Tanker stocks are proving to be one of the hottest sectors of the market. There are valid reasons behind this hype. Beat Billions drilled down the tanker industry a few days earlier and concluded this industry will likely provide a stellar performance in the next 12 months, both from a financial and market perspective. What is the best tanker stock to buy? This is the question raised by many opportunistic investors who are trying to gain exposure to this sector. Euronav (EURN) is one obvious choice as the leading independent tanker company in the world. In full disclosure, the author of this article has already invested in Euronav shares. There are many articles published on Teekay Tankers (TNK) and Frontline (FRO) as well, and many investors are actively following these companies. Scorpio Tankers Inc. (STNG) is kind of a forgotten child that has not received much attention despite the hype about tanker stocks. STNG stock has declined by 47% in 2020, underperforming its peer group by a considerable margin.
The odds, as we believe, have tilted in favor of STNG to deliver market-beating returns in the coming months. A turnaround is on the cards and contrarian investors should pay close attention to this opportunity.
The thesis is centered on the expected turnaround
Scorpio Tankers is a loss-making company. Coming into 2020, the management was looking to turnaround the company in 2020, but Covid-19 landed a punch in the gut as the demand for crude oil fell sharply following the mobility restrictions imposed by governments around the world to curb the spread of the virus. The oil price war between Saudi Arabia and Russia, on the other hand, painted a gloomy outlook for the company and the industry as well. However, oil markets went into contango (futures contracts trading higher than the spot price for oil), drastically improving the prospects for the industry as oil majors ran out of storage space. With this, turnaround hopes for Scorpio Tankers have once again resurfaced, thanks to these abnormal market conditions.
If you still haven’t read our view of the tanker industry, here’s s quick summary of the two most important conclusions we reached last week. It goes without saying that these are critical assumptions in our model for Scorpio as well.
- Tanker companies are charging rates as high as over $100,000 per day (VLCCs charge close to $300,000 as confirmed by Euronav CEO) from oil majors for using their ships as temporary oil storage facilities. This will lead to a bump in earnings in the coming quarters.
- When oil market dynamics return to normalcy, the demand for tankers will still be high as countries around the world will restart their manufacturing operations.
The surge in per-day rents has significantly improved the odds of Scorpio Tankers to grow its net income this year. The company has a base rate of $20,000 per day for its ships, and an increase of 25% in rates will translate to a 200% increase in net cash flow, according to the latest filings of the company.
At the time of preparing this document, I bet the management had no clue that rates will not jump by just 25%, but over 400%. We can use the fourth quarter of 2019 as a proxy to see what happens when rates jump so drastically as they have in the last few weeks.
Back in Q4 2019, geopolitical issues led to a surge in tanker rates to over $140,000 per day. U.S. sanctions on two units of a Chinese shipping company was the primary driver of rates in October, whereas the tensions in the Middle East fueled the increase in rates in November and December.
This positive trend in rates helped Scorpio Tankers generate positive earnings in the fourth quarter to the tune of $12 million. In comparison, the company made a loss of $45.3 million in the third quarter of the year. This goes on to show the positive impact of rising tanker rates on Scorpio’s earnings.
A similar, or even a greater, positive impact can be expected in the next couple of quarters as tanker rates remain at elevated levels. If tanker rates remain as high as they are today in the next two quarters, Scorpio Tankers will most likely turnaround its business operations.
Investors should keep an eye on the debt burden
At Beat Billions, we focus on opportunities for growth-oriented investors, and we have a strong commitment to finding such opportunities in small-cap stocks. As a result, we constantly come across companies that are operating with massive debt loads. Scorpio Tankers falls into this category.
As illustrated below, the debt burden has come down in the last 5 years. So has the debt-to-equity ratio. Investors, however, should not be too excited about this development.
The easy thing to do is to look at this chart and conclude the financial position of Scorpio is improving. Be warned, it is not. The company tapped into equity markets twice in the last 18 months to raise funds. These funds and depreciation savings helped Scorpio reduce its debt burden. At Beat Billions, we are searching for companies that are growing their cash flows organically by improving their net income. With this in mind, we believe investors should constantly monitor the cash flow profile of the company to identify any potential warnings signs regarding liquidity issues.
Is STNG stock the best way to gain exposure to the tanker industry?
We don’t think so. Investors can easily select the leading companies in the industry such as Euronav, Frontline, and Teekay to gain exposure to this promising industry. However, there’s a strong case for STNG shares that should grip the attention of contrarian investors.
As we pointed out earlier, STNG stock has declined greater than its peers. This is bad, we know. However, when earnings reports are released, there’s every opportunity for STNG shares to jump by a much larger percentage than its peer group. From a fundamental analysis perspective, there’s every reason to believe that Scorpio Tankers will be reporting positive earnings. The company will report first-quarter earnings on May 06, and the financial performance in the first quarter of this year would have been lackluster. But, the management, in the earnings conference call, will likely paint a very positive outlook for the future, which should help shares gain some traction.
The best returns by investing in STNG stock will most likely be realized by investors who hold on to the stock through the end of this year.
Takeaway: An attractive play for the next 12 months
Scorpio Tankers stock is poised to deliver stellar returns to investors in the next few months, driven by macroeconomic tailwinds. This opportunity is ideal for investors with an investment time horizon of at least 12 months and an above-average risk tolerance. However, as always, we urge our readers to note that Beat Billions is not an investment advisor and it’s best to consult a qualified advisor before reaching an investment conclusion.
Disclosure: Dilantha De Silva, the author of this article, is long Euronav and may initiate a long position on STNG within the next 48 hours.
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