Shipping, wtf?

Almost 50% of Our Man’s losses in January and February came from the Shipping positions.  There's a broader post on OM's thoughts coming, but here’s a follow-up to the recent post on shipping.

COVID-19 was identified in January in China and there was a sharply bifurcated reaction in the market.  Initially, Western markets generally held-up well, but economically sensitive stocks exposed to China were dramatically impacted, before markets tumbled in the second half of February.  For example, energy names started falling in mid-January and continued to collapse in February; the S&P Energy Sector lost ~12% in January and then another ~15% in February.  In many cases, the losses in these sectors and stocks were at odds with fundamentals, which brings us nicely to Shipping!

Before we start, some things pulled from the last Shipping post as a reminder of the context around OM’s position:

• It’s a high conviction Dislocation position that is fully sized and ‘on the clock’.
• It’s treated as a quasi PE-position in the portfolio. This means it’s not a position OM looks to trade and it’s sized such that he’s willing to absorb the mark-to-market losses as long as fundamentals don’t change. In the long-term, OM expects to be paid for this volatility.
• It will require patience and will power.
• Here’s the plan!

 So with that said, it was barely a month or so ago that OM said he wouldn’t be reacting to every 20-30% move in shipping with a post. But a 30-50% move in crude & product shipping prices in 8 weeks was not pretty and deserves a post! The chart below shows OM’s position size and the P&L contribution from tankers:

Why so bad so fast? 

• Seasonality: It’s a very seasonal business!  Investors should compare rates to this time in prior years rather than what they were a week or month ago!  Rates started to fall from their highs in January and this seasonality seems to have caught a number of investors by surprise!
• China & Coronavirus: Anything that is a first order impact of the economic slowdown in China was sold, and sold heavily. Oil is down 30%+ from its early 2020 peak, and OM gets it crude/product tankers are a small ugly levered sub-sector that has something to do with oil. 

Given this what is OM doing? 

Well despite the coronavirus, economic slowdown in China, collapse in oil price, etc. the shipping day rates have held up remarkably well.  The below chart is for Medium Range (MR) tankers, but the rates for other tanker types show broadly similar stories. 

Source: Hellenic Shipping News, Allied

To add further context, despite everything many those rates are at or close to 10-year highs!

Thus, so far OM has done nothing.  There’s a huge dichotomy between shipping rates and its implications for companies’ revenue, earnings and cash flow, and the stock price action.  The stock price matters, the P&L matters, but position sizing matters most! This is where having a plan – the research, time frame, and data points you’re tracking for buying/selling – really helps.

At February-end, OM was largely back to his cost basis in individual names, with the overall position size much reduced as a % of capital.  As long as rates continue to track above previous years, OM won’t be selling.  If the discrepancy continues to grow between the market’s implied valuation and the companies’ likely earnings, he’s far more inclined to buy more.  Maybe a LOT more.  The stocks are trading at 0.5-0.8x NAV (or less than 1.0x EV/GAV, to account for the leverage) and at these rates they are generating a ton of cash. It won’t be today, it likely won’t be tomorrow but the longer the dichotomy persists and the less the stocks appear like a falling knife, the bigger a potential position OM is willing to countenance eventually taking. 

So what is he thinking on the individual names:

• Navigator Holdings (NVGS):  The one name OM will likely exit.  It is a liquefied gas transportation company not a crude/product transportation one.  Expect it to come out of the portfolio as OM focuses entirely on crude/product tankers.
• Scorpio Tankers (STNG):  OM will probably not add to this one as it’s the most levered.   The leverage makes it the one most likely to run into problems if the COVID-19 impact is prolonged.  If the impact is not prolonged, OM expects it will also be the one investors flock back to.
• Euronav (EURN): The safest name with a strong balance sheet, good management, reasonable operational leverage and is cheap (trading at 0.7-0.8x P/NAV and EV/NAV).
• Diamond S (DSSI): Refinanced its debt out to 2024, is very cheap (0.45-0.6x P/NAV and EV/GAV) but it has a stock overhang (PE lock-up rolls off in March 2020) and management has underwhelmed.
• Teekay Tankers (TNK): This is a name that OM will be adding to the portfolio to replace Navigator Holdings.  It’s a midsize crude tanker play that’s trading at ~0.75-0.85x P/NAV and EV/GAV, which refinanced its debt and during the first quarter.  Its results summed up the stock price/rates dichotomy; a $12.50 stock (at the time) earned over $2.47 for the QUARTER and is expected to earn over $2.60 for the upcoming QUARTER! Yes it is high season, and yes Q2 and Q3 won’t be close to as good - though analysts still expect them to be profitable - so the market really has to believe things are going to get a LOT worse.

In summation, OM suspects we’ll look back in a year or so and either have a good chortle about how inefficient markets can be or we’ll sadly sup our beers and commiserate about how foolish OM was!

Disclaimer:  Nothing above represents a recommendation in any way, shape or form so please don’t even think of trying to take it that way.  For added clarity, while Our Man is invested in NVGS, STNG, DSSSI and EURN and may invest in TNK - that’s a terrible reason for anyone else to invest in them.  You should not buy any of these securities because Our Man has mentioned them, but should do your own work and decide what’s best for you given your own circumstances/risk tolerance/etc.