Scorpio Tankers Business & Capital Allocation Strategy - Riding The Positive Product Tanker Sector Fundamentals

Capital Link’s President Nicolas Bornozis hosted an interview with Mr. Robert Bugbee, President & Director of Scorpio Tankers STNG on Monday, May 8, 2023. The interview, which is part of Capital Link’s Trending News Podcast Series, covered Scorpio’s recently announced results for Q1 2023, as well as the company’s strategy, development, and sector outlook.

Scorpio Tankers is a leading international provider in the transportation of refined petroleum products. The Company’s fleet consists of 113 wholly owned, finance leased or bareboat chartered-in tankers (39 LR2, 60 MR and 14 Handymax). Scorpio Tankers is a publicly listed company and trades on the New York Stock Exchange under the ticker “STNG.”

FULL INTERVIEW

Interview Highlights

• Fleet development – rationale for the repurchasing of 42 vessels
• STNG’s focus on refinancing, deleveraging and liquidity.
• Chartering strategy – focus on spot market and participation in pools.
• Capital allocation – fleet development; share buy backs and dividend policy.
• Share buy backs versus dividend payments.
• Current conditions and outlook of the product tanker sector – no clouds in the horizon

Strong Q1 2023 Results

Optimistic about the “very robust” market, Scorpio President Mr. Robert Bugbee highlighted the company’s impressive Q1 results, described Scorpio’s share buyback strategy for shareholder returns, and discussed its approach to debt reduction and fleet ownership, which involves purchasing back leased ships and negotiating more flexible lease financing plans, during the recent interview with Capital Link.

Coming off a strong product tanker market in late 2022, Scorpio Tanker’s recently announced Q1 results bore a stark difference to its Q1 results from last year: in Q1 of 2023, the company had a net income of $193.3 million and an adjusted EBITDA of 286.4 million, while in Q1 of 2022, it recorded a loss of $-84.4 million and an adjusted EBITDA of 79.4 million.

Current Status & Outlook of the Product Tanker Sector

While the market was certainly bolstered by increased charter rates in early 2023, there was also a bit of uncertainty early in the first quarter due to a lack of clarity as to how exactly the EU’s sanction on Russian oil, which came into effect in early February, would impact the product tanker market, Mr. Bugbee noted. However, the sector benefitted from the sanctions, as trade routes changed and ton-miles increased when countries sought out products from other, more far-flung destinations due to the ban on Russian oil.  

In terms of the current status of the market, Scorpio’s President argued that the second quarter of 2023 began even stronger than the first but has begun to weaken. This slight dip, however, is temporary as “we are right between the heating seasons and the driving seasons in the northern hemisphere,” he noted. “Despite slight weakness in the last week or so, rates are still at very high levels,” he continued.

Despite this hiccup, Mr. Bugbee stressed that the market’s supply and demand dynamics are quite strong, highlighting that demand for jet fuel has risen rapidly. “We’re very optimistic going forward,” Mr. Bugbee said, as transportation and travel is expected to pick up in the Spring, in turn increasing demand for transportation fuels. The increases in ton miles, as well as disrupted trade routes due to the war in Ukraine and sanctions on Russia will continue to play a significant role in demand as well.

In addition to these strong demand fundamentals, the supply side of the sector is extremely tight—the tanker orderbook is very low and the global fleet is aging—resulting in healthy market conditions. When asked whether the company is interested in expanding its fleet by acquiring newbuilds or second hand vessels, the President answered simply: “No. Not at all.” The company has one of the youngest fleets in the sector, with its fuel-efficient vessels aged at an average of 7.3 years.

Rather than acquiring ships, he expressed, the company may do the opposite. “You may see us sell a handful of our older assets,” Mr. Bugbee said, “especially as our shares are trading so much below NAV. The money would be much better deployed in acquiring stock.”

Buying Back Vessels, Lease Financing Play Major Role in Debt Reduction

Scorpio Tanker’s fleet is made up of 113 product tankers, which the company either owns, leases, or charters-in. While the company frequently opted to lease vessels in the past, it has recently pivoted toward buying back these ships. As of August 2022, Scorpio has given notice to repurchase a total of 42 leased vessels and has repaid the debt for 28 of the ships, with the rest to be paid off within the year.  A few days after the podcast, on May 11, 2023, Scorpio announced it had given notice to exercise the purchase options for five additional ships, bringing the total number of vessel buybacks to 47.

The thinking behind this shift is twofold, Mr. Bugbee expressed. “First of all, the total amount of debt we have is falling very rapidly,” he stated, as a great portion of Scorpio’s debt was made up of lease finance that was put on when the markets were weak, and the company’s liquidity was low.

Secondly, now that the balance sheet has improved, the company can “accelerate the repurchase of those lease financings, and is incentivized to do so,” as the new financing is both “less expensive and more flexible” than the previous financing. This results in “less debt, lower margins, and more flexibility” for Scorpio, he underscored. While the company is seeking out new refinancing for the vessels, it is also using part of its own cashflow to buyback the ships.

During the interview, he expressed that he would like to exercise the option to buy back even more of the company’s leased vessels, as the Scorpio President stated that they “expect to have the cashflow anyway” due to the strength of the market.  “But more importantly than that,” he continued, “we recently announced a large commercial debt finance, which will really accelerate the ability to take down those leases.” Scorpio will use this commercial debt financing package, which amounts to over one billion dollars, mainly to buyback its leased vessels.

Lease financing has played an integral role in Scorpio’s debt reduction strategy. During the period from December 2021 through June 2023, the company projects to have reduced its debt by $1.4 million, the great share of which—$1.1 billion—relates to lease financing.

While not aiming “to go to zero” in terms of debt level, this is a strategy that the company will continue to follow, Mr. Bugbee stressed. “We have a range that we think is optimal, but we’re not yet ready to discuss that openly. We’re just going to do the job first—which is to take the debt down to where that range is.”

Share Buybacks Provide “The Best Value Creation for Shareholders” Compared to Dividends

Apart from reducing its debt, the company has also used its strong cashflow to repurchase its shares—since July of last year, Scorpio has bought back $350.2 million in common shares. A few days after the podcast, on May 11, 2023, Scorpio announced the buy back of an additional $94.6 million of common shares.

When choosing between share buy backs and dividends in terms of shareholder rewards, Scorpio’s President expressed that the answer was “easy”—buying back stock provides “the best value creation for shareholders,” as the stock is currently trading below NAV, the company’s fleet is quite young, and the market is robust.

The company plans to continue following this strategy of shareholder returns as long as the stock is undervalued, as “it would be irresponsible not to take advantage” of the stock’s substantial discount at the moment, he asserted.

If the gap between the stock price and NAV were to lessen, he stated, the company would consider alternative methods of providing shareholder returns, such as paying a special dividend. In terms of regular dividends, the company recently increased its quarterly dividend by 20%, from $0.20 to $0.25, amounting to an annualized yield of 2%.

In terms of high dividends, Mr. Bugbee argued that the Product Tanker sector is not an industry that should pay high payout dividends, there has to be a better way… we’re seeing in the tanker industry that these high payout dividends related to income don’t stop the stock price going down,” he noted.

Product Tanker Market: No clouds in the horizon

Some may consider the Scorpio President’s view of the market and its development as too optimistic, but Mr. Bugbee refuses to speculate about what could drive a downfall of the market, arguing that no one could have predicted the major events that caused crises in the sector anyway.

When asked what causes him concern about the current state of the market, not one worry came to mind. “Nothing…I’m very sure that there are many things that could take down the market that no one is thinking about at the moment,” Mr. Bugbee stated.

“Since the early part of my career, I’ve never seen anybody predict those things that actually hit the market very hard,” he expressed, listing 9/11 and the Covid-19 pandemic as examples.

This article is for information purposes only and does not constitute investment advice.