Scorpio Tankers Inc.( STNG): Strategic Excellence and Product Tanker Market Strength

Company Update & Product Tanker Sector Outlook

In a recent installment of Capital Link's Shipping Webinar Series, Mr. Robert Bugbee , President & Director, and Mr. James Doyle, CFA , Head of Corporate Development & IR at Scorpio Tankers Inc. (NYSE: STNG), discussed the company’s strategy, product tanker outlook, and STNG’s recently announced Q1 2024 results with Mr. Nicolas Bornozis , President of Capital Link.

Link to Webinar:

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Highlights:

• From January 1, 2023, through March 2024, STNG has generated $1.3 billion in EBITDA and $777 million in adjusted net income.
• The company has reduced its debt by $557 million over the past year.
• STNG has focused on share buybacks while maintaining its dividend to return value to shareholders—the company paid $79 million in dividends and repurchased $490 million worth of shares.
• Last year, STNG’s operating cash break-even was around $17,000 but it is expected to drop to approximately $12,500 in Q3 of this year.
• The company’s operating costs have dropped due to debt repayments and its modern, efficient fleet of 109 tankers (average age of 8.2 years).
• Market fundamentals remain strong due to geopolitical factors creating efficiency and reducing the supply of tankers.

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Scorpio Tankers (NYSE: STNG) provides marine transportation of refined petroleum products globally. The company owns or lease-finances a fleet of 109 product tankers (39 LR2 tankers, 56 MR tankers, and 14 Handymax tankers) with an average age of 8.2 years, making STNG one of the world’s leading product tanker owners.

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Q1 2024 Results Highlight Efficacy of STNG’s Strategy

In its recently announced Q1 2024 results, the efficacy of STNG’s strategy focused on debt reduction, operational efficiency, and prudent capital allocation was made clear. By the end of Q1 2024, STNG had reduced its net debt to $811 million, close to the scrap value of its fleet, reaching the lower end of its target debt level. Recently, the company announced an additional debt prepayment of $223 million from its $1 billion facility.

Mr. Robert Bugbee, President and Director, elaborated on the benefits of this debt reduction, explaining that the announced prepayment will reduce STNG’s gross debt, which in turn will decrease interest rate costs and amortization expenses. Last year, STNG’s operating cash break-even was around $17,000, but it is expected to drop to approximately $12,500 in Q3 of this year. This significant debt reduction substantially lowers the operating cash break-even point, resulting in greater financial resilience for the company, regardless of market conditions.

STNG’s lower operational costs are partly due to the company’s extensive debt reduction strategy and its young, modern fleet. This fleet boosts the company’s operational efficiency significantly. Coupled with the focus on debt reduction, STNG’s modern fleet provides financial stability in challenging market conditions, enabling the company to maintain lower operating costs and benefit from stronger cash flow.

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Capital Allocation Strategy – Focus on Share Buybacks

From January 1, 2023, through March 2024, STNG generated $1.3 billion in EBITDA and $777 million in adjusted net income. When allocating this capital, STNG has focused on reducing its debt and providing value to shareholders. The company has reduced its debt by $557 million, excluding the recently announced $223 million reduction. It has also paid $79 million in dividends and repurchased $490 million worth of its shares.

Historically, STNG has prioritized share buybacks as a key component of its capital allocation strategy. This focus has contributed to a significant increase in the company's stock value, rising from $62.52 at the beginning of the year to over $82 currently. Despite this growth, the company’s President has mentioned that STNG does not disclose its exact Net Asset Value (NAV).

However, Mr. Bugbee addressed the underlying performance and value drivers of the stock, emphasizing that while strategies like stock buybacks or debt reduction can enhance stock value, the primary factors that will drive the stock above its NAV are the security of earnings, the reduced fear of a decline, and the actual earnings themselves. He highlighted that the company’s debt reduction efforts have alleviated much of the market's fear of a downturn, leading to potentially better stock multiples regardless of market conditions. Mr. Bugbee suggested that in the current unique market situation, NAV might not be the most appropriate metric to gauge the stock's value.

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Modern Fleet Provides Financial Security

STNG is well-positioned with one of the largest fleets in the sector. Its vessels are relatively young, averaging 8.2 years, and the company does not have any new builds on order. In response to strong market bids, STNG has started selectively selling its older vessels. This strategy ensures that the company maintains a modern and efficient fleet while capitalizing on high asset values. Mr. Bugbee highlighted that asset values are high due to strong new building prices and robust three-year time charter rates.

STNG’s oldest vessels are still among the newest in the industry. Given the high value of these vessels and the company's historical trading at a discount to NAV, the strategy has been to "gently prune the tree,” meaning selling one or two older vessels in response to strong bids rather than conducting aggressive sales. This measured approach to fleet management will likely continue, ensuring the fleet remains modern without drastic changes.

STNG’s commercial strategy involves maintaining confidence in the spot market while selectively chartering out vessels to key partners in longer-term contracts. This approach balances the spot market, which tends to be more volatile, and time charter markets, which provide more financial clarity, ensuring strong overall performance.

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Sector Fundamentals and Market Outlook

When asked about his outlook for the product tanker market, Mr. Bugbee responded positively regarding its future. He attributed this positive outlook to pent-up demand, hesitations over energy price collapses, and unusual weather patterns in the northern hemisphere, leading to varied energy needs. He has observed growing consumption and a strengthening global economy, with no reports indicating a decrease in product and crude requirements for the third quarter. He anticipates a strong market through the summer, with no significant soft season, and expects further strength in the fourth and first quarters.

Geopolitical factors, such as the closure of the Red Sea and ongoing sanctions, contribute to strong market dynamics by creating inefficiencies and restricting vessel movements, benefiting the product tanker market. Mr. Bugbee expects these factors to continue positively influencing the sector.

Sanctions imposed in response to the war in Ukraine play a similar role in the tanker market, restricting freedom of movement, creating inefficiencies, and extending transit times. These elements positively influence the market by generating additional demand for shipping capacity. Even if the conflict ends, these sanctions are likely to persist.

Regarding the product tanker sector’s supply and demand fundamentals, Mr. Bugbee expressed cautious optimism. He acknowledged that the current market strength is partly due to geopolitical factors such as international conflicts and the closure of the Red Sea. However, he emphasized that the underlying fundamentals remain strong, with steady demand and a limited supply of new builds. While the overall tanker market might not be in a "new era," the product tanker sector is well-positioned for continued strength.

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Regulatory Landscape and Decarbonization

Apart from geopolitical factors, another key element impacting shipping across all sectors is environmental regulations. Mr. James Doyle, Head of Corporate Development & IR, addressed the regulatory environment, noting the increasing impact of regulations like the EU Emissions Trading System (ETS) and IMO regulations on shipping markets. He stated that regulations will continue to tighten and highlighted the company's preparedness, particularly with their Eco fleet, to meet the EU ETS regulations.

Mr. Doyle noted that IMO regulations will initially impact older vessels, affecting future ship orders and engine types. He emphasized the uncertainty around future fuel choices, such as ammonia and hydrogen, and the necessity for these fuels to be widely available. Despite this lack of clarity regarding alternative fuels, Mr. Doyle expressed confidence in the company's current position and readiness to adapt quickly.

Closing the webinar, Mr. Bornozis recalled a previous discussion with Mr. Bugbee for Capital Link, in which STNG’s President stated that he feared nothing in the market. When asked if his view had changed, Mr. Bugbee admitted that he is now apprehensive about the unknowns in the market. He highlighted several concerns, including the strong market environment, high leverage within the industry, and pressures on shipyards negotiating favorable terms. Additionally, he mentioned the challenges posed by an aging fleet, with many ships nearing 20 years old, which presents a significant hurdle, especially in the product market. Despite the current positive conditions, Bugbee remains cautious about unforeseen challenges.

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