I got a question from a reader about tanker stock Overseas Shipholding Group (OSG):
What do you think about OSG at this moment? Price is almost equal to book value. PE is a low 3. Earnings are almost 30% of stock price. Is it a good buy? What's your projection on this one? You held this stock couple years ago and not sure, if you still have any interest in this stock?
OSG is a big tanker owning company, not quite the biggest but certainly near the top of the heap. I took a wild ride on some tanker stocks in 2003 and 2004 as they recovered from a dramatic bottom to reach ridiculous heights, but I sold all the shares I owned of Frontline (FRO), OMI (OMM), Torm (TRMD) and OSG in December of 2004.
That turns out to have been a reasonable point to get out -- it was the end of the uninterrupted shot to the moon, though you could certainly have made plenty of money in these stocks over the past year or so as well.
Since my portfolio was overwhelmingly oil stocks and tanker stocks in 2004, that's my frame of reference on prices -- and investor psychology being what it is, I can't face buying oil stocks at today's prices after having sold them about 50% ago. That doesn't make sense on any rational level, but it's still a human being placing the buy orders here and that's one of my handicaps.
But tanker stocks haven't climbed so much since I sold all of mine -- so what do I think of the sector?
Back when I made my purchases, it was an undiscovered sector in many ways and the argument in favor of the shares was almost irrefutable. FRO, the largest operator, was crossing $14 after having hit a bottom the previous year of $3 (it's at about $40 today), so volatility was expected, but the business climate was brewing a perfect storm for any company that owned VLCC or Suezmax tankers, anything that could transport crude oil from the Middle East to the US, China and India. Single hulled ships were being phased out gradual Venezuela and Africa, which are shorter trips for US bound tankers, were having production or political problems and more oil had to be freighted longer distances, no one had invested in any new large crude carriers for years because of the cheap oil climate and lack of demand for tonnage, and as soon as it became clear that more tankers were needed the rush was on to build them -- but shipyards had full order books already and the backlog for new tonnage reached years ahead.
So any company that owned tankers could charge ridiculous dayrates for them as demand went through the roof. FRO was my biggest holding and a big beneficiary, because they had their entire fleet leveraged to spot voyages at high rates (instead of long term contracts at more moderated prices) and because they were committed to spitting off almost all of their free cash flow as dividends. FRO yielded upwards of 30% for a year or so, in addition to capital gains of more than 100%.
I think that easy money is over for all of the companies in this space, but I think they're also fairly valued and might make reasonable investments here. Here's my thumbnail assessment of each -- but remember, this is based on my memory and I haven't looked into these in any great detail lately:
● FRO -- still highly leveraged and with very low book value in comparison to it's competitors. That's because they've spun off all their tonnage to Ship Finance Limited (SFL -- almost a FRO subsidiary, but separately owned and traded), and they lease it back to then charter on the spot market. I think they're still the largest VLCC operator, and due to the fact that they've already spun off their boats they don't have the same downside protection that some of the more stable operators do. This is the best bet for leveraging returns to higher spot rates, in my opinion.
● If you want a little more stability but like the buccaneering bets of Frontline, buy SFL -- you get the yield from leasing the tankers to FRO, and this is fairly stable so it almost acts like a REIT, but you also get a profit-sharing kicker if FRO's rates top an agreed number.
● OSG is a more stable tanker company, also focused on the large crude carriers in the main, and with some complex lease and share agreements with other investors to help finance these incredibly expensive boats. OSG has a more diverse fleet, and never got quite the sexy attention given to FRO or some of the others. They time charter more of their boats, which makes things a bit more stable and means they're not as subject to vacillating spot rates -- either high or low. OSG would make me sleep better at night than FRO.
● OMM is a smaller company that focuses on smaller ships -- Suezmax and Aframax tankers, I believe. I actually like this company more than either FRO or OSG at this point because the management never placed outsize bets during the wild bull market in 2004, and because they're in slightly different business. OMM charters both product tankers (carrying refined products like heating oil or jet fuel or gasoline) and smaller crude oil tankers. It was their practice to have about half their fleet on multi-year time charter and half on the spot market to try to get the best of both worlds, which made a lot of sense. Whereas FRO always seemed to be aggressively trying to free up cash to dividend out to its majority stockholder (and the rest of us, of course), OMM always seemed to me to be building a sustainable business with lower debt and a longer range vision than OSG or FRO, though all companies in this sector are pretty heavily leveraged.
● And TRMD was my favorite for awhile -- six months after selling it, it sat on my wish list. This Danish company is very thinly traded here in the US and still very much uncovered, but it's not nearly as cheap as it used to be, either. Today I still like Torm's exposure to a very diverse set of shipping businesses, from a few bulkers to product tankers, including edible oils and other non-petroleum products.
I reconsider buying into this business every now and then, but the real time to buy is when everyone thinks things have bottomed out and the banks are going to start repossessing the ships.
It might be that the tanker industry is more corporate and better financed now, and won't see those wild swings as marginally financed families tried to build their fleets. If so, the downside will be a bit more limited than it used to be in this sector.
I think I'd be more interested in product tankers in the near term, since I believe the real worldwide shortages are going to be in refined products, not crude oil for the foreseeable future ... but that's just me. If I were to buy one of these today it would probably be OMI, but as stated earlier, I'm not in the market at the moment.
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