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Oil tankers: Short on supply, long on profits
Fact of life: There aren't enough oil tankers to meet the world's demand for crude oil. That's not good for consumers, but it's great for shipping executives and shareholders alike.
By Jon D. Markman
One of the lessons of recent market action is that you generally want to own companies in industries where supply is tight and sell companies in industries where supply is plentiful. That may sound elemental, but it provides a pretty square framework for making decisions about investment capital allocation.
The framework would lead you to be long natural resources and trucking stocks, to be sure, and short the makers of dime-a-dozen stuff like commodity semiconductors. But the idea also takes longs into the fabulous and mysterious world of oil tankers.
To supply all of the worlds crude-oil needs today, there are only about 3,500 tankers steaming out on the open seas or anchored at ports. Demand for their services far exceeds this supply, and, as a result, tanker rates have soared in the past year much faster than the price of crude oil itself. According to a report by McQuilling Services, an ocean-transport consultant, the world will be 26% short of big oil tankers, known as very large crude carriers, or VLCCs, through the end of this year. (A VLCC is a crude-oil tanker of at least 200,000 tons deadweight. It is big, larger than an aircraft carrier.) When you consider not just the number of tankers afloat but also the extent to which they are actually available due to port congestion, the supertanker industry appears even more tonnage deficient, according to a Bloomberg report on the McQuilling finding.
As a result of the shortage, the oil-shipping business has been exceedingly profitable. Rates on the big bruisers that haul 2 million barrels of oil from the Persian Gulf to Japan hit as much as $250,000 per day last fall and are not too far off that pace today. That's a rate said to be 10 times the break-even point for tanker owners.
Even as crude oil prices appear to have topped this month, its important to realize that these high rates are being locked in for half a decade. A great many tankers are owned by the big oil companies like Saudi Aramco and ConocoPhillips (COP, news, msgs). Increasingly, however, more are leased on one- to five-year charters or picked up on the spot market for one-way or round-trip runs. That gets a big capital expense off the oil companies books, not to mention liability in the event of a spill. The folks behind the leasing are typically powerful private trading firms like Glencore International of Switzerland or Vitol of the Netherlands -- which might each have 175 ships under lease at any given time -- or major oil companies like Exxon Mobil (XOM, news, msgs) or ChevronTexaco (CVX, news, msgs).
Most oil-tanker companies are still privately held and are based either in the Scandinavian countries or in Greece. Several have made spectacular public debuts in the past year, however, and I spoke to the chief executive of one of them last Thursday: Evangelos Pistiolis of Top Tankers (TOPT, news, msgs).
Pistiolis is the fourth shipping company CEO with whom Ive spoken, and they are all cut from the same cloth: Upper-crust British accents, Continental engineering degrees, smooth Mediterranean temperaments, rich families and homes in some sunny port along the coast of Greece. Life is good for the shipping magnates, and, fortunately, the same can be said for their shareholders.
Related oil and energy resources
Its not just their growth, which has been outstanding. Its that most of the tanker companies have such powerful cash flow that they are able to throw off huge quarterly dividends. Frontline (FRO, news, msgs) and Nordic American Tanker (NAT, news, msgs), which are based in Bermuda, yield the most at 19.7% and 13.5%. Top Tankers yields 4.5%; when it went public, the dividend yield was 8%. Meanwhile, competitor Tsakos Energy Navigation (TNP, news, msgs) also yields 4.5%.
They earn that much cash because there just arent enough boats to meet the requirements of the worlds energy needs even though new tankers are finally being built. It takes a long time to construct enough ships to meet spikes in interest, and, at todays steel prices, many potential builders continue to hold off.
The name of the game these days therefore is for fleet owners to buy used ships at good prices from less successful operators, refurbish them quickly and put them on long-term charters at todays high prices. It takes a certain amount of savvy to find the right ships and make those deals, and that is what distinguishes the better tanker companies from competitors.
Top Tanker shares have outpaced most of their oil-tanker cohorts, not to mention the broad market, since coming public in August last year, up 62% with dividends. The Standard & Poor's 500 Index ($INX) is up 6% in that span, while even mighty Exxon Mobil is up just 29%. In the most recent 12 months, Top Tanker earned $32.7 million on $93.8 million in revenue. That is a pretty amazing net margin of 34.9%. And yet the forward price/earnings multiple is just 5.4 for 2005 and 7.6 for 2006, which probably means that the market doesnt think that the good times will continue.
Pistiolis disagrees. He says the company can remain handsomely profitable even at significantly lower levels of crude-oil demand and prices. His company has all of its nine Suezmax (sized to the Suez Canal's maximum dimensions) and 11 more maneuverable Handymax tankers out on multiyear charters. And it plans to do the same with the next three new Handymaxes Top Tankers is due to receive in the next month. All told, the company claims to be third largest in the world in both double-hulled Handymaxes and double-hulled Suezmaxes; by concentrating on a size, it gets economies of scale. (Double-hulled carriers are supposed to be able to withstand accidents like the one that caused the Exxon Valdez spill in 1989.)
Top Tankers -- which focuses primarily on routes west of the Suez Canal, sending oil to Europe, the Black Sea and, to a lesser extent, the U.S. East Coast, West Africa and Singapore -- doesnt participate in the spot market. Through a profit-sharing arrangement with customers, however, it does partially benefit from rising shipping rates. Pistiolis said he plans to move the company into as many as 15 dry-bulk ships over the next two years, though he considers the coal, iron ore, alumina, fertilizer and grains businesses less sophisticated, with lower standards and with more tiresome negotiations. In petroleum trading, the majors will inspect your ship up and down before leasing; in dry bulk, they dont even know what an inspection is, he said.
So what you have, in sum, is a small company selling for a forward price-to-earnings multiple of 5.3 for this year and 7.6 for 2006. Its revenue is growing at better than 20% per year, it has a focus on cost control, it has most of its capacity and income locked in over the next five years. And it pays a healthy dividend and is run by experienced managers with a proven record for making good deals on its ships.
It sounds good, but beware: The tanker business has been very cyclical, with shares of companies like Knightsbridge Tankers (VLCCF, news, msgs) going from a high of $26 in 1998 to around $9 in 2003. So if you dip into these waters, dont expect to be able to float forever.
Fine Print
To learn more about shipping rates, visit the Baltic Exchange Web site. The exchange is probably the world's most important source of shipping market information. Most of the best information, however, is only available via subscription. To learn more about Top Tankers, visit this page. . . . To learn more about Frontline, visit its Web site. . . . To learn more about Knightsbridge, visit its Web site. . . . To learn more about the Swiss shipping giant Glencore International, formerly controlled by fugitive financier Marc Rich, visit its Web site. . . . To learn more about the Dutch trading company Vitol, check this page.
Jon D. Markman is publisher of StockTactics Advisor, an independent weekly investment newsletter, as well as senior strategist and portfolio manager at Pinnacle Investment Advisors. While he cannot provide personalized investment advice or recommendations, he welcomes column critiques and comments at jon.markman@gmail.com; put COMMENT in the subject line. At the time of publication, he held no positions in stocks mentioned in this column.
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