Nordic American Tankers: Challenges Remain Amidst Spot Rate Volatility

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About: Nordic American Tankers Limited (NAT)
by: Street Smart Investor
Summary

Strong 1Q19 results, but volatile spot markets remain a challenge.

OPEC and non-OPEC production cuts coupled with 2020 sulfur regulation to keep spot market and the company's earnings trend volatile.

Decline in orderbook can potentially tighten the tanker supply on or after 2020.

Volatility in earnings and spot market rates can provide attractive trading opportunity in the stock.

Investment Summary

I had written on Nordic American Tankers (NAT) on July 21, 2018, with a “Neutral” rating. I had expected the stock to remain sideways amidst industry headwinds and that has largely been the trend in the last 11 months.

The renewed coverage on Nordic American Tankers will focus on the key stock triggers for the next 12-18 months. The key conclusion is that even with an uptrend in spot rates for 1Q19, challenges sustain for the industry and I expect spot rates to be volatile.

It's worth noting that Nordic American Tankers was trading at $2.69 on May 20, 2019. The stock has declined by 22% to current levels of $2.09 within three weeks. While the steep correction might present a short-term trading opportunity, I believe that gradual long-term exposure can be considered considering some positives to be outlined in the thesis.

Strong 1Q19 Results

On May 14, 2019, Nordic American Tankers reported robust numbers for 1Q19 and the stock surged higher by 27.5% within a week. The key highlight of the result was that the time charter equivalent rate for vessels was 30% higher in 1Q19 as compared to 4Q18.

Higher day rates translated into higher revenue, operating income and operating cash flows for 1Q19 as compared to 1Q18 as well as 4Q18.

Just to put things into perspective, revenue increased to $53.6 million in 1Q19 as compared to $29.6 million in 1Q18 and $44.1 million in 4Q18.

The operating income for 1Q19 was $18.3 million as compared to an operating loss of $11.1 million in 1Q18 and an operating income of $5.4 million in 4Q18. Therefore, higher day rates did trigger growth in earnings and the stock reacted positively.

The markets however discount the future and as mentioned at the onset, Nordic American Tankers stock has sharply declined by 22% in the last three weeks after an initial excitement related to the results.

Volatile Spot Market Rates

The key factor that has resulted in the renewed decline in Nordic American Tankers stock is the fact that spot rates have remained volatile.

Just to put things into perspective, the day rate for Suezmax for year-to-date 2019 is $21,800. While day rates have increased to $22,500 for the week ended June 7, 2019, the day rate for the prior week was $14,800.

I believe this volatility in day rate is likely to keep the stock volatile and present attractive trading opportunities. I also believe that volatility in spot rates is likely to sustain in the coming quarters.

The key reasons for this opinion is as follows –

  1. In 2020, International Maritime Organization will enforce a 0.5% global sulfur cap as compared to the current cap of 3.5%. The objective is to reduce pollution as environmental concerns increase globally. The primary impact of the regulation will be on ship owners. However, the sulfur cap also will impact refiners as demand for low sulfur fuel will increase beyond 2020 and refiners need to invest in refinery upgrade in the next 12-18 months. The implication of refinery upgrades will be a relatively decline in demand for tankers as outflow of fuel from refineries declines during upgrade. This will negatively impact spot rates in the foreseeable future.
  2. In April 2019, the OPEC and non-OPEC members complied with the supply pact for the first time in 16 months. With potential global economic slowdown due to trade wars, the production cut is likely to continue and this will weaken demand for tankers in the coming quarters. In particular, the spot market is likely to remain very volatile as indicated by the recent trend in spot rates.

The Positives

Amidst concerns on volatile spot rates, there are reasons to believe that Nordic American Tankers might have bottomed out at around $2 per share.

The single most important reason for holding this view is the fact that the orderbook for new tankers has declined in 2019. Just to put things into perspective, the article from Hellenic Shipping News suggests that no Panamax/LR1 order has been placed in 2019. In addition, only six Suezmax and eight Aframax/LR2 orders have been placed.

With relatively weak global economic activity and production cut by OPEC and non-OPEC members, I believe that the orderbook is likely to remain slim. This can support spot rates in the medium to long term.

I also believe that Nordic American Tankers would be looking at having a fine balance of tankers in the spot market and on medium- to long-term charters. This will help in reducing the earnings volatility. On May 30, 2019, Nordic American Tankers announced that it has signed a 12-15 month charter for a Suezmax vessel with Equinor.

From a financial perspective, Nordic American Tankers is well positioned with $416 million in balance sheet debt and a debt-to-capitalization of 40.9%. In addition, the book value of vessels as of 1Q19 was $938 million and this implies a loan-to-value of 44.3%. Therefore, there's ample financial flexibility and with no near-term investment program, the company’s credit health is likely to remain stable.

Conclusion

The first quarter of 2019 was among the best in the recent past for Nordic American Tankers as spot rates trended higher and the company could deliver robust operating cash flows. However, the stock failed to sustain the rally as volatility in spot rates implies volatile earnings and cash flow in the coming quarters.

Based on a factors discussed, I expect this volatility to sustain in the coming quarters. However, Nordic American Tankers can provide attractive trading opportunities amidst volatility in spot rates. Long-term investors also can consider gradual exposure to the stock as declines in orderbook can potentially translate into spot rates and time charter rates firming up beyond the 12-18 months time horizon.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.