Summary
- Shortage of refined petroleum products - not oil - will lead to a spike in shipping demand and increased ton-mile demand.
- The Russia-Ukraine conflict has strained Europe’s energy supply, with threats of additional supply constraints ahead of winter, leading to increased ton-mile demand.
- Scorpio Tankers is well positioned to capture increased demand with largest, youngest fleet vs. tanker competitors.
- High debt levels are a cause for concern, as well as a lack of profitability with negative NI for the last 4 of 5 years.
Investment Thesis
Scorpio Tankers (STNG) has had an impressive run this year, up roughly 150% since last September. Much of this run has been attributed to an increase in demand for tanker shipping services, due to a shortage of refineries, and therefore a shortage of supply of refined petroleum products as much of the world went back to business-as-usual coming out of the historically low inventories period that was COVID-19. With the ongoing Russia-Ukraine conflict and more strains on the supply of gas to much of Europe in the very near future, there is reason to believe in increased demand for tanker shipping services in the short-to-medium term. This acts as a catalyst for Scorpio Tankers, which I believe is well positioned to capture the additional demand.
Outlook
From a top-down lens, the maritime shipping industry - and more specifically, the oil tanker shipping industry - has a positive outlook and is expected to grow. Growth is largely attributed to demand returning to pre-COVID levels, planned increases in production by OPEC ( Bloomberg ), and an existing refineries shortage raising the price of post-refinement shipping ( SP Global ). In greater context, there is a macroeconomic need to source oil and gas from other countries, as Russia threatens to further cut Europe off from its supply, all of which contributes to growing opportunity for .
According to a Scorpio presentation in Q3 2020, many oil refineries closed in 2020 due to poor margins and increased environmental regulations and competition, causing some refineries to close or convert infrastructure to non-refinement processes ( SP Global ). These closures have continued into 2022 , even as demand has begun to recover. As a result, refined petroleum products are scarce, ultimately bidding up the price and ton-mile fees for post-refinement products whose production will likely be replaced through imports.
To further add to supply shocks, according to a Bloomberg Intelligence report by Lee Klaskow, the Russia-Ukraine conflict is dislocating supply worldwide. This, again, is good for tankers like Scorpio for two reasons: (1) Increased pricing power and (2) increased ton-mile rates. With many countries in Europe facing an energy crisis due to supply constraints, there is desperation to meet demand and countries are forced to become price takers to meet their needs. As for ton-mile rates, simply put, the countries in Europe who are being either restricted or totally cut off must source their energy needs from elsewhere, which increases the distance traveled by these tankers.
There are two catalysts that could benefit STNG in a huge way: colder temperatures and ongoing supply constraints. Despite what was supposed to be a fugacious fight, the world is now witnessing Russia's sixth month of invading Ukraine, with no measurable end in sight. This staunchly disrupted Europe's energy supply early on, and Russia continues to threaten further measures to restrict supply. Given this world stage, I foresee Russia making good on their threats just when Europe needs fuel most - Winter. As temperatures start dropping, the need for fuel grows, further increasing ton-mile rates and STNG's pricing power.
Scorpio Tankers has spent the last several years decreasing the average age of its fleet by purchasing new tankers, and in 2022, exercising a purchase option on tankers that added six tankers to their fleet. Scorpio is now the largest tanker company worldwide, with a young fleet that will have less idle time and fewer demerits , which I believe will allow them to efficiently capture the increase in demand for post-refinement shipping services.
Risks
As always, there are risks I'll note that cannot be overlooked. Although Scorpio has reduced debt from close to $3B as of year-ended 2021 to $2.6B of July 27th, 2022, Scorpio is still a highly levered company at current debt levels, with a debt to EBITDA ratio of almost 9. It will be important to monitor debt levels and how well they continue to pay down and service their debt.
Another concern is their lack of profitability. In the last five years reported, Scorpio was only profitable in 2020. While the case is similar for their peers in the tanker industry, these are two risks that should be monitored before considering an investment.
Valuation
Although STNG is up close to 150% since last September, I do believe there is room for additional upside. What I believe is already priced in is the return to normal demand post-COVID and the closure of refineries during that period. What I do not believe has been priced in is additional refineries continuing to close, as well as the prolonged Russian war and how grave the energy crisis will become in the next few months, leading to increases in pricing power, ton-miles rates and ultimately margins for Scorpio Tankers' perspective. From a comparables standpoint, Scorpio's estimated EV/EBITDA is only about half of the industry estimated median, as well as a P/B and P/EBITDA ratio below the industry median.
Conclusion
The oil shipping industry has a positive growth outlook as energy demands return to pre-pandemic levels, coupled with the Russia-Ukraine conflict that will lead to supply dislocation and an increase in ton-mile prices. The demand for Scorpio's refined product shipping will also outpace that of crude-tanker shipping, as there exists a shortage of refineries which lends pricing power to Scorpio Tankers by customers who are willing to pay a higher price for limited supply. Additionally, with the largest and youngest tanker fleet in the industry, I see Scorpio Tankers as being a trusted company to fulfill post-refinement shipping needs, and I believe they will be able to capture much of this excess demand. While their risks are not to be ignored, their comparable valuation indicates there is additional upside as long as they can continue to pay down debt and grow their margins.
For further details see:
Scorpio Tankers: Further Upside From Refinery Shortage And European Energy Issues