STNG - Scorpio Tankers: Up To A 33% Potential Upside

2023-11-16 16:28:23 ET

Summary

• Scorpio Tankers released its Q3-2023 earnings, reporting a strong profit.
• The company's stock has increased in value by 9% since the beginning of the year and is currently trading at a 7% discount to its 52-week maximum.
• The oil tanker market dynamics, including disruptions in oil export routes and increasing demand for oil refined products, create favorable conditions for Scorpio Tankers and other tanker companies.
• The potential upside could be up to 33%.

A couple of days ago, Scorpio Tankers (STNG) released its Q3-2023 earnings report showing results that were a bit better than what analysts had forecast. The stock increased by about 5% in the following trading hours with trading volumes higher than the average. In this article, I will give an overview of the Q3-2023 results and I will explain why I believe that Scorpio Tankers – one of the leading oil refined product tanker companies – is still worth a buy recommendation. Indeed Scorpio Tankers has already grown a lot in the past quarters, but I believe there is still room to invest in the stock and capitalize on the favorable market conditions.

I have also recently covered other oil tanker companies such as International Seaways and Teekay Tankers .

Stock performance

Scorpio Tankers is currently trading at $58.2/share, equivalent to a market cap of $2.9 billion. Since the beginning of the year, the stock increased its value by about 9%, while, year-on-year, the performance shows a +18%.

When I wrote my last article about Scorpio Tankers, the stock was trading at $49.9/share and has gained about 17% since. The 52-week minimum is $41/share, recorded in July 2023, while the 52-week maximum is $63$/share, touched in February 2023. Therefore, Scorpio Tankers is trading at about a 7% discount premium to its 52-week maximum and at a 42% premium to the minimum.

Q3-2023 results

Despite declining 41% year-on-year, total revenue generation for Q3 was still strong at $291 M. The main driver behind the revenue decline is the fall in day rates across all vessel classes: LR2 rates declined by 17%, MR by 18% and Handymax by 45%. It is worth noting that Scorpio Tankers’ fleet is composed of 39 LR2 vessels, 59 MRs and 14 Handymax vessels. On the other side, the average number of voyage days for Q3-2023 was in line with the previous year. Revenues show a declining trend even if compared to the previous quarter: in this case, the decline is less strong (-12%) and is still motivated by the declining tanker rates. From my point of view, the revenue decline should not be seen as a worrisome event rather as a dynamic that is affecting all oil tanker companies.

The reduction in revenues was accompanied by a less-than-proportional decline in operating expenses. The total OpEx for Q3-2023 was $150 M (-18% year-on-year) with vessel operating expenses – the most relevant item - that was in line with the previous year at $79 M. On the contrary, voyage expenses were only $2 M versus the $34 M of the previous year since the company had a reduced number of vessels operating outside the Scorpio pools.

EBIT was $141 M (-54% y-o-y and -17% q-o-q) while net income was $100 M (-62% y-o-y and -24% q-o-q). While EBIT and net income are declining due to the drop of day rates, they are still at solid levels.

Cash flows

Considering the first nine months of the year, cash flow from operations was $679 M, mostly driven by the high net income ($4 M) and by the added-back depreciation. It is worth mentioning that the CFFO for 9M-2023 was higher than the 9M-2022 due to the decrease in inventories and receivables. Despite investments in scrubbers and other vessel minor improvements, cash flow from investing was positive at $16 M thanks to the sale of 2012-built MR STI Amber for $34 M. Cash flow from financing was negative at -$708 M and was the result of debt restructuring and repurchase of common stock ($489 M).

Liquidity and debt

When analyzing Scorpio Tankers, it is work focusing on its debt. At the beginning of the year, the outstanding debt was $2.0 bn while as of September 30 ^th , 2023, the debt has reduced by $200 M to $1.8 bn. By the end of the year, the company is targeting to further reduce the indebtedness level to $1.5 bn. At the end of Q3-2023, the debt is composed of $934 M in lease financing, $791 M in bank facilities and $71 M of unsecured notes. Cash and cash equivalent amount to $365 M, bringing the net debt to $1.4 bn or 48% of the current market cap. It is clear that the current debt that is on Scorpio balance sheet is still high, but the management has set some clear guidelines to reduce it. From my point of view, the deleveraging process will make the balance sheet much stronger and will also help the share price to go up. Indeed, as can be seen from the chart below, comparing Scorpio Tankers with two of the largest oil tanker companies - Euronav NV and DHT Holdings - one can see that a lower net-debt-to-equity ratio is usually associated with a higher price-to-earnings ratio. Therefore, if Scorpio Tankers managed to reduce its debt exposure, its P/E would be likely to expand, leading to an increase in stock price.

Shares repurchase program and dividends

Even during Q3-2023, Scorpio Tankers continued its share repurchase program by repurchasing 1.9 million shares for $91 M. Since the beginning of the year, the total amount of shares that have been bought back is 10 million, for a total cost of $490 M. The idea behind this strategy is that, as far as the market valuation is lower than the NAV, the company will continue to buy back shares rather than paying high dividends that, however, were still paid. Indeed, the quarterly dividend was raised from $0.25/share to $0.35/share.

Oil tanker market dynamics

Scorpio Tankers’ stock has gained a lot of value in the past quarters, but I believe that the run is far from over since the oil (and oil product) tanker market dynamics are creating favorable conditions to turn tanker companies into incredible FCF-generating machines.

As we all know, the oil export routes have been disrupted since Q1-2022 due to the Russian-Ukrainian conflict and the consequent European ban on oil (and refined products) imported from Russia. This has forced the EU countries to replace the Russian supply via pipe with oil coming in from other countries (USA, African Countries, Southeast Asia) leading to longer tanker voyages and stronger demand for vessels.

In addition, seaborne exports of oil refined products continue to increase due to a strong global demand, low global inventories and a dislocated refined capacity. In other words, the demand for oil-refined products is increasing in countries where internal production cannot meet demand and seaborn imports are thus needed. As a consequence, refined ton product miles are increasing leading oil tanker companies to have fewer idle days and higher bookings.

The two forces described above support the demand for vessels that, however, is currently not completely met by supply. Indeed, the number of oil tanker vessels is limited, and new orders are at historically low levels due to inflation, shipyards lack of capacity and uncertain future regulations.

Despite the day rates have been declining since the peak reached in Q4-2022, I believe that for all the reasons mentioned above, rates will remain at a level high enough to ensure profitability for oil tanker companies. A first interesting sign comes from Scorpio Tankers average Q4 rates (based on roughly a 50% booked capacity): the average rates for MR and Handymax are around $30k/day, higher than Q3-2023, while for the LR is about $40k/day.

Analysts’ view

Scorpio Tankers is currently covered by 12 analysts with 11 of them having a buy (9) or strong buy (2) rating. Only one analyst is a bit more conservative and has issued a hold recommendation. The average target price is $77.8/share, which would represent a +33% return on the current share price.

Risks

Today, one of the most relevant risks I can see for Scorpio Tankers is associated with environmental regulations. The risk that different countries could define different regulations to be met could mean that Scorpio Tankers would have to carry out unexpected capital expenditures to upgrade or modernize the fleet to make it more sustainable. However, I believe that since Scorpio Tankers’ fleet is quite modern - with an average age of 7.5 years - it is therefore more sustainable than older fleets such as International Seaways one (13 years average age).

Conclusion

Overall, I believe that Scorpio Tankers is a solid company. The management has started a program to reduce the indebtedness level and I believe that this will help support the stock price value. In addition, the oil tankers’ demand/supply keeps the industry under pressure pushing day rates up. All considered, I believe that Scorpio Tankers is still worth a buy recommendation.

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