Overseas Shipholding Group, Inc. (NYSE:OSG) Q3 2022 Earnings Conference Call November 4, 2022 9:30 AM ET
Sam Norton - President and CEO
Dick Trueblood - VP and CFO
Conference Call Participants
Climent Molins - Value Investor's Edge
Good afternoon. Welcome to the Overseas Shipholding Group Third Quarter 2022 Earnings Release Conference Call. My name is Adam, and I'll be your operator for today. [Operator Instructions]
I will now hand over to Sam Norton to begin. So Sam, please go ahead when you are ready.
Thank you, Adam.
It's a beautiful morning here in Tampa, Florida, providing an appropriate backdrop for Dick Trueblood and I to share with you our presentation of OSG 2022 third quarter results. Thank you for listening in and for allowing us to share with you details as to the current state of our business and to other additional commentary and insight into the opportunities and challenges that lie ahead.
I would like to welcome in particular, regular participants on this call who have exhibited commendable patients in maintaining their interest in OSG during what has been a challenging emergence from the market disruptions occasioned by COVID-19.
To start, I would like to direct everyone's attention to the narrative on Pages 2 and 3 of the PowerPoint presentation available on our website regarding forward-looking statements, estimates and other information that may be provided during the course of this call. The contents of that narrative are an important part of this presentation, and I urge everyone to read and consider them carefully.
We will be offering you more than just the historical perspective on OSG today, and our presentation includes forward-looking statements, including statements about anticipated future results.
These statements are subject to uncertainties and risks. Actual results may differ materially from those contemplated by our forward-looking statements and could be affected by a variety of risk factors, including factors beyond our control.
For a discussion of these factors, we refer you to our Form 10-Q for the third quarter of 2022 filed yesterday and available at the SEC's Internet site, www.sec.gov as well as on our own website, www.osg.com. Forward-looking statements in this presentation speak only as of the date of these materials, and we do not assume any obligation to update any forward-looking statements, except as may be legally required.
In addition, our presentation today includes certain non-GAAP financial measures, which we define and reconcile to the most closely comparable GAAP measure in our earnings release, which is also posted on our website.
Financial results achieved during the past quarter provide a welcome affirmation of our long-held belief in the viability of OSG's business strategy, exceeding our expectations and demonstrating strength through the balance of the year and into 2023. Our niche businesses, in particular, delivered stellar results for the quarter, adding meaningfully to the continuing rebound seen in the time charter equivalent returns of our conventional tankers and ATBs.
Adjusted EBITDA of $42.3 million generated $14 million of free cash flow for the period, clearly, the best performance on that measure in many years. Our expectations for future financial performance appear to provide continuing evidence of the benefits of having both our niche and conventional trading businesses healthy and profitable at the same time.
OSG vessels are essentially fully committed well into the middle of next year, with only our internationally trading MRs with exposure to the spot market. Even that limited spot market exposure were more likely than not prove to be beneficial in the months ahead, given the currently strong MR rates obtainable and nationally.
Considering only our Jones Act assets, 92% of available vessel operating days are covered for all of 2023. Cash flows derived from the shift to profitable charters among our conventional tankers and the steady and strong earnings provided by our niche market activities are contributing and should continue for the foreseeable future to continue to contribute, not only profits as reflected on our GAAP reported income statements but also to improving the quality of OSG's balance sheet.
I will defer to Dick to take you through the details behind these headline results. I will focus my comments on the broader current market environment and the impact that what many observers are calling an emerging energy crisis is having and will likely have in the future on OSG's business. To state the obvious, OSG's business is largely a domestic business closely integrated with the distribution needs of domestic producers of crude oil and refined products.
Some would then surmise that OSG should be largely immune to the major disruptions to energy supply chains and transportation price volatility witnessed in the international tanker markets of late.
The United States is a large producer of natural gas, crude oil and refined petroleum products. Shouldn't such energy independence prove insulation or provide insulation from the chaos and foreign markets. Understanding two things help answer this question.
The first, energy is largely an undifferentiated commodity that is priced globally at the marginal cost of the delivered price. The second, the marginal cost of energy's delivered price is all about location, location, location and the availability of transportation links to connect surplus supply with markets that are in need. Ships and ports are the enabling vehicles for intercontinental trade.
If the cost of shipping allows a trader to buy product domestically and sell it overseas at a delivered cost that generates a profit then the product will move to the market that offers the higher price. The intercontinental trade of energy products is ruthlessly efficient in seeking out and closing these price arbitrage opportunities. Prior to 2016, the U.S. was for all intents and purposes an energy island, insulated from the international energy market. Export of U.S.-produced crude oil was legally banned.
Refined product exports were made only in small amounts. LNG export facilities were not in service. Over the past six years, market and regulatory changes have radically altered this landscape, allowing U.S. energy products to participate in international markets more actively. This increase in the access to international markets has been a net positive for domestic energy producers and the shippers who enable the flow of goods. The side effect of this, however, has been to make energy independence a chimera.
Under current laws, irrespective of where natural gas, crude oil and refined products are produced U.S. consumers are more and more subject to competing demands from foreign markets, a development which helps explain current low product inventory levels and why local prices are rising despite the fact that the U.S. is the largest producer of these products.
The opening up of international markets to U.S. energy producers has thus reduced the level of insulation that OSG ships have from international events. The ability for a trader to choose most profitable trade, a domestic sale versus an international sale means that Jones Act vessels are indirectly competing with foreign flag vessels for the transport of domestically produced energy products.
The existing and pending economic sanctions against Russia limit many OECD countries from purchasing Russian oil and gas, creating supply shortages and considerable uncertainty in international energy markets.
The wide profit margin accompany this uncertainty have had the effect of drawing record levels of domestically produced oil and gas products overseas. Last week, the EIA disclosed nearly 11.5 million barrels of crude oil and refined products per day were exported during the week ended October 21.
These are truly astounding export figures, an increase of over 30% when compared with the average volumes exported last year and a 240% increase from the average export volumes seen in 2015. The elevated interplay between domestic and international energy transport costs and the visible contrast between record exports on the one hand and record low domestic product inventories on the other has two important implications for OS.
First, it creates rising pressure for intervention to waive existing domestic maritime regulations, opening a wide chasm of moral hazard for those wishing to exploit political expediency. If traders were our key economic actors in the domestic energy transportation ecosystem are rewarded with Jones Act waivers whenever conditions appear favorable to ask for one, they will no longer see the need to guard against risks by planning and entering into time charters, and we'll act accordingly, increasing overall systemic risk with little or no consequence to themselves.
Waivers perniciously undermine conditions meant to ensure long-term visibility and stability in the availability and delivery of vital energy products, allowing profit-motivated actors to occasionally operate outside these rules with little downside risk and with the promise of windfall profits will undoubtedly cause great harm to the communities these rules are intended to benefit and protect. Grants of waivers in any, but the most extreme conditions should thus be assiduously avoided.
Second, if only indirectly, the increased influence of foreign tanker rates on domestic trade has the effect of increasing volatility in demand for our conventional tankers. While heightened volatility is not always a negative development, the related lack of visibility of forward earnings suggests higher risks. This development, to a large degree, explains our rationale for electing not to extend three MR tankers leased from American Shipping Company.
As previously announced, the delivery - the redelivery in December of three conventional tankers will reduce OSG's exposure to the [ballroom] and often unpredictable and undifferentiated domestic MR tanker market. Redelivery of these ships will reduce real financial leverage in our business, releasing OSG from annual fixed payment obligations of approximately $27 million during 2023 and beyond.
The effective deleveraging achieved through the decision not to extend the options of these three vessels when taken together with the positive free cash flow performance expected in the quarters ahead, provides OSG with enhanced flexibility to address existing and anticipated business opportunities with lower volatility and improved profitability.
As noted on prior calls, we consider there to be interesting opportunities for expanding our business in several of the niche markets in which we have already achieved a level of success.
Specifically, we remain very focused on the continued emergence of renewable diesel as an increasingly important driver of domestic marine transport demand. Our experience with customers in this emerging sector is that security of access to transportation capacity offered by long-term contracts is a more important element in the commercial discussions and has been the case recently with customers involved in crude and refined oil product trades.
This bias offers opportunity for OSG to reduce exposure to volatility in our conventional tanker trades. Over the past year, we have negotiated time charters with four different charters engaged in renewable diesel trade with the result that by the middle of next year, 50% of our conventional tanker fleet will be employed in trades related to renewable diesel, with several of these contracts extending beyond the end of 2023.
New business with further growth opportunities in the Jones Act has not often been seen in recent years, and we are excited about the role that OSG plays in this emerging business. In addition, prospects for an enlarged U.S. flag fleet operating outside of the United States and outside of the Jones Act trades are solidified.
Congressionally approved and funded tanker security program is expected to be stood up during the first half of next year. OSG has taken a leadership role in working with its industry, labor and government partners to make this vision a reality. Consideration is being given to expand the approved 10 ship program to a 20 ship program. Further, the U.S. Department of Defense is seeking bids to provide five additional U.S. Flag tankers to assist with reorganizing fuel storage operation at Hawaii's Red Hill facility.
Our Overseas Mykonos, Overseas Santorini and Overseas Sun Coast are well positioned to benefit from these programs. Depending on the pace and extent of the growth of these programs, opportunities to add additional vessels to our current fleet could well arise.
Looking elsewhere in our current portfolio of assets, renewed focus on the importance of sustaining and increasing domestic crude oil production bodes well for the continued future of the vessels acquired through our purchase of Alaskan Tanker Company in 2020.
There is good reason to believe that the demand for these vessels will remain strong for the foreseeable future. Opportunities to increase time charter earnings from ATC vessels in 2023 and beyond, an important area of focus for us at this juncture. We are developing and working to finalize business inquiries that are already in hand for these vessels.
Lastly, we recognize in importance of understanding and participating in newly developing markets that would transition the U.S. economy away from fossil fuels. These evolving markets point to interesting and exciting potential for OSG to leverage its strong operating franchise to participate in these new trades. OSG continues to commit resources toward an expressed goal of identifying the best opportunities that will arise from this transition, and we are optimistic that these efforts will yield positive results over the medium term.
I will now turn the call over to Dick to provide you with further details of our third quarter results for 2022. Dick? All right.
Let's turn to Slide 7. We commenced a $5 million share buyback in late June. During the third quarter, we purchased 3.6 million shares for total consideration of $10.7 million. At September 30, we had cumulatively purchased 3,800 million shares for $11 million at an average purchase price per share of $2.92.
In early October, we completed the share repurchase program for a total acquisition cost of $14.7 million, with a resulting average share purchase price of $2.95. TCE revenues rose to $115.1 million in the third quarter of 2022 from $75.4 million in the year ago quarter, an increase of 53%.
Quarterly adjusted EBITDA was $42.3 million, an increase of $30.1 million from last year's third quarter. TCE revenue growth from the second quarter of 2022 was $12.7 million or 11.5%. Adjusted EBITDA grew 34% or $10.8 million from the prior quarter. Market demand remained strong with rates at levels significantly greater than experienced in 2021. We are close to fully committed through December 2022 and as we look forward to 2023, we are almost fully booked for the first half of 2023 and 92% committed for the balance of the year.
Please turn to Slide 8. There were no vessels in layup during the third quarter as compared to two in layup four portions of the second quarter. Our Jones Act conventional tankers employed days rose to 852 during the quarter or 93% of total days. We had 51 drydock days during the quarter. Comparatively, we had 379 employee days in Q3 2021 when we began to return ships to service. The overseas camp left layup in early May and underwent a required drydock period in ballast water treatment system installation before she commenced operations.
The OSG 350 Vision returned to service in late May. During the third quarter, Tampa was fully employed and the OSG 350 had 1,200 employed days before commencing a time charter.
Please turn to Slide 9. Lightering revenues increased $4.3 million this quarter due to a combination of greater volumes lightered by the OSG 351 and a time charter for the OSG 350 which commenced in August. Our APDs increased our revenue contribution by $700,000. The OSG 204 entered into a short-term time charter upon completion of our previous long-term time charter.
The TCE rate increased from the earlier time charter, increasing her revenue contribution. After completion of our short-term time charters, she will enter into a long-term charter. Mykonos and Santorini continue to participate in the Maritime Security Program and also provide services to the government of Israel.
We performed several charters for the Military Sealift Command, which provided a high level of utilization as well as rates greater than those generally available in the international market. Our international flag tanker contributed increased revenues as international market rates rose significantly from prior periods. As a result, our non-Jones Act tanker revenues increased $1.8 million in the prior quarters.
The Jones Act Handysize tanker revenues were consistent with the prior quarter. While contract rates are moderating on a portfolio basis by lower rated contracts previously entered into. Further, there were more days in drydock, which reduced revenues due to the increase of off-hire days. Revenues from our Jones Act shuttle tankers increased as the Overseas Tampa was in service for the full quarter. We experienced a slight decrease in Alaskan Tanker revenues resulting from the Alaskan Explorers scheduled drydock period.
Please turn to Slide 10. The niche businesses registered an $11.9 million increase in revenues, driven by the increases in the number of MSC voyages, higher international rates for the Overseas Sun Coast, increased lightering volumes for the OSG 351 and the return to service of both the Overseas Tampa and the OSG 350 for a full quarter.
Please turn to Slide 11. Vessel operating contribution increased $10.3 million from Q2 2022 to $47 million in the current quarter. The niche businesses contributed virtually all of the increased vessel operating contribution for reasons previously stated. Jones Act Handysize Tankers contributions dropped slightly, principally due to off-hire days related to the scheduled drydock period. Vessel operating contribution for those vessels were $7 million, a slight decrease from the prior quarter. The ATB contribution increased slightly due to higher short-term business and Alaskan Tanker contribution dropped due to off-hire days for the Alaskan Navigator of drydock.
The combined vessel operating contribution of our niche market activities, ATBs and the Alaskan crude oil tankers provided a vessel operating contribution in the quarter - current quarter of $40 million compared to $29 million in the second quarter, continuing their consistent performance.
Please turn to Slide 12. Adjusted EBITDA increased $10.8 million from Q2 at $35.1 million from the third quarter of 2021. 2022 year-to-date adjusted EBITDA is $99.2 million. This reflects the improved market conditions, increased rates as well as the increase in vessels and service.
Please turn to Slide 13. Third quarter net income increased $9.5 million to $13.2 million. Year-to-date net income was $16.5 million compared to $42.6 million loss for the first three quarters of 2021. Improved operating results stemmed from improved market conditions, which resulted in the return to service of all ships that were in layup in 2021. Further, the rate environment contract duration have both improved.
Please turn to Slide 14. As our results improve, we want to provide information concerning the profit-sharing arrangement that exists for the vessels we bareboat charter from American Shipping Company. The chart provides information for the years 2022 through 2024.
The 2022 information reflects all 10 vessels we currently charter from American Shipping while subsequent years reflect the seven vessels that we will continue to bareboat after redelivering three vessels in December this year.
The calculation, which is governed by the terms of the contract between AMSC and OSG provides for specific deductions to be taken in determining whether there is any profit is defined to share between us. These deductions include, among other items, an OSG management fee, an OSG profit layer and deductions for drydock costs, all of which are prior to the determination of the existence of any profit share. Shareable profit, if any, is then split evenly between the parties.
The slide provides an estimate of anticipated profit share under the AMSC bareboat charters for 2022 through 2024. The underlying information used to develop 2023 and 2024 estimates is based on our assessment of the market in each year as informed by current market conditions. There will not be any profit sharing payments in 2022 due to the carryforward of losses sustained on the AMSC vessels in 2021.
In 2023, if we achieve an average TCE rate of $63,400 per day across the seven AMSC vessels, there would be no profit sharing. In 2024, if we achieved an average rate of $64,300 a day, there will likewise not be any profit share.
Finally, it is worth noting that if certain costs are recovered, the minimum average rate that will result in profit share declines. The calculations are complex and have a variety of factors involved. This chart is meant to be indicative of possible outcomes based on the assumptions made.
Please turn to Slide 15. At June 30, 2022, we had total cash of $84 million. During the third quarter, we generated $42 million of adjusted EBITDA. Working capital used $5 million of cash. Our receivables increased due to the increased utilization of our vessels, coupled with increased rates and especially the increase in MSC voyages. Additionally, we reduced the outstanding accounts payable balances during the quarter. We expended $9 million on drydocking and improvements to our vessels. As previously mentioned, we purchased 3.6 million shares of our stock for $10.7 million during the quarter.
We made debt service payments of $13 million in the quarter. Also in the quarter, we purchased the U.S. Treasury note assuring in August 2024 for approximately $15 million. The result was we ended the quarter with $74 million of cash.
Please turn to Slide 16. Our total debt at September 30 was $434 million. This represents a decrease of $5 million in outstanding indebtedness since June 2022. Scheduled loan amortization for the remainder of the year is approximately $6 million. With $346 million of equity, our net debt-to-equity ratio is 1x.
This concludes my comments on the financial statements, and I'd like to turn the call back to Sam. Sam?
Thank you, Dick.
Our third quarter results evidenced healthy operating conditions in our core markets. OSG's fleet is responding to the changing patterns of domestic and international transportation fuel shipments and is well positioned to participate in emerging areas of opportunity.
Our healthy book of forward time charter coverage gives us firm visibility towards the results expected for the remainder of 2022 and into 2023. We anticipate continuing strength in all important financial metrics and a gradual build in available cash balances over the next several quarters as profitable time charters at higher utilization rates are realized.
For the final quarter, expect to see that costs associated with the redelivery of the three American shipping company tankers and the reduction of vessel available days associated with fewer trading tankers in December will result in a small decrease sequentially from third quarter levels for TCE and adjusted EBITDA, respectively.
Even with this, we are now confident in guiding higher for our full year 2022 financial performance. Charter equivalent earnings for the full year should come in at about $420 million and adjusted EBITDA should exceed $133 million. Taking into consideration cash used for share repurchases, we anticipate year-end cash balances of between $90 million and $100 million.
Looking further ahead to 2023, absent changes in the trajectory of current market trends, we believe OSG's healthy fundamentals after the prospect of continued solid financial performance throughout 2023. Our current forecast has time charter equivalent earnings for 2023 approaching $400 million. Factoring in some allowance for anticipated cost increases, we are confident that attaining this top line result should generate adjusted EBITDA of between $100 million and $135 million during 2023.
After deducting debt service and capital expenses, we anticipate that free cash flow for the next year should be between $50 million and $55 million. Stability in our financial profile translates to positive free cash flow in the quarters ahead and improvements in our balance sheet. As stated on prior calls, use of surplus cash flow should it arise, will be a regular topic of conversation with our Board. investment in growth opportunities, reduction of outstanding debt and continued consideration to extending acquisition of shares under a renewed share repurchase program will all be part of this conversation.
Our mission is now squarely focused on execution, operational excellence and the pursuit of niche business growth opportunities through utilizing OSG's unique franchise to position ourselves for a better future.
Adam, we can now open up the call to questions.
[Operator Instructions] Our first question today comes from Climent Molins from Value Investor's. Please go ahead. Your line is open.
Good morning. Thank you for taking my questions. After raising guidance, like the guidance you had previously provided, could you provide some commentary on what were the drivers for the improved performance relative to the previous numbers you had provided?
Broadly speaking, it was really the niche market activities that we are engaged with that provided the better-than-expected results. And in particular, the international MR trading market has been trading at near historical highs. We do have the overseas Sun Coast participating in a pool in that market. I believe that we experienced net earnings or time charter equivalent earnings on that vessel that was probably $10,000 to $15,000 per day higher than our even-budgeted expectation.
And then the other two vessels are trade internationally, the Overseas Mykonos and Overseas Santorini, as Dick mentioned, benefited from a number of Military Sealift Command time charters and voyage charters during the quarter, driving older performance by those two vessels in order of magnitude of close to $2 million for the quarter. So those are very positive surprises for us. The balance of activity in conventional tankers and conventional ATBs were as per expectations, but significantly improved from previous quarters.
And we also saw a slightly better results from our lightering businesses, given slightly higher volumes than our budgeted levels, largely driven by PAD1 refineries running at or above 100% of the capacity during the quarter to try and continue to provide more diesel product to the Northeast. I think those are the key drivers of the better-than-expected results that we achieved during the quarter.
That's very helpful. Thank you. You provided some commentary regarding capital allocation. But after completing the share repurchase program, creating significant value, how do you think about additional share repurchases?
Look, as I mentioned, I think that we see largely three buckets of opportunity for surplus cash flow generated from our businesses. First and foremost in our lines, at least, is to consider and pursue growth opportunities to reinvest capital in ships and shipping opportunities that will generate strong longer-term cash flows.
The second bucket is a regular consideration of deleveraging our business. That can be achieved in numerous ways in addition to deleveraging through redelivery of some of the American Shipping Company ships that we referred to earlier. We're also looking for ways to reduce liabilities on our balance sheet. These are liabilities that are generally associated with interest-bearing debt, but we also have other liabilities that are carried on the balance sheet that we have opportunities to reduce. So we look at those opportunities regularly as ways for strengthening the balance sheet of the company.
And then the third opportunity, as you asked or refer to is to consider share repurchases when appropriate. The Board took steps in June to authorize a $5 million share repurchase program, which we fully completed during the third quarter or actually into October.
And as I said in my remarks, I think that it is highly probable that a conversation about extending or reinstating a share repurchase program going forward is going to feature in our conversations and something that is likely to be a feature of our capital allocation you've seen in the coming quarters.
Make sense. That's all from me. I'll pass it over. Thank you for taking my questions and congratulations for the quarter.
Thank you, Climent.
[Operator Instructions] As we have no further questions, I hand back to Sam for any concluding remarks.
That's great, Adam. And thank you, everyone, for participating on today's call, and we look forward to speaking with you again soon. Wishing everybody a good day.
This concludes today's call. Thank you very much for your attendance. You may now disconnect your lines.