Tuesday, July 12, 2011

A Tale of Two Tanker Companies


Just because a sector seems weak doesn’t mean there aren’t serious pockets of value there, notes Peter Staas in Personal Finance. Look at oil transport, where the battleship of the industry is sinking, allowing small privateers to claim its territory.

The economic recovery has brought little relief for tanker companies that have substantial exposure to the spot market, where vessels are available for short-term leases.

Although US oil demand continues to recover from its recessionary nadir, and consumption in China and other emerging markets has increased markedly, spot rates have recovered only marginally over the past few years.

In many ways, these challenges are the industry’s own doing: Tanker capacity has swamped demand for oil shipments. The roots of this overhang trace back to the last bull market for tankers, when many operators ordered new vessels from shipyards based on overzealous assumptions about demand trends.

According to the world’s largest supertanker operator, Frontline (FRO), the industry abstained from ordering any very large crude carriers (VLCC) in the first quarter, and 28% of new vessels slated for delivery during that period have yet to arrive.

Moreover, some tanker operators have converted outstanding VLCC orders into carriers capable of carrying liquefied natural gas (LNG), a market where tanker rates continue to climb amid rising demand for natural gas in Europe and Asia. Meanwhile, only 13 Suezmax ships were delivered, a slippage of 43%.

From the beginning of the year to June 10, VLCCs traveling from the Middle East to the Far East commanded an average day rate of $19,129—well below Frontline’s break-even rate of roughly $29,700 per day. At times, these day rates dipped to as low as $5,045.

With only 11% of its fleet covered by long-term charters in 2012, Frontline will continue to struggle. Even worse, the average day rate on a five-year charter is $34,500—a price that offers only limited profits for Frontline.

Given these challenging fundamentals, it’s little wonder that the company’s Vice President, Tor Olav, told delegates at the Nor-Shipping conference in late May: “We have to go through a lot of pain before we’re into profitable territory. We have just started on a down cycle, which is going to be brutal.”

Frontline’s difficulties stand in stark contrast to Knightsbridge Tankers (VLCCF), which has 77% of its tankers booked under time charters.

Knightsbridge owns four VLCC tankers. One ship operates on the spot market, and is managed by a cooperative. The other three VLCCs are on time-charter deals: One expires in June 2011, one in May 2012, and the final in August 2012.

In addition to VLCCs, Knightsbridge also owns two smaller dry-bulk carriers, ships designed to transport dry commodities such as coal, grains, and metals. These two ships, both built and put into service last year, aren’t due to come off their time charters until 2014.

Because Knightsbridge’s fleet is small, the single spot VLCC provides some leverage to an improvement in spot rates. Meanwhile, the time-chartered ships offer income stability that supports the firm’s 9.3% dividend yield.

And with an average break-even rate of $18,700 per day, Knightsbridge will have much more flexibility than Frontline when its current time charters expire.

Despite the differences between the two companies, Frontline Chairman John Fredriksen’s bearish outlook on the spot market for supertankers prompted shares of Knightsbridge and other companies with low operating costs and solid time-charter coverage to sell off. Frontline is regarded a bellwether for tanker stocks; many investors assume that the industry’s fortunes follow those of its largest operator.

Investors looking for high yields and attractive valuations would do well to take advantage of this temporary misunderstanding and buy Knightsbridge.

No comments:

Post a Comment