Scorpio Is Bullish on the Tanker Market, But Is it Right?

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Scorpio Tankers (NYSE: STNG), led by shipping veteran Robert Bugee, is looking to become the biggest force in the tanker market after buying much of the global capacity for tanker production for the next few years.

The company currently owns 15 vessels and operates an additional 25, which are chartered. Scorpio also has 54 new vessels on order and holds about 60% of the worldwide contracts to build LR2 longer range tankers and 25% of worldwide contracts to build medium range tankers. The company believes that by ordering a fleet of similar, longer range vessels, it will be able to achieve better economies of scale.

The global tanker market has been suffering from chronic oversupply problems during the past few years, and although the market is starting to pick up again, part of the reason for its pick up is a reduction in the number of ships being produced. Scorpio's management believes that demand for oil and refined product transportation will pick up rapidly over the next few years as demand in Asia and Latin America grows.

However, the rest of the industry is not so sure and the CEO of Nordic American Tankers (NYSE: NAT) has clearly stated that a rise in shipping rates will only happen if there is a significant reduction in ship capacity. Some orders left over from 2007/2008, when the market was at its peak, are only just starting to be delivered and ship production was in-line to begin tapering off next year, but with Scorpio's extra bullish bet, this could be about to change.

Can Scorpio support the extra ships?

It would appear that Scorpio can afford to take on the extra debt that it needs to be able to fund the ships. The company increased its borrowing by 23% from Q4 2012 to Q1 2013, but still managed to reduce its debt to equity level while increasing its net cash position (this was done by issuing additional equity).

Scorpio is also in one of the best positions financially out of all the tanker companies on the market. Unlike Nordic American, which has a negative view on the tanker market in the short-term, Scorpio made a small Q1 2013 profit, the first time since 2009! Meanwhile, Nordic incurred a huge $32 million loss on revenue of only $17.3 million.

<table> <thead> <tr><th> <p>Company</p> </th><th> <p>Cash</p> </th><th> <p>Debt</p> </th><th> <p>Debt to Equity Q1 2013</p> </th><th> <p>Debt to Equity Q4 2012</p> </th></tr> </thead> <tbody> <tr> <td> <p>Scorpio</p> </td> <td> <p>$400</p> </td> <td> <p>$175</p> </td> <td> <p>20%</p> </td> <td> <p>34%</p> </td> </tr> <tr> <td> <p>Nordic American</p> </td> <td> <p>$23.6</p> </td> <td> <p>$250</p> </td> <td> <p>32%</p> </td> <td> <p>31%</p> </td> </tr> <tr> <td> <p>Teekay</p> </td> <td> <p>$172</p> </td> <td> <p>$1,873</p> </td> <td> <p>290%</p> </td> <td> <p>270%</p> </td> </tr> </tbody> </table>

Figures in $U.S. millions

Meanwhile, Teekay Offshore Partners (NYSE: TOO), a owner-operator of shuttle tankers, is finding it hard to turn a consistent profit as day rates vary. During the last four years, Teekay's net income has fluctuated between $(116) million and $122 million (2012). In addition, during the past five quarters, net income has swayed between $(12) million and $68 million with an average of $28 million per quarter. Furthermore, Teekay's huge debt pile is strangling the company's net income, as debt interest alone accounted for 25% of EBIT during 2012.

Scorpio has one of the best balance sheets in the business with low levels of debt and the company's asset base just keeps growing, but for how much longer? With the company's fleet projected to more than double over the next few years, based on the number of ships on order, the company will have to find customers to use them.

According to U.K.-based Drewry Maritime Research, global supply in the tanker market still exceeds demand by about 87 million dead-weight-tones and supply is still far outstripping demand as demand for tankers expanded 0.6% during the fourth quarter of last year while supply expanded 1%. In addition, supply is expected to exceed demand by almost 200% during 2013 as new ships continue to be delivered that were ordered back in 2007/2008. 

Foolish summary

So, Scorpio is making a huge bullish bet on the tanker market and the company could be right. Whatever the outcome, it would appear that Scorpio is in the best position to make this bet as the company has one of the best balance sheets in the tanker sector and the company has just returned to profitability. For investors who like risk, Scorpio could be a good punt, but risk averse investors should wait for a stronger recovery in the shipping sector.

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