Investors Should Brace for Storms in the Tanker Industry

Investors Should Brace for Storms in the Tanker Industry

Day rates for the world's biggest crude oil tankers crashed nearly 70% at the beginning of August, erasing all of the gains that were made during the first half of this year, and clouding the outlook for shipping tanker companies like Nordic American Tankers (NYSE: NAT), Scorpio Tankers and Frontline (NYSE: FRO). All three companies just reported good second quarter results after several years of deteriorating returns.

These declines come as the US, which was previously the world's largest importer of crude, becomes more self-sufficient and exports more refined products. According to government data, the US is already importing around 28% less oil than its peak in 2005.

Rates are volatile
I have previously written about the outlook for the shipping market; this was before the recent collapse in rates. Previously, the market for very large crude carriers (VLCC's) faced over-supply conditions. The market favored smaller Suezemax ships for shorter journeys and more efficiency, which placed Scorpio in the best position as the company's fleet is mostly Suezemax ships. Meanwhile, Frontline was set to suffer, as the company's fleet is mostly VLCC's. However, this forecast has not materialized as the rising demand for Suezmax's caused their day rates to spike, and the general oversupply in the shipping industry meant that companies quickly switched to the now cheaper VLCC's.

Rates for VLCC's peaked at $24,493 per day during July, but at the beginning of this month they collapsed to just $7,954 per day. Frontline, which has a fleet almost entirely composed of VLCC's, has stated that it needs day rates to be above $25,500 for it to break even, but current forward contracts suggest this won't happen until 2015. Analysts now expect the company to lose between $1.00 and $1.50 per share for the next two years, down from estimates in August, which predicted profits by 2014.

A good quarter by the future is uncertain
However, Scorpio is noting a slight improvement: The company's recent second quarter earnings showed that the company's revenue expanded 83% from the lows seen in the third quarter last year, but this was at the expense of gross margins, which fell from 36% to 31% from the first quarter to the second. What raises concern here is the fact that the company is spending heavily to increase the number of vessels in its fleet, but at the same time is diluting shareholder equity by issuing stock (number of shares expanded 59% from Q1 to Q2). Currently, Scorpio has 54 new vessels on order, expanding its current fleet by 135%. Originally, when I commented on this expansion, it seemed like a profitable idea, but with the current situation in the shipping world this could lead the company into stormy waters.

Struggling to make headway
Elsewhere, Nordic American continues to flounder. The company is going nowhere and has failed to even make use of the rising day rates during the last quarter. Nordic's revenue collapsed 42% during the second quarter and the company burned through nearly $50 million in cash ($100 million of stock was issued to cover this). Moreover, Nordic continues to offer a dividend to investors, which looks attractive at first but careful analysis reveals that the company is having to make the payout from its cash balance. Unfortunately, this cash balance was supposed to be used for the purchase of a new ship at the beginning of this year -- the order was cancelled.

Foolish summary
All in all, this volatility in the tanker market is not good news for Foolish investors. Indeed, it would appear that shipping company earnings are going to remain erratic for some time yet.

Investors should be prepared for significant turbulence ahead.

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