Nordic American Tankers: An Extremely Expensive And Risky Oil Tanker Company

| About: Nordic American (NAT)

Summary

The only thing that distinguishes Nordic American Tankers from other similar companies is that it always pays dividends way higher than earnings.

The main source of money for these dividends is secondary stock offerings. Such business model is not sustainable.

Based on any imaginable metric, NAT is several times more expensive than any other tanker stock.

In addition to being very expensive, NAT is also very risky. 100% spot market exposure, aging fleet and raising level of leverage may create very serious problems for the company.

There are several phrases that Herbjorn Hansson, CEO and President of Nordic American Tankers (NYSE:NAT) keeps saying in every press release:

- NAT is special and very different from other tanker companies;

- Net Asset Value [NAV], or the steel value of a vessel, is completely irrelevant when valuing NAT as a going concern traded on the stock exchange;

- We have only one type of ship in our fleet, the Suezmaxes, which is another competitive advantage of NAT.

In my opinion, these statements are very misleading. Let's have a look at the business model of NAT. The company owns oil tanker vessels, but all technical management is outsourced to third parties. In the latest annual report, it is written:

The Company has outsourced the technical management of its vessels to third-party companies operating under the supervision of the Manager. The compensation under the technical management agreements is in accordance with industry standards.

Technical management agreements: As of December 31, 2014, the ship management firm of V.Ships Norway AS or V.Ships provides the technical management for 14 of our vessels. The ship management firm Columbia Shipmanagement Ltd, Cyprus provides the technical management for four of our vessels. The ship management firm Hellespont Ship Management GmbH & Co KG, Germany provides the technical management for four of the Company's vessels.

Technical managers hire the crew of the ships, provide maintenance and arrange dry-docking. It is the technical manager, who can be proud of "the quality of the NAT fleet is at the top of the tanker industry," as they always write in quarterly reports. The only merit of the management of NAT is that they chose a good technical manager. But it was not difficult. V.Ships is the largest ship manager in the world.

The commercial management of the fleet is also very simple. All of the ships are employed in the spot market. 100% of revenue is dependent on the suezmax spot market. The management of NAT cannot influence the revenue in any way. NAT is completely a price-taker. Before 2012, the commercial management of the fleet was also outsourced to Gemini Tankers, a subsidiary of Teekay Shipping Corporation (NYSE:TK). After 2012, the commercial management is done by Orion Tankers pool, a 100% subsidiary of NAT. However, financial results they achieve are naturally very close to Gemini Tankers. Both are just price-takers without competitive advantages. Below is a table, showing average revenue per ship per day for Orion Tankers pool and Gemini Tankers Suezmax pool for recent quarters:

Orion (NAT)

Gemini (Teekay)

Q3/2015

35000

34782

Q2/2015

38800

38767

Q1/2015

37000

39433

Click to enlarge

As can be seen from the table above, both tanker pools produced very similar results in each of the quarters. It is no wonder, because both are completely price-takers. In fact, a typical fee that is charged for commercial management of a spot pool is about 1%, so having it outsourced or doing it internally does not really have any significant impact to the financial result.

It is not clear, what competitive advantage does NAT have by having only one type of ship in the fleet. The revenue depends only on market, and here it is not possible to have a competitive advantage. As for the costs, all technical management it outsourced and I doubt that third-party providers make significant discounts for giving them only one type of ships.

In reality, NAT is not a business, but an investment vehicle that allows investors to take exposure to the spot suezmax tanker market. A good confirmation of this thesis can be seen from the number of employees that NAT has. In the last annual report it was written:

As of December 31, 2014, we had two full-time employees and the Company had a total of 21 full-time employees.

It is not quite clear what is the difference between "we" and "the Company." At the beginning of the annual report it was written:

Throughout this annual report, all references to "Nordic American Tankers," "NAT," the "Company," "the Group," "we," "our," and "us" refer to Nordic American Tankers Limited and its subsidiaries.

So, it should have been the same. My best guess is that NAT had 2 employees and its wholly-owned subsidiary Orion Tankers Pool had 19 employees.

The financial performance of NAT could be easily reproduced by any investor with sufficient capital by buying several suezmax tankers in the open market (the average age of the fleet should be close to the fleet of the NAT), by using the same leverage as NAT, by outsourcing technical management to V.Ships and commercial management to Gemini Tankers. The required equity for such an investment is equal to the NAV of NAT.

In my opinion, the most similar investment vehicle to NAT is an index-linked ETF linked to the index of some not so easy to invest country. Although it is theoretically possible, in practice, it is not so easy to reconstruct the portfolio structure of NAT. You need to have at least $50 mln. in equity. However, the same can be said about an investment, for a retail US investor, in the stock market of some not so developed and far-away country, like Mongolia, for example. It is not so easy and very expensive to come to Mongolia, to open a brokerage account and to invest in blue chip stocks of this country.

How to evaluate the fair value of an ETF linked to the Mongolian market index? The main metric is, of course, NAV. If the ETF trades above the NAV, it reflects the premium you have to pay to get exposure to this market. The same can be said about NAT and suezmax vessels which it owns. The market value of the ship reflects the consensus that ship-owners place regarding earnings that ship will generate during its lifetime, taking into consideration the required rate of return. It is very similar to what the market price of a stock implies in stock market.

The management of NAT keeps telling us that the NAV is "the steel value of a vessel." It is absolutely misleading, because such statement apparently implies the scrap value (the amount of money that the ship-owner would receive if he decided to recycle the vessel). In reality, NAV reflects the expected cash flow that the fleet will generate during its lifetime (according to the opinion of ship-owners that operate in the second-hand market of ships).

For the management of NAT, to tell that NAV is irrelevant is the same as for the manager of a Mongolian ETF to write in the annual report after a particularly good year in Mongolian stock market: "Just look at our performance for the last year. NAV is irrelevant for our fund. Based on the return we achieved, our current stock price (at 2x NAV) is extremely cheap. Buy our stock as soon as you can."

The only real thing that makes NAT special is the dividend they pay. They paid the dividend for 74 quarters and in every quarter the dividend paid was higher than earnings. How can it be possible? To better understand the financial engineering that NAT uses, I made a table:

2015

2014

2013

2012

2011

Number of shares outstanding

(in mln.)

89.2

89.2

75.4

52.9

47.3

Number of ships in the fleet

26

24

20

20

20

Average age of vessels

12.4

12

12.6

11.6

10.6

Fair market value of the fleet

(in $mln.)

896

831

652

702

762

Fair market value of Nordic American Offshore Ltd. (NYSE:NAO) investment (in $ mln.)

24

45

65

0

0

Pro-forma net debt (in $mln.)

332

251

159

169

189

NAV (in $mln.)

588

625

558

533

573

NAV per share

6.59

7.01

7.41

10.06

12.11

Debt/Assets ratio

36%

29%

22%

24%

25%

Gross proceed from secondary public offering of shares (in $mln.)

0

119

168

85

0

Total amount, paid in dividends

(in $mln.)

142

63

36

56

57

Total amount, paid in dividends

per share

1.59

0.71

0.56

1.06

1.2

Click to enlarge

The table above shows key figures for NAT at the end of each of the last 5 years. Dividends and offerings reflect amounts paid and raised during the corresponding year.

To calculate pro forma net debt, I used the balance sheet data and increased it to the remaining amounts of payments to shipyards for newbuildings and declared, but not yet paid dividend for Q4.

To calculate the fair market of the fleet, I used shipbroker assessments. For example, such information can be found here.

I applied the same assessment values (using current data) to ships in every year. That is, I assumed that the market price of a 5-year old suezmax vessel was the same every year since 2011. In reality, naturally it fluctuated, but for better comparison and for better understanding of trends, I decided to eliminate this volatility.

There are many interesting observations which can be derived from this table.

During the last 5 years, NAT has paid $354 mln. in dividends. At the same time, the company has raised $372 mln. in secondary share offerings. It does not look like a good business decision. Secondary offerings are not free, the company had to pay high underwriting commissions. But NAT is special and very different from other tanker companies, for them it makes perfect sense.

Since the end of 2011 till the end of 2015, NAV per share has decreased from $12.11 per share to $6.59 per share. During this time, the company paid dividends of $3.92 per share. The total return, based on NAV, for the last 4 years has been -13.2%.

By the end of 2009, NAT had no debt at all. The pro-forma net debt, calculated the same way like in the table above would have shown a negative value. Since that time, NAT has gradually increased leverage. Now, debt to assets ratio stands at 36%. While it still looks good, there is nothing really unique in it. At the same time, after taking into consideration extremely high operational leverage (which I will discuss below), in comparison with other tanker companies, I would assess the risk level of NAT as being above average.

Now back to the question, why is NAT a special company and why does it makes sense to make distributions of $354 mln. and at the same time to make secondary offerings for the same amount? The real business, where the management of NAT is engaged is not shipping. Their shipping business is very simple and straightforward. They just outsource technical management and get spot market rates. Real value creating activities are focused on keeping the stock way above the NAV and on selling shares at prices way above their intrinsic value. When a company sells shares at a price two times higher its intrinsic value, half of proceeds becomes net profit for existing shareholders.

High stock price of NAT is not simply the long-term goal of the management, like it should be in a well-run public company. It is the requirement to continue the business model that NAT has and has had for many years. This is why, financial reports of NAT look more like aggressive commercials to buy shares, rather than a source for providing information about the business of the company. This is why the CEO, instead of hosting a conference call with analysts to discuss the quarterly report, goes to CNBC and tells the same mantra about the company being special and other misleading stuff like telling that NAT has never cut the dividend for 74 quarters.

Several years ago, I wrote two articles about another special shipping company, Navios Maritime Partners L.P. (NYSE:NMM), which was also in the business of paying dividends way higher than earnings, artificially keeping high market price per share and regularly making secondary offerings:

Skeptical of Navios Maritime's Success: Beware Dividend Longevity and MLP Status

Navios Maritime Partners - Big Problems Ahead

Have a look at the stock price of NMM today. I am sure that fundamentally, both NMM and NAT have exactly the same business model and the outcome will be the same. This model is not sustainable. I do not know when, but eventually, NAT will end up the same way like NMM. NAT may be a good short-term investment, but long term, it is a disaster.

Now, to the point of why tankers are now having such great returns on the market value of vessels (or NAV in other words). My investment credo is that it is too difficult to be cleverer than the market, comprised of well-informed professionals. The only place where it is possible to have an edge is in small cap equities, where the majority of shareholders is comprised of retail investors prone to the propaganda of the management.

In case of shipping, it means that it is very difficult to have an edge by analyzing macro trends and by finding mispricing in the S&P market of ships. The only case when NAV (and accordingly the market value of the fleet) is not relevant for the valuation of shipping company is when the survival of the company is at stake. If the company goes bankrupt, shareholders of the company will get close to zero, no matter how high was the NAV. In case of NAT, there is no bankruptcy on the horizon, so this observation is not relevant.

However, I will try to explain why the current return on tankers is so high, compared to the market value of ships. The main problem, in my opinion, is the poor state of ocean shipping in general. Of course, for tankers, it does not matter that dry bulk and box ship industries are in dire straits. The problem for tankers is that there is huge idle shipbuilding capacity. During the commodity boom of the last 10 years, shipbuilding capacity was expanded by several times. Now, tankers have become the only commercially profitable segment of shipping. They have become the only source of new orders. Naturally, shipyards are offering extremely attractive prices for ship-owners to place new orders. As a result, tanker order book is very high and keeps growing. The new supply of ships will soon send the rates down. The shipping downward cycle will finish only when the last profitable segment (tankers) will also loose profitability and the excess shipbuilding capacity will be diminished through the bankruptcy of shipyards. It happened before and it will happen again.

Stock market investors in other, ordinary tanker companies (not special like NAT) are even more pessimistic than ship-owners. Stocks of all other tanker companies are trading below the NAV. Below is a comparison of some other tanker stocks.

Company

Quarter

NAV per share

Market price per share

Price/NAV

Debt/

Assets

Forward P/E

Nordic American Tankers

Q4/2015

6.59

12.42

1.88

36%

14.79

Teekay Tankers Ltd. (NYSE:TNK)

Q3/2015

5.73

4.03

0.7

50%

2.70

Double Hull Tankers (NYSE:DHT)

Q3/2015

8.26

5.59

0.68

50%

7.36

Gener8 Maritime Inc. (NYSE:GNRT)

Q3/2015

14.84

5.34

0.36

59%

2.35

Click to enlarge

There are some other US listed tanker stocks, like Frontline Ltd. (NYSE:FRO), Navios Maritime Acquisition Corporation (NYSE:NNA), Euronav NV (NYSE:EURN), Scorpio Tankers Inc. (NYSE:STNG). All of them are far cheaper than NAT on every imaginable metric.

NAT is the only public tanker company with the fleet comprised of only suezmax vessels. However, it is not so important. Historically, the correlation in performance between suezmax and VLCC ships has been very high.

In addition to being very expensive, NAT is also very risky. The financial leverage, although still manageable, has been constantly growing over the last 5 years. If NAT keeps the level of dividends like now, the leverage will increase. In addition to it, NAT has very high operating leverage. By operating leverage I mean 100% spot market exposure and aging fleet. Such factors tend to lead to very high return in a strong market (like now) and to big losses in a poor market (which is widely expected soon by all market participants).

Conclusion

The management of NAT always tells that this company is special. I agree with them. However, the company is special not because it has competitive advantages, but because the management pays artificially high dividends, aggressively promotes the stock and make secondary stock offerings at prices far higher than the intrinsic value. Such a model is not sustainable. To have this stock in the portfolio as a source of long-term income in the form of dividends is a big mistake.

All of tanker shipping companies look extremely cheap. All of them, except NAT, have forward P/E far below 10. Some of these companies, like TNK and GNRT have forward P/E ratio below 3. However, there is a very good reason for such valuations. All of tanker market participants consider current rates as non-sustainable. At some point, they are going to come down very fast. In this case, NAT, with aging fleet and 100% spot exposure becomes one of the most risky stocks. In shipping, the market moves very fast. Have a look at dry bulk companies. In August 2015, just 5 months ago, Genco Shipping & Trading Ltd (NYSE:GNK) and Eagle Bulk Shipping Inc. (NASDAQ:EGLE) had balance sheets even better than NAT has today, with Debt/Assets ratio of about 30%. Both of these companies had 100% spot exposure. The result of the downturn in the dry bulk market has become catastrophic for them. Both of these companies are at the brink of bankruptcy now. Have a look at the stock performance of these companies for the last 6 months.

I believe that NAT is the worst tanker stock based on risk/return ratio. It will have by far the lowest return, if the tanker market defies expectations and keeps strong, and it will become one of the most risky stocks if tanker rates crash.

Disclosure: I am/we are short NAT.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.