Scorpio Tankers (NYSE:STNG) – IMO2020 an Upcoming Catalyst

IMO2020 is a upcoming catalyst that would boost tanker charter rates due to the rush to stock up on low sulfur blend fuels in ports worldwide.

Combined with supply straining and demand picking up in a seasonally strong quarter, Scorpio Tankers (NYSE:STNG) could benefit from the industry’s bullish fundamentals and share price could go higher in the short term.

IMO2020

The International Maritime Organization {IMO} for short is rolling out a new regulation regarding the acceptable levels of sulfur oxides {SOx} emissions from 3.5%m/m to 0.5% m/m with the goal of reducing ship-produced air pollution.

This new rule comes in effect on January 1st, 2020. This new rule is causing many changes across the shipping sector creating a lot of investment opportunities in a wide variety of companies.

Direct Effect

A direct effect would be shipowners mulling over whether they should either switch to low sulfur fuel or install an Exhaust Gas Cleaning System (usually called a “scrubber”).

Source: https://www.marineinsight.com/tech/scrubber-system-on-ship/

https://gcaptain.com/ship-owners-scramble-to-install-scrubbers-ahead-of-imo-2020/

Indirect Effect

1- Ports around the world will be starting to stock up on low sulfur fuels. This would increase demand of tankers right till end 2019.

2- Global issues such as trade wars, sanctions on COSCO and all that business going on, traditional shipping routes could be disrupted and lead longer routes and increase journey distances. (not directly related to IMO2020)

3- More shipping companies are scrapping their older tankers as they are unable justify installing scrubbers with only a few years of service left. As ships get older, their fuel efficiency gets lower, hence it would be uneconomical to use high grade fuel for these ships.

4- As tankers rush to get scrubbers installed to meet the 1 Jan 2020 deadline, this would mean that a large number of tankers would be out of service for a period of time.

Why STNG?

Scorpio Tankers is a shipping company involved in the transportation of refined fuel products from the refinery to end users via their product tankers.

Largest and Most Modern Fleet

STNG has 109 tankers with average of 4.1 years. This puts them as the largest the most modern product tanker fleet.

Taken from STNG 2QFY19/20 presentation slides

Strong Cash Flow Generation

According to their latest financial statements, STNG required about US$730mil to breakeven and anything after that would be their operating cast flow and earnings. According to the company, every $1000 increase in daily rates equates to about $43 million of cash flow.

The table below shows how the increase in current rates would generate incremental cash flow for STNG to use it to service debt, share buybacks or dividends.

Source: https://seekingalpha.com/article/4254702-scorpio-tankers-potentially-explosive-opportunity-much-hated-industry

They have also shown an improvement in their income and cash flow from the past year. This is mainly due to the increase in charter rates so far.

Taken from STNG 2QFY19/20 presentation slides

IMO2020 as Main Catalyst

With IMO2020 starting to kick in, combined with the stronger tanker season in 4Q, the product charter rates will start to rise.

Another point to note is that they have decided to fit most of their tankers with scrubbers. This allows them to have access to cheap fuels while being compliant to IMO2020.

Taken from STNG Corporate Presentation Slides

Skin in the Game

On 25 Sept 19, President of STNG Bugbee purchased call options on 150,000 shares for a consideration of US$492,000.

On 1 Oct 2019, he did it again, purchased call options on 100,000 shares for US$265,000.

This is probably the first time I saw any management doing this. This goes to show how confident he is in the near term future of his company. (For info on the announcements, please refer to here and here)

Risk

The shipping industry is well-known among investors for its bad governance and overall capital destruction mainly through bad investments and over-supply. The shipping industry has taken advantage of the low interest-rate environment for the past 10 years to build as many ships as possible pushing charter rates to barely cash-flow positive and unprofitable levels.

Rates

The main factor which I’m relying on for this investment is the increase of product tanker charter rates due to IMO2020 and other supply and demand factors.

Taken from STNG 2QFY19/20 presentation slides

The fact that they have started to rise is a good sign but I cannot predict how high it will go. Especially since IMO2020 has not yet taken effect

Debt

The shipping industry is always laid with debt. Companies would leverage on debt to purchase ships and tankers and repay them over the course of the ship’s service.

As for STNG, current debt stands at around US$2.8b and you can find their debt repayment schedule below. Their current cash stands at US$56mil. From the table it seems manageable as they have recently issued convertible bonds in end 2018 and it seems unlikely they will do so again in the near term.

However, if rates plunge again, I would expect them to raise more money through another round of dilution.

Taken from STNG 6K filed on 31 July 2019

Scrubber Installation

STNG had just commenced their scrubber installation and is expected to complete at end 2020. Together with the other shipping companies, shipyards doing scrubber installations are pretty much packed and fully booked. A risk would be the delay in the installation schedule as a result affect their charter revenues.

In a recent interview with J Mintzmyer, lead researcher at Value Investor’s Edge, President of STNG Robert Bugbee touched on this topic and is quite optimistic about the installation schedule relative to his peers. One point which he raised was that they were one of the first movers in this aspect while his competitors were mulling about whether to invest the money in this operation. This led to them having an earlier completion schedule while the rest have to wait due to the lack of available shipyards to install the scrubbers.

Excerpt transcript from the interview mentioned above. Source: https://seekingalpha.com/article/4294624-robert-bugbee-scorpio-tankers-imo-positioning-podcast-transcript

Conclusion

Like they always say, shipping only makes money 1 out of every 10 years. The stars are aligned for it to happen in 2020 with all the catalyst mentioned above.

This is a short term investment and my time frame would be about 3-6 months starting now till the initial months after IMO2020 kicks in. I think if this plays out and charter rates go up tremendously, STNG could go US$40 and beyond.

Cheers to all. This is my 50th post on this blog and I would like to thank my readers for their support.

The Moss Piglet is vested in STNG at US$30.85

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