The plot thickens.
On Wednesday, U.S.-listed tanker owners reported record-high results, executives confirmed strengthening rates on conference calls, the broader stock market was relatively stable (at least until the last hour), the price of crude oil declined … and yet, tanker stocks fell sharply in heavy trading.
It was “the craziest price action I’ve seen in my nine years covering the space,” Jefferies shipping analyst Randy Giveans told FreightWaves.
There have been plenty of bad days for tanker stocks, including the day before. Sometimes, you could blame bad results. Sometimes, you could blame the coronavirus — negative macro momentum was just too strong. And sometimes, you could blame rising oil prices, which make floating storage less attractive, a negative for tanker demand.
But whodunit this time?
Some investors head for exit
Jon Chappell, the shipping analyst at investment bank Evercore ISI, told FreightWaves, “I’m afraid sentiment has shifted. Expectations were too high, and worse, there is no differentiation during a sell-off.
“We just downgraded DHT [NYSE: DHT] on Sunday night and even I don’t think the stock should be down 6% on a first-quarter EPS [earnings per share] beat and $110,000-per-day, second-quarter-to-date VLCC [very large crude carrier] rates.”
The analyst made those comments at around midday. DHT closed down 8% in almost double average trading volume.
“And Scorpio Tankers [NYSE: STNG] is even more insane,” Chappell continued. Before market open on Wednesday, Scorpio Tankers reported net income of $46.6 million for the first quarter of 2020, triple its net income in the same period last year. Earnings of 85 cents per share demolished the consensus forecast of 49 cents per share.
“That stock was trading below 50% of NAV, they crushed the first quarter, second-quarter-to-date rates were very good and indications are that current rates are even higher, the call went really well, and the stock gets puked?” Chappell exclaimed.
During the conference call with analysts, Scorpio Tankers head trader Lars Dencker Nielsen revealed that one of the company’s LR2 product tankers (vessels with a capacity of 80,000-119,999 deadweight tons) was just booked at an eye-popping rate $178,000 per day for 40 days.
And yet, Scorpio Tankers’ stock closed the trading day down 10% in almost triple average volume.
“That one is mind-blowing to me, but it shows that investors don’t try to find safe havens when they’re exiting a hot sector,” said Chappell.
“This is exactly what we were afraid of and it’s the reason we shifted our views and downgraded three stocks [DHT, Frontline (NYSE: FRO) and Nordic American Tankers (NYSE: NAT)] ahead of what we expected to be a great earnings season. Right now, again, sentiment and macro are more important than EPS, dividends and micro. This was a very painful lesson for us in 2016 and at least we got ahead of it this time.”
According to Giveans, “Today’s performance is ridiculous. Both DHT and Scorpio Tankers were up 4-5% when the market opened, and both press releases and calls were very bullish. These earnings-to-equities disconnects are crazy. Had I not looked at the screen, I would have assumed shares would be 10% higher.
“I know many investors who bought in the last six weeks to hold until earnings, so I guess [they are] dumping today — although to get the DHT dividend, you have to be a shareholder on May 19, 2020.”
Giveans continued, “Today’s weakness seems all about falling rates and concerns that rates are heading back to $10,000 per day — which is just silly. Rates have been quoted as ‘plunging’ or ‘diving,’ but of course rates are going down this week, because of Far East holidays, fewer exports out of Saudi Arabia, charterers remaining slow to fix, and contango tightening. Rates are still strong, and we expect rates to improve in the coming weeks.”
Rate expectations inflated?
One of the undercurrents on recent quarterly tanker calls was that investors might not be getting the right numbers and may be interpreting reported rates incorrectly.
When a spot “fixture” deal is first reported, it is “on subjects,” which means the charterer has a period of time to vet the ship before “lifting subjects” and closing the deal, after which it is “fully fixed.” Sometimes, particularly in frothy markets, the charterer does not lift subjects and the fixture fails.
The real market rate is the level of fully fixed deals, but broker reports and indices cited in the press take into account the initially reported fixtures, even the ones that fail — which can inflate the numbers during a hot market.
As Ardmore Tankers (NYSE: ASC) CEO Anthony Gurnee said during a conference call on Tuesday, “The indices people are quoting and the rates shipbrokers are throwing around tend to be somewhat detached from reality. As our chartering team likes to say, it’s basically fairy dust until you actually fix it.”
A “prevailing feature” of volatile markets is a practice called “fixing and failing,” he continued. A trader secures a ship first, then tries to complete the physical cargo side of the trade; if the cargo trade falls through or pricing moves against the trader, the trader walks away from the ship fixture. “Companies that develop a reputation for fixing and failing find it hard to get ships, so I think there’s a bit of good-behavior monitoring that goes on in the market,” said Gurnee.
The practice “is really a bit of a disgrace for the industry,” lamented DHT co-CEO Trygve Munthe. “The routine is that the charterer agrees to terms for a spot voyage but typically has 48 hours to clear the ship through the system from a quality-assurance perspective. When rates skyrocket, like we saw last fall and this year, if a ship was put on subjects at very high rates and then rates came sharply off, there was a threat made to the owners that if you don’t give us a better rate, we’re not going to lift subjects. There are very, very few honorable exceptions, but this is a factor for most charterers, whether traders or oil companies, from the East to Europe to America.”
Asked about solutions, he replied, “Some people have been talking about making a ‘shame list’ and going public with the worst offenders, but nothing has really happened yet.”
“There has certainly been some chartering abuse of rates, fixing voyages and then failing if rates fall,” said Giveans. “As a result, when we calculate the average TCE [time charter equivalent] for a quarter, we give a discount to headline brokers rates.”
FreightWaves asked Frode Mørkedal, managing director of equity research at Clarksons Platou Securities, for his view on whether failed fixtures have pushed index rates and broker reports higher than fully fixed rates.
“I believe this could be an issue,” he acknowledged, although he pointed to a less nefarious driver than Munthe has in mind.
“In a very high market, there is increased volatility, not just for freight, but also in the underlying commodity market. One should expect that if oil prices drop suddenly, or something else unforeseen happens, a charterer would go back and try to change the freight agreement … events have changed in his trade and he has to change his plans with it.”
Mørkedal emphasized another reason that reported rates diverge from actual rates. “The main issue for companies not being able to meet market indexes like our own is simply the huge drop in bunker [marine fuel] prices during the period,” he explained. “A tanker may have fuel tanks that last for 100 days, so I reckon a lot of companies have fueled with expensive bunkers earlier in the quarter than what our spot voyage calculation assumes.”
Indices and spot-rate reports are based on TCE calculations, in which spot freight contracts negotiated in dollars per ton of cargo are translated into dollars per day, net of fuel expense. The lower the fuel cost, the higher the TCE, regardless of the initial dollars-per-ton spot freight rate.
The lag effect
It’s not just that reported rates may diverge from actual rates; it’s also that currently reported rates don’t reflect currently accounted-for revenues.
Scorpio Tankers President Robert Bugbee explained, “The indexes are always ahead of what the vessel is earning because the vessel won’t load until a month forward of the reported numbers.”
DHT co-CEO Svein Moxnes Harfjeld believes “people tend to miss the time lag in fixing cargoes, the time lag in the cost of bunkers, and how far away you are when you fix a cargo from when revenues start to come in.”
According to Munthe, “The first known revenue for our second quarter may have been booked in December or January; even though most of [the voyages’] performance was in the first quarter, they extended into the second quarter.
“Right now, for example, we have at least three ships that are fixed on spot voyages that will not complete until way into July, into the third quarter.
“It’s easier to get your head around [the lag effect] if you look back at the incredible volatility of freight rates over the past several months. If you look at the first quarter, in the middle [of the period] there were six weeks when [VLCC] rates were just over $20,000 a day. This year, we’ve seen spot rates under $15,000 a day and spot rates over $250,000 a day. So, there were ships showing up and being loaded and fixed at rates that were quite different than rates we’ve seen in the past few weeks.”
As Harfjeld put it, “Some people on the outside don’t really understand how the business operates and they look at indexes way, way too much.” More FreightWaves/American Shipper articles by Greg Miller