SBBA - Scorpio Tankers: Why The Bulls Are Tapping Out

Summary

• STNG has started the year on the wrong foot, falling by about 11% amid a notable decline in product tanker rates.
• The Baltic Clean Tanker Index has fallen by as much as 67% YTD and sustained weakness could adversely impact STNG's revenue and earnings outlook.
• Product tanker rates have historically been a reliable crystal ball for STNG's stock and the current fall is therefore worrying.
• STNG's move to strengthen its balance sheet may not be enough to stem the selling pressure and recent price action suggests the bulls are headed for the exits.
• STNG also has a high valuation vs historical averages which could further weigh on the stock.

After returning more than 250% in 2022, Scorpio Tankers ( STNG ) has started off 2023 on the wrong foot. It has declined close to 14% YTD even as its market cap has fallen 20% from its December all time high of around $3 billion to the current $2.4 billion. I'm convinced that this is not a healthy correction following an unrelenting bull run, but early signs of an imminent and possibly significant downturn in the stock.

To be clear, I'm not pessimistic on STNG's underlying business. On the contrary, I consider the management's execution last year amid record high product tanker rates to be highly impressive. They made the right strategic decisions in my view and the market rewarded them for it.

Fortifying the balance sheet

STNG, which operates a fleet of 124 tankers that provide seaborne transportation of refined petroleum products across global shipping routes, capitalized on record earnings in FY 2022 to fortify its balance sheet through accelerated debt repayments. STNG brought down its outstanding debt by 40% to $1.87 billion in Dec 2022 from $3.16 billion in Dec 2021, even as cash balances doubled to $467.6 million from $230.4 million over this period. The Monaco based company has never made more money in its 13 year history as a publicly traded company than it did in 2022.

STNG's improved financial position, along with potent catalysts such as record high product tanker rates in 2022, and a historically low valuation, helped propel the stock through its incredible bull run during the year. I initiated a long position in the stock in Q2 2021, sharing with SA readers in a June 2021 article that STNG was positioned to significantly increase in value given its undervaluation (at the time) and the prospect of higher product tanker rates. I added to my STNG position in 2022 as the thesis played out and rates skyrocketed. I even encouraged investors to cautiously invest in June 2022 in this article .

However, past performance is not the basis of my investment decisions and I gladly sold my holdings in Q4 2022, noting in a recent article in December that it was not the time to get greedy as product tanker rates were likely to decline in 2023 after a record surge.

I still hold this view and reiterate my sell rating given the recent precipitous fall in the Baltic Clean Tanker Index (BTCI), which has fallen more than 67% YTD. The BTCI is a measure of prices to ship refined petroleum products across global routes. It has been in a free fall since the last week of December 2022.

Notoriously cyclical

STNG is in a notoriously cyclical sector where good times don't last forever. Those who think that "this time it's different" need to look at how rapidly the BTCI has fallen in less than four weeks. Product tanker rates are normalizing and this will likely deflate STNG's stock. Investors should take STNG's rough start to the year as an ominous sign of what is to come in the coming weeks and months as product tanker rates crater.

Spot prices as measured by the Baltic Exchange had slipped below $30K per day across all major types of vessels as at Jan 24th. In contrast, STNG enjoyed rates as high as $45K per day in Q4 2022.

With product tanker rates coming back to a normalized range, STNG's revenue and earnings outlook could weaken in 2023. Although STNG indicated in its Q4 2022 earnings presentation that it had secured a 3 year time charter out agreement for some of its vessels with a major oil customer at an average rate of $37,500 per day, this is not enough to shield it from falling rates. STNG still heavily relies on the spot markets and its earnings are vulnerable to the downturn in product tanker rates.

In the past, product tanker rates have been a reliable crystal ball that have foretold the trend in STNG's stock price. I expect this to remain the case and see more downside to the stock given how the BTCI has started the year.

Underperforming the broader market

STNG outperformed the S&P 500 in 2022 but in the four years before that invariably underperformed the broader market by a wide margin.

What changed in 2022? STNG benefited from the unprecedented surge in product tanker rates. This was an unusual event that I don't expect to replicate itself in 2023 with a recession looming and given how product tanker rates have started the year.

While some STNG bulls might argue that the company's stronger balance sheet fundamentally changes the picture, the recent price action suggests that investors are awakening to the reality that product tanker rates are the most decisive factor when it comes to STNG's stock performance. Bulls are tapping out because product tanker rates are declining. I expect this trend to remain as long as tanker rates remain weak in 2023.

Main risks to thesis

Several factors could lead to my thesis falling apart in the next 2-3 quarters. With oil inventories near historic lows, refining capacity closures and oil demand increasing in China, product tankers are still in great demand. They are also being used to supply more immediate demand and from further afar following disruptions to shipping routes brought about by the Russia-Ukraine war. The supply of product tankers is also at a record low, and this could help support elevated product tanker rates. These factors could push tanker rates higher and possibly fuel a rally in STNG.

That said, my investment style is more along the lines of responding to events instead of trying to predict the future. At the moment, product tanker rates are falling and could, in my view, remain weak for a quarter or more. Moreover, STNG's valuation is look lofty at current levels. Even though its EV/EBITDA of 6.32x is 68% lower than its 5 year average EV/EBITDA, its price to sales (Fwd) of 2.13x is 37% higher than its 5 year average P/S ratio. I would defer to price to sales as the metric of choice here since EBITDA (the denominator for EV/EBITDA) was abnormally high last year amid record high tanker rates, hence the low multiple. By P/S ratio, STNG is overvalued. Why pay more for a stock that has likely already peaked and is facing the prospect of weaker earnings in the coming quarters?

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