Shipping/Tankers: Can you spell C-O-N-T-A-N-G-O?

Yup, it’s yet another Tankers post!  If you think that all OM talks about is tankers, you’d be right and Mrs. OM and his colleagues can vouch for that! 

After the last update, OM kept buying tanker stocks until finally reaching the “stop buying” limit of 25% NAV on March 23rd.  This article helps explain why.

It was just over a year ago when OM first wrote about tankers, and November's update laid out the thesis' key points:

• Tanker Supply:  After years of oversupply, the tanker markets were finally tight with order books well below historical averages.  With the supply of vessels fixed in the short-run, small changes in demand can have a big impact on tanker rates.
• Operating (and Financial) Leverage:  The operational leverage of tankers, where most of the costs are fixed, means that a small change in rates has a massive impact on the P&L.
• Valuation:  The fall in the tanker stocks during January/February 2020 took valuations back to the early 2019 lows of 0.3-0.5x net asset value.
• Impact of IMO 2020: OM felt that IMO 2020 was going to be the catalyst that brought tanker stocks to the attention of others.  This was largely proving to be the case, though rates are very seasonal, January’s was the best January in a decade and February was heading in a similar direction.  It has since been usurped...

So what changed?

In the last three weeks there have been major changes to both the demand and supply for oil:

• Demand has collapsed.  In response to Covid-19 most of Europe, the US and India are on lockdown, while even the recovering parts of Asia (such as China) are only operating at 70-80% of historical levels.  Unsurprisingly, this has meant that the demand for oil and oil products has also collapsed, with some estimating it has fallen by 20 million barrels/day. 
• Supply has increased.  In the first half of March, OPEC+ couldn’t come to an agreement to reduce oil production after the Russians balked at further cuts.  Saudi Arabia responded by stating it would increase its own production by 2-3 million barrels/day and offering discounts to key customers.

These factors have led to the oil price plummeting.  It has also created two interesting things for tankers; the surplus of oil (10-20mn barrels/day) needs to be stored somewhere and there is a huge contango in the oil markets.

Oil can be stored on land in tanks, at refineries, at oil terminals and in countries’ strategic oil reserves.  However, there’s only ~1 billion barrels of storage available globally and the oil has to be shipped there on crude tankers that move really really slowly! 

Oil can also be stored at sea, in crude tankers, and the contango in the oil market is making this exceptionally attractive.   Contango is when the futures price of a commodity is higher than the current spot price.

This shows that magnitude of the contango, which is surpassing that of the Great Financial Crisis.  Today, someone buying oil and immediately hedging it six months out (by selling the future) can make ~$13.43 per barrel of oil profit, less the cost of storing it for 6 months.   Or put another way, you could make almost ~$27mn risk-free profit if you filled a VLCC tanker to store your oil.  How much to pay for that storage?  The answer has been a lot, the majority of your profit since the market for tankers is tight your profit is risk-free.  The impact of this is two-fold (i) its putting a floor on tanker rates, and (ii) every VLCC that’s used for floating storage is unavailable to transport crude (at a time when Saudi wants to increase production).  

What has this meant?

Well Q2 is typically the seasonal low for tankers as refineries go into maintenance and the deals signed today are for journeys in the second quarter.  Yet, as the chart below shows we’re seeing record rates – in fact rates haven’t been higher since the 1980s!!!

Source: Allied Shipbroking

The chart is for VLCCs, but you could substitute just about any crude or product tanker chart in there and it would look similar.

Will it last forever? 

Of course not but remember the operating leverage.  It means the sharp uptick in rates is dropping straight into the profits and free cash flow.  Combined with the low valuations, OMs tanker holdings are conservatively going to earn 25-50% of their entire market caps in just the first half of 2020.   Until last week, the market didn’t care and there’s a reason why this industry has seen companies and mgmt. aggressively buying shares!

It’s a perfect once in a generation positive storm; a tight tanker market, with massive excess supply and a huge contango incentivizing storage all at a time when cos are trading at low valuations.  

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 DHT, TNK, STNG, DSSSI and EURN - 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.

Things from my Newsblur; 2020 Part 1

With COVID-19 having spread to the West, OM has repurposed this Things from my Newsblur into a COVID-19 special.   Hopefully, a non-COVID-19 mental health break Things from my Newsblur will soon be upcoming. 

Stay safe people and WASH YOUR HANDS!

It’s hard not to drown in the sea of information, and misinformation, out there on COVID-19.  For OM, the single best curator of all things COVID-19 has been Azeem Azhar (@azeem), who’s refocused his weekly newsletter towards the subject.  His Exponential View newsletter is always one of OM’s weekly must reads.  That is especially the case this week, so if you read nothing else find time for this one.

Exponential View Newsletter #262 (free)
Read this; great curation of all things COVID-19, from progress against the virus, to China after covid and what it may mean for business models.  (Azeem Azhar)

Can Handwashing Really Stop the Spread of COVID-19

In short, it won’t eliminate the risk of infection but there’s evidence that it’s a simple and powerful safety measure.  Importantly, it also allows people to feel that they have something they can control in this fight.  (Sara Rigby, Science Focus)

Coronavirus: Why You Must Act Now
Coronavirus: The Hammer & the Dance (follow-up to above article)

Tomas Pueyo’s original post used statistical analysis of the data available in early March to show why Western nations had to move far more aggressively on COVID-19.  It has been viewed 40 million times, and widely shared and quoted by numerous experts.   His follow-up article on what the next 18 months might look like offers a glimpse at the potential road ahead.  (Tomas Pueyo, published in Medium)

Why the Coronavirus Has Been So Successful

This clear and detailed report on the pandemic explains why we should all be taking social distancing and self-isolation seriously.  (The Atlantic, Ed Yong)

But it’s not all bad news; having most of the world’s best scientists focus on one disease, leads to jumps in progress.

There are over 250 clinical trials for COVID-19 currently underway.

There’s already new cheaper and quicker tests developed for testing for it and numerous groups are racing to develop antibody tests that can show if you’ve previously had COVID-19 (and thus potentially be immune to it).

We can learn best practices from some other countries’ success in stopping the virus affecting their healthcare workers. 

Portfolio Update: No Más!

Our Man followed through with the things on his docket last week, reducing the portfolio’s exposure about 8-10% above Thursday's market bottom.  Frankly, OM hopes it’s a decision that looks abysmal in the future, since that likely means that COVID-19 came and passed quickly with limited impact.

The primary rationale for it was a combination of material year-to-date losses, increasing evidence of the West’s questionable handling of the COVID-19 outbreak, and the increased uncertainty caused by COVID-19.  

• The losses began with Shipping’s sell-off in January and accelerated last week, as emerging market indices collapsed.
• It appears that most of the Western governments were caught off-guard by the spread of COVID-19, and reacting to events rather than having proactive plans.   Bizarrely, the UK is an exception; it has a very clear plan though it is highly controversial and has been at least partially misunderstood.   If you’re in the UK you must read Azeem Azhar’s newsletter post on it.  If you're not in the UK, you should read it anyway.
• The uncertainty around COVID-19’s impact is worth discussing as ideally one should be a buyer in weeks like last week when there is “blood in the streets”.  The argument for buying now is that this too shall pass, and numerous high quality stocks cheap on historical (or post-COVID-19) earnings.  Thus buying today is right, even if there’s another 10-20% downside, as these names will be markedly higher in 12-months’ time.  Normally, OM would nod in agreement.  However, with COVID-19’s spread to Europe and the Americas, the weak response and the potential multiple week lock-downs ahead OM believes the range of outcomes is exceptionally wide.  In the best case, it will look like nothing more than your typical economic or market slowdown and OM’s decision will be costly.  However, the impacts of a prolonged lock-down are non-linear; too many (both large and small) businesses have too thin margins, too many fixed costs, and too much debt to be able to survive with limited revenue for that long.  That starts to raise questions of the health of the economy we'll come back to post COVID-19.  OM suspects that in many scenarios, the solution is going to look a lot like MMT.

Portfolio Changes

The planned reductions to the portfolio were discussed in the previous post but were:

• Technical Book:  The Technical Book’s sell signal flashed in the final days of February, but OM waited for a meaningful bounce that never really came.  He exited it at the close (thankfully!) on Friday, but the delay (vs. the first trading day of March) cost a couple hundred bps!
• Greece:  OM cut this back materially.  It was the only particularly hard decision in the reduction of exposure.  The new government in Greece is largely doing very good job, including their fast response to COVID-19, but it doesn’t matter.  The economic rebound is going to be tested by COVID-19’s impact on tourism among other things, and Greek equities are going to get limited attention from investors.  The Greece ETF is trading below the levels when folks thought the country was run by a Crazy Leftist and about to leave the euro for the drachma.   This is why it’s still the 2nd largest position in the book.
• Brazil, India & Vietnam:  Both Brazil and India saw their first COVID-19 cases during the week, which led to OM to slightly increase his reduction in those positions.  Longer-term, Vietnam continues to a beneficiary of broadening supply chains but was also reduced.
• SaaS & Uranium:  The exposure to the older ETFs was cut back.  There are some more recently launched ETFs that better fit the theses, and OM will be adding these when the moment comes.  OM also trimmed back the JD.com position, which is up for the year.

OM also bought some more crude and oil product tankers!

In the week since OM’s last post on Shipping, Saudi Arabia and Russia started an all-out price water which saw oil prices tumble 30%+.  The combination of the attractiveness of storing crude & oil products and the Saudis hitting the bid on every VLCC tanker they could find saw tanker rates rise 4-8x last week!  This is the start of the low season, but instead rates are printing at all-time highs; there are ships that are literally making a year’s worth of income in a single 45-day voyage!!  OM added some Double Hull Tankers (DHT, crude tanker company with a fleet of VLCCs) but didn’t get filled in his attempt to buy Teekay Tankers (TNK).  If these rates continue and the stocks don't reflect it, expect OM to continue to keep buying more of his existing positions (and TNK) till he hits 25% NAV.    Given the cash flow that these companies are going to throw off in Q1 and Q2, OM is happy keeping this position at a much higher size though he’ll be selling lots of the rest of the portfolio to keep overall risk in check.  OM exited the existing position in Navigator Holdings (NVGS), which is focused on liquid natural gas not crude and oil products.

Portfolio (as at 03/13/20 - all delta and leverage adjusted, as appropriate)

Dislocations: 31.0%

17.9% - Shipping (STNG, DSSI, EURN, DHT and NVGS)

9.9% - Greece (GREK, ALBKY, and EGFEY)

3.2% - Uranium (CCJ and NXE)

Thematic: 15.1%

5.2% - Tech 4th Industrial Revolution (JD & WCLD)

3.4% - Vietnam (VNM)

3.3% - Brazil (EWZ)

3.2% - India (INDA)

0.0% - Blockchain/Crypto (no positions)

Technical: 0.0%

0.0% - OEW Technical positions (DDM, SSO, and QLD)

Idiosyncratic: 16.9%

14.2% - Funds (ARTTX, CWS, GVAL, and CAPE)

2.6% - Equities (TPL)

Shorts/Hedges: 0.0%

Cash: 37.1%

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 all of the securities mentioned that’s a terrible reason for anyone else to do so.  Our Man also holds some cash and a few other securities (of negligible value).  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. 

COVID-19 and Portfolio Thoughts

Well, that was a fun! *sarcasm alert*

Our Man isn’t a doctor and, unlike far too many in finance and politics, he doesn’t even want to play one on TV! It says far too much about today’s world that the most sensible thing about COVID-19 from a non-expert came from the manager of Liverpool FC!

Thus OM isn’t going to opine on the spread of COVID-19, how you should deal with it, and what the various estimates of the virus’s potential R0, incubation period and case fatality rate are or what they might mean.  If, like OM, you work at a smaller company he will point you in the direction of Elad Gil’s primer and if you want to start thinking about the broader economic effects of a pandemic then Professor Wren-Lewis has you covered.   The three things OM will note is that so far we’ve learned:

1. Strict containment works in limiting COVID-19’s spread (see Singapore)
2. Aggressive and broad testing helps identify early who to isolate in order to prevent the virus' spread (see South Korea).
3. Western countries have, so far, been slow to do both of these things.

Instead OM is going to talk about is the market and some forward looking thoughts, as well as what it might mean for the portfolio. 

While COVID-19 originated in China, it was largely ignored by Western markets until the end of February, which coincided with (was caused by?) a sharp rise in cases in the West. The subsequent correction has been swift, sharp and brutal.   The largest factor in COVID-19’s market impact is the uncertainty – how far will it spread, how bad or deadly is it, and how much impact will it have on the economy and life. In the absence of high quality data, and limited trust in leadership and institutions (WHO, Chinese Government, CDC, etc.), the range of outcomes is wide and it’s often the loudest, not the best placed, voice that holds court. After not affecting the markets for ~6 weeks, this uncertainty quickly became doubt and fear.  In such times, investors go where they feel safest and to what has worked previously – especially government bonds. In the US equity markets, that has been Software and especially Software-as-a-Service, which ended February +7% for the year.

Since COVID-19 started in China, OM will be watching to see the resumption of normality there first.  Like all systems, China’s is incentives based - watch what the government does not what it says. OM is doing that by stealing Bill Bishop of Sinocism’s playbook for signs of China declaring victory.   OM doesn’t expect to be a buyer of much until we at least start to see:

• Xi visit Wuhan
• The Two Sessions is re-arranged
• Kids are sent back to school

OM’s operating assumption is that the uncertainty is the West will linger until there is greater clarity on COVID-19’s spread and impact, and the stock market will reflect this.  The longer it lingers then the worse the economic impacts of COVID-19 will be.  Even at this stage, OM suspects we’re starting to approach the point where we need both fiscal and monetary stimulus and the much like in 2008, it’s not going to come (in enough size) immediately.  Finally, the UK with an emboldened Prime Minister, a new Chancellor and a new Governor of the Bank of England might even be the first country to go full MMT on us!

So what is OM doing with the portfolio?

Unfortunately, nothing so far. 

Here are the things on his docket for the coming days/weeks:

- Technical Book: It saw its sell signal near the end of February.  Real-life issues meant OM failed to exit it during last week’s bounce, he won’t be so remiss next time.

- Uranium:  Though it has largely held up pretty well, OM is looking to exit the Uranium ETF (URA) position that is about 50% of the uranium exposure.  This reflects the reconstitution of the ETF to provider broader uranium exposure, and not just to the miners.  OM’s thesis is focused on the miners and a new more appropriate ETF (URNM) launched at the tail-end 2019.  Expect the capital to end up there eventually.

- Emerging Markets exposure:  OM has a LOT of it – Greece, Vietnam, Brazil and India are ~40% of the portfolio.  Irrespective of the long-term outlook, in times of financial stress emerging markets are never the place to be and OM will be trimming this exposure back.  This was not an unknown risk, and he should have been more proactive much earlier in the year!

- Software-as-a-Service: is largely flat on the year, despite everything.  OM suspects that it goes one of two ways from here: 

(i) COVID-19 fears are quickly dispelled and Software becomes that mythical investment; it protected when there was huge uncertainty and is also growing rapidly.  If so, OM expects to hear justifications that surely such a business, which was valued at 10x Sales before the model proved itself in times of economic stress deserves a higher multiple still?  And so, a real bubble shall have its narrative (and crypto as the logical extreme of this concept will go crazy).

(ii)  Or perhaps SAAS stocks are just 2020’s version of commodity stocks in 2008 – bullet proof and up healthily in mid-2008, until they collapsed to end the year down ~80%.  If so, they’re probably an attractive buy with far far better valuations at that point!  

Either way, OM will be exiting his position in the broad Software ETF (IGV); originally, it was the best of the bad proxies for SaaS.  OM would rather add capital to the existing position in the WisdomTree Cloud Computing ETF (WCLD), a recently launched SaaS-specific ETF, when it becomes clearer which path software will take.

- Shipping:  Oh shipping, that beautiful delightful hot mess.  See the most recent post!

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 all of the securities mentioned that’s a terrible reason for anyone else to do so.  Our Man also holds some cash and a few other securities (of negligible value).  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. 

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.