All Of Euronav's Tankers Have Now Been Delivered - Let The Cash Flow Hit The Treasury (And Your Pockets)

| About: Euronav NV (EURN)
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Summary

Euronav's net income was lower due to the lower charter rates, but the company will definitely remain profitable.

The final VLCC has been delivered, which means Euronav's capital expenditures will fall dramatically to less than $50M per year.

This means the free cash flow will increase substantially, and the payout ratio of the dividend will decrease, paving the way to reduce debt.

I still think the book value of Euronav's vessels is very conservative. Despite this, Euronav is still trading at a 30% discount to its book value.

Introduction

I was the very first author here to cover Euronav (NYSE:EURN) here on Seeking Alpha, as I thought the company was in a great shape to take advantage of increasing charter rates. Just a few week after that article, Euronav stepped up the plate and acquired young VLCC vessels timing the bottom of the market pretty well, as it paid fire-sale prices for the new VLCC's and could now, two years later, probably still sell them at a profit.

EURN Chart

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Euronav now has a very liquid listing on the NYSE with an average daily volume of almost 750,000 shares, so it's no longer necessary to use Euronext Brussels to execute your trades.

Euronav's first half of the year

Euronav's first quarter was pretty amazing with a total revenue of $215M, but - no unexpectedly - the company's revenue took a step back in the second quarter of the year as the traditional seasonality in the earnings of a tanker operator sets in. Q2 and Q3 traditionally are the weakest quarters for an oil shipping company as the summer season in the northern hemisphere usually reduces the demand for oil transportation.

Source: financial statements

The total revenue in the first half of the year fell by approximately 3% to $404M, whilst the pre-tax result fell by 10% to $154M. That being said, there were some one-time items associated with this lower pre-tax income. Yes, the company reported a $13.8M gain on the sale of an asset, but it also reported a $24.2M loss on the 'disposal of investments in equity accounted investees', and that's most definitely a non-recurring item as well.

If I would adjust the pre-tax income for these one-time items, the result would have remained pretty stable and be just 3% lower than H1 last year. The net income in the first half of the year was $154M, or approximately $0.97/share. That's fine, but as Euronav still has quite a bit of debt, I'm obviously always very interested in a company's cash flow profile as well. That's specifically the case in sectors where the initial capex for assets is very high, but the sustaining capex very low. That's most definitely the case in the oil tanker sector; a new VLCC vessel usually costs $80-100M (depending on the market conditions), but the sustaining capex is less than $1M per year which creates a substantial discrepancy between the income statement (where the depreciation rates are being taken into consideration) and the cash flow statement (as the depreciation charges are non-cash expenses).

Source: financial statements

That's clearly visible in the cash flow statements, as Euronav generated a total operating cash flow of $291M, and approximately $255M after ignoring the changes in its working capital position.

Yes, the tanker rates are quite weak now, but that's not unusual

Sure, almost the entire operating cash flow was spent on the acquisition of new vessels, leaving a total free cash flow of just $55M in H1. Indeed, that's not fantastic at all, but the key point here is the fact that this was almost entirely expansion capex, as Euronav paid the final deposits for its new vessels. In May, the VLCC Anne was delivered, and this immediately marks the end of Euronav's capex program. This basically means the free cash flow will be very close to the adjusted operating cash flow. Even if you'd budget an annual sustaining capex of $40M, Euronav will still generate $400M+ in adjusted free cash flow, based on the H1 results.

Source: company presentation

That is, if the charter rates gain some momentum again. The charter prices definitely weakened in the second quarter of the year, and right now the one-year charters for a VLCC are priced at $34,000/day whilst Suezmaxes are being marketed at $25,000/day. Euronav has fixed 50% of its Q3 availability for its VLCC's at $31,800/day whilst 39% of the available days for it Suezmax vessels were fixed at $20,900/day.

Will the lower charter rates have an impact on the (generous) dividend? Not unlike other shipping companies, Euronav has attracted quite a few shareholders with its very favorable dividend policy as the company plans to pay its shareholders 80% of the normalized net income (excluding profits on the sale of vessels). Since the start of this policy approximately 18 months ago, Euronav has already paid $1.69 per share in dividends, and will once again pay an interim-dividend in September. Euronav also thinks the weak momentum on the oil tanker market might be temporary. From the conference call:

"The freight rates in VLCC terms have hit the rate lows last seen in Q3 of last year. Will these factors persist? The number of cargoes remains consistent as do signals from core markets such as India and China. Indeed, a similar dip in rates was seen last year and lasted all of five weeks. The key to the timing of a recovery will depend significantly on the attitude of owners. Currently, we feel they are collectively on holiday. Whilst the disruptive factors in recent weeks have had an impact, the underlying tanker market fundamentals remain solid. "

The exact details of the dividend will be announced later in August, when it will publish the 'final' half-year results. Euronav doesn't pay 80% of the H1 profits as a dividend (last year the payout ratio based on the H1 net income was 55%, followed by a substantially higher dividend after the end of the financial year).

The net income in the first half of the year was $0.97 per share due to a low associated with the disposal of a subsidiary where the equity accounting method was used. However, this $0.97 also contains the profit from selling an older vessel, and the adjusted EPS (excluding this one-time event) was $0.89. However, if you would also exclude the equity loss on the grounds of it being an exceptional loss as well, the adjusted EPS would be $1.04. It's impossible to 'guesstimate' how high the interim dividend will be, but given the current (temporary) weaker situation on the tanker market, I can imagine Euronav's board will be quite conservative and cut the interim dividend to $0.30-0.40. But on the other hand, a case could also be made for the removal of capital expenditures in the near future, reducing the need to hoard some cash right now.

The book value remains understated

One of the main reasons why I liked Euronav in the past is the fact the company uses a very conservative depreciation schedule for its vessels. This theory has been confirmed several times in the past when Euronav was able to sell older vessels above the book value.

And this still seems to be going on. According to the balance sheet, Euronav's fleet was valued at $2.6B, but I still feel this represents an undervaluation. The average age of the VLCC fleet is 6 years, and 5 year old vessels are being sold for $63M. If I would now use a value of $60M for a 6 year old vessel and multiply it by the 30.5 attributable VLCC-style vessels in Euronav's fleet, the value of the VLCC's is already $1.9B.

Source: company presentation

But Euronav also owns 20 Suezmax vessels (according to the fleet page) with an average age of 10 years. According to Compass Maritime, the value of a 10 year old Suezmax is $35M per vessel, which means these vessels have a market value of $700M.

What does this mean? Simply put, the market value of the VLCC's and the Suezmax'es alone represent the TOTAL book value of all vessels on the balance sheet. In a simplified form, this means the 2 FSO's on the balance sheet are basically thrown in for free, and this adds an additional layer of safety.

Investment thesis

Long story short, the fun times are only starting for Euronav as the capex will fall off a cliff, and even with the lower charter rates, I'm still expecting the company to generate an operating cash flow of $275M and a free cash flow of $250M going forward. This also means the dividend is completely safe. Let's assume the full-year EPS will be $1.60 (which also takes the lower charter rates into consideration), then the total dividend would be $1.28, or approximately $205M per year.

The (approximate) total operating cost is $285-300M per year, so even if Euronav would have to charter its entire VLCC and Suezmax fleet at respectively $30,000/day and $20,000/day, its EBITDA would very likely come in at $300M, and the free cash flow at $275M. This allows Euronav to use $70M for debt reduction. And of course, there's plenty of leverage here as according to Euronav, every $5,000/day it can hike its charter rates, the EBITDA increases by in excess of $70M.

And that's why Euronav remains one of my favorite oil tankers. The management has proven it knows what it's doing, and now the capex levels will drop off a cliff, the dividend will most definitely be covered by the free cash flow, whilst the excess cash will be used to deleverage the company's balance sheet (which had a net debt position of $975M as of at the end of H1). I have a long position in Euronav, but will very likely increase this position later this week as the company's share price is approximately 30% lower than its (conservative) book value.

Disclosure: I am/we are long EURN.

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

Additional disclosure: I have a long position in Euronav, and have written put options that are both in the money and out of the money