STNG- Scorpio Tankers Inc. engages in the seaborne transportation of refined petroleum products worldwide. As of October 1, 2019, its owned or finance leased 124 product tankers, including 42 LR2 tankers, 12 LR1 tankers, 56 MR tankers, and 14 Handymax tankers with an average age of 3.7 years.
In October 2016, the International Maritime Organization (IMO), the United Nations agency for maritime safety and the prevention of pollution by vessels, set January 1, 2020 as the implementation date for vessels to comply with its low sulfur fuel oil requirement, which cuts sulfur levels from 3.5% to 0.5%. Shipowners may comply with this regulation by using 0.5% sulfur fuels on board, which is likely to be available around the world by 2020, but likely at a higher cost, or installing scrubbers for cleaning of the exhaust gas.
This event that involve important investments from companies produce two effects: in the short term (1-2 years) each ship will have to be docked at least 30 days at a shipyard in order to carry out repairs which will decrease the available fleet at a certain point, and another long-term effect will lead to the effective decrease of the fleet because for the old vessels the investments will be very high in relation to their market value, which will make them uneconomical to operate. Costs of compliance with these regulatory changes may be significant and may have an adverse material effect on vessels over 15 years old, because at their present value it is not economical to invest in them.
To begin with, I want to tell you that my philosophy is to be able to answer the questions below and to invest accordingly.
First – how to think about the company :
1. What is the competitive advantage based on? Apart from the fact that it owns the largest fleet on petroleum products and is also the newest in the industry, it does not have a competitive advantage. In fact, in this industry you can hardly have any significant competitive advantage.
2. Why does it work? Why now? IMO 2020 first, and then what convinces me the most is the supply direction, which is still in decline. The orderbook is small and aging vessels will lead to a shortfall in the market. At the moment, banks are not happy to lend to shipping companies, which leads me intuitively to the fact that it is not too much interest to invest in this market, which will lead to a shortage of supply. This is the most important thing in the long term in this industry.
3. How long can it continue? How long will the opportunity last? If the factors described above will materialize in the market, the offer can be restored in a longer period of time. Freight rates can normalize and maybe even increase for a sufficient period of time for the price to increase significantly.
4. What are the forces that can affect it? In general, shipping activity is volatile and can suffer sudden and less predictable movements. If companies fail to pass customers increasing costs ( with scrubbers or with low sulfur fuel consumption) and rates do not increase in the next period, losses may continue. The first who will lose will be those who have old fleets, that will try to remove them from the market, thus creating the premises for a return of rates, based on shortage of supply.
Second – how to think about the market: what are the expectations in the market, what is the feeling.
1. Is the opinion different from the consensus? Yes. If the market were confident that rates would continue to rise or even that they would be maintained at the current level, the price would be much higher now.
2. Am I right? You can never know, but I say that there are a few factors that will lead to a shortage of vessels in the market and consequently to an upper rates. If the rates will not increase now, they will increase in the future, since some companies had been sold at the beginning of the year at a level below the replacement cost.
3. What is missing Mr. Market? I think it’s a processing problem in the middle. It is not very clear to what extent the offer will fall due to the drydocks for IMO 2020 and to what extent bunkers (fuel costs), the largest expense in shipping, will afect the profit. Against the consensus I see the rates remain at a high level and the bunkers to be passed to the customers
4. When the gap will close? A good point in shipping is that the information is incorporated quickly , if a good Q4 is announced, with an optimistic outlook, I think it price will increase a lot. If my thinking proves to be good, the investment thesis it will be quickly validated by the market.
STNG being one of the largest companies in the shipping of petroleum products, it can increase the most because large funds will want to buy at some point.
I think that at an average level of rates comparable to this year, STNG will generate an important free cash flow respective to the current market capitalization of $ 1.97 billion.
I believe that now the future benefits are greater than the risks involved but don’t forget, future is always uncertain.
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This article was written based on independent thinking of the author and also following a subjective rationing, is based on available public information, cannot be considered accurate and it not represent an investment recommendation.
Behind10k is not engaged in an investor relations agreement with Scorpio Tankers nor has it received any compensation from Scorpio Tankers for the preparation or distribution of this article.
The author of this article has acquired of Scorpio Tankers through open market transactions and for investment purposes only, an can sell the shares without notice.
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