies.

Based on the strength of the product tanker market and where other marine shipping companies trade, as well as its strong balance sheet, I think the company can command between a 5.5-6.5x multiple on 2024 EBITDA. The company should also be able to reduce debt by at least $500 million based on current spot rates. That put a fair value on the stock of between $75-93.

Conclusion

STNG is a nice way to play the current strong market in product tanker dayrates. The industry has a lot of current tailwinds that should help push rates moving forward, while a modest order book and aging global fleet bode well over the medium term. The company also has a lot of nice capital allocation opportunities that should benefit shareholders.

While operating in the spot market comes with risks, currently the risks look manageable and dayrates look like they should continue to march higher. Given the strong market and upside in the stock, I’m going to start the name with a “Buy” rating. My target is $85.

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