Scorpio Tankers Inc. (NYSE:STNG) Q3 2023 Earnings Call Transcript

Scorpio Tankers Inc. (NYSE:STNG) Q3 2023 Earnings Call Transcript November 9, 2023

Scorpio Tankers Inc. beats earnings expectations. Reported EPS is $1.91, expectations were $1.66.

Operator: Hello and welcome to the Scorpio Tankers Inc. Third Quarter 2023 Conference Call. I would now like to turn the call over to James Doyle, Head of Corporate Development and IR. Please go ahead, sir.

James Doyle: Thank you for joining us today. Welcome to the Scorpio Tankers, third quarter 2023 earnings conference call. On the call with me today are, Emmanuel Lauro, Chief Executive Officer; Robert Bugbee, President; Cameron Mackey, Chief Operating Officer; Chris Avella, Chief Financial Officer; Sean Hager, Head of US Chartering. Earlier today, we issued our third quarter earnings press release which is available on our website scorpiotankers.com. The information discussed on this call is based on information as of today, November 9, 2023 and may contain forward-looking statements that involve risk and uncertainty. Actual results may differ materially from those set forth in such statements. For a discussion of these risks and uncertainties, you should review the forward-looking statement disclosure in the earnings press release as well as Scorpio Tankers’ SEC filings which are available at scorpiotankers.com and sec.gov.

Call participants are advised that the audio of this conference call is being broadcasted live on the internet and is also being recorded for playback purposes. An archive of the webcast will be made available on the Investor Relations page of our website for approximately 14 days. We will be giving a short presentation today. The presentation is available at scorpiotankers.com on the Investor Relations page under Reports and Presentation. These slides will also be available on the webcast. After the presentation, patient we will go to Q&A. For those asking questions, please limit the number of questions to two. If you have an additional question, please rejoin the queue. Now, I’d like to introduce our Chief Executive Officer, Emmanuel Lauro.

Emanuele Lauro: Thank you, James. And thanks, everybody for joining us today. We are pleased to report another quarter of strong financial results. In the third quarter, the company generated $200 million in adjusted EBITDA and despite the conclusion of summer driving season and innovative refinery maintenance, late experienced a steady and sequential increase throughout the quarter. Today, this increase continues and is driven by the same factors which have led to an elevated rate environment for the last six quarters. These factors are strong global demand for refined products, dislocated refining capacity and a constrained maritime supply. The cash flows have been significant and transformative for the company. The quality of Scorpio Tankers as an investment is improving each day deleveraging and returning capital to shareholders is our primary focus.

Our balance sheet continues to improve and the company has today a net debt of $1.3 billion. We have reduced RSA leaseback financing from $2.3 billion in 2022 to EUR730 million as of today. In the fourth quarter we expect to repay a further $460 million in these financings, of which EUR196 million have already been repaid. We have more than $100 million in liquidity consisting of EUR520 million in unrestricted cash and nearly $300 million available under our revolving credit facility. In the third quarter we repurchase close to 80 million of company shares. Year to date, we have returned over $530 million to shareholders, of these, EUR490 million in share repurchases and 40 million in dividends. Today, we have announced the renewal of our securities repurchase program for up to $250 million and we have increased our quarterly dividend from $0.25 to $0.35 per share.

Looking forward, we expect low global inventories, robust demand and limited fleet growth to support strong product tanker fundamentals. With this, I finished with my remarks and I would like to turn the call to Robert. Thank you.

Robert Bugbee: Hi, thank you Emanuele. Good morning, everybody. It’s really a fantastic start to the quarter. We’re really happy with the way that the market has been shaping up. It’s already great springboard for the potential substantial rate improvement when the winter season kicks off in three to four weeks’ time. And that’s exactly what we expect. Rates have steadily improved since early July. Neither the OPEC cuts on the weaker season have halted that headline demand for products has improved steadily as well. Well demand for product crude is expected to continue to grow further. And this is as a result of post-COVID economic activity, low inventory and is not at the moment is a result of fear for example in the Middle East for war exploration which is just pure economic demand and activity.

Present spot markets in all our categories according to Clarksons and indeed our own trading desks or above the guidance we have given today for the start of fourth quarter. We’re truly very optimistic that the developments through the next month as we enter the strongest season. This is a very consistent, strong and broad rate increase. That’s very important to know, July has been better than June, August better than July, September better than August, October better than September and November better than October. When it comes to the strongest season coming, I am extremely confident that once again winter will come the Northern Hemisphere, I base this confidence primarily on historical precedent. There is now quite a lot of data going back a few years showing that winter has come every year.

Furthermore, the scientific community weather forecasts group based Solstice worshipers and young children are in general agreement with the scientific community that winter will come, therefore, increasing the rate of demand growth. There is much less certainty of product 10 mile decline as a result of recession as the weather turns is fear of demand slowdown will, we believe, be but to candle in the winter wind. Just for those people who are new to the product tanker market or nutating, for those of you who may have forgotten as we’ve started winter with nearly a year ago, winter is good. It’s really good for the product market and product rates. Thank you very much again for your support. And I’ll turn it over to James.

James Doyle: Thank you Robert. Slide 7, please. As Emmanuel said, cash flows from a strong rate environment have been significant and transformative for the company. Over the last seven quarters we’ve generated $2.5 billion in EBITDA reduced outstanding debt by $1.3 billion and return $710 million on share repurchases and dividends. Slide, please. We continue to reduce our expensive lease financing and have given notice to repurchase 76 vessels of which 56 have been repurchased as of today. After repurchasing, these vessels are either encumbered or refinance at lower interest margins in new facilities. Slide 9, please. While the year-to-date debt repayment has been slightly lower due to timing of lease repurchases, in the fourth quarter we will repay $527 million in outstanding debt.

As you can see from the graph on the left our estimated December 31 debt balance is expected to be $1.55 billion. And on the right we have refinanced a significant amount of lease financing, taking it down from $2.2 billion to $739 million today. Slide 10, please. Since the December 2021, our net debt has improved by $1.6 billion and today is at $1.3 billion. With no new buildings on order we have minimal CapEx. Today, we have $521 million in unrestricted cash and $280 million available under our revolver. The company is well positioned. Slide 11 please. The company has significant operating leverage. In Q3 so far, including time charters, the fleet is averaging close to $33,000 per day. At $30,000 per day the company generates almost $800 million in free cash flow per year and at $40,000 almost $1.2 billion.

This would equate to $14 and $22 per share in free cash flow, a 26% or 41% free cash flow yield. Slide 13, please. For the last six quarters rates have defied seasonality, refinery maintenance and other short term headwinds. As refinery maintenance concludes this month, we expect fundamentals and rates to improve. Over the last week, we have already started to see it. Today, spot or 2 rates are at $42,000 per day and MRs at $34,000 per day. Global inventories remain extremely low, requiring an increase in product exports for more immediate consumption in the U.S. and then the rest of the world, distillate inventories are well below their 5-year average which could create a very tight market as heating oil and jet fuel demand increase in Q4 and Q1.

Slide 14, please. Year over year, we expect fourth quarter demand for refined products to be $2.6 million barrels a day higher than last year. And next year, on average we expect demand to be 1.3 million barrels above 2020 period. The increase in demand is leading to higher seaborne exports. Year to date CPP exports on average 1.4 million barrels a day about 2019 level and in September average 1.8 million barrels. Given well global inventories, increased consumption will continue to be met through imports with product tankers, reallocating barrels around the world, not only have exports increased but barrels are travelling longer distances. Slide 15, please. While demand is above pre-COVID levels refining capacity is lower and more dislocated.

The impact of new export oriented refineries coming online has led to an increase in exports and ton miles. Since 2017, Middle East product exports have increased 30%, while ton miles have increased 78%. Refinery closures have also created the need to replace lost production in places like Australia, where product imports have increased 48% since closing 2 large refineries in 2020. All of these changes are driving an increase in ton miles as ton mile demand increases, vessel capacity is reduced and supply tight. Slide 16, please. And it’s not just about refining capacity closing and opening. In each region, there are different refinery configurations, domestic needs and regulatory requirements. Product tankers are the conduit for rebalancing surplus nap in the Middle East Asia, surplus gasoline from Europe to Asia.

And in many cases some of the largest product exporters are also the largest importers like the U.S., UAE and South Korea. This dynamic creates increased triangulation of fleet which leads to higher utilization and rate. We expect this to continue. Slide 17, please. Russian exports of refined products have declined to more normalized levels of around 1.4 million barrels a day. The grey fleet or vessels that are servicing Russia currently stands at 453 vessels. Many of these vessels which have moved into this trade are 13 years and older and will likely not return to the premium trades given their age and trading history. This has and will continue to benefit the supply vessel servicing non-sanctioned trade plate. Slide 18, please. Today the order book is 10% of the current fleet, while the average age of the product tanker fleet is close to 13 years old.

The strong spot market, healthy long-term time charter rates, constructive demand outlook and aging fleet has led to more than building orders. But there are constraints to ordering, new builds are expensive. There are long lead times for delivery and uncertainty about propulsion systems to satisfy future environmental regulation. That said, without new building orders, this year, the fleet was expected to shrink over the next few years. Starting next year, 8 million deadweight tons per year of product tankers will turn 20 each year, the equivalent of 160 MRs. By 2026, 9.3% of the fleet will be 20 years and older. The age of the fleet and upcoming environmental regulations will have a material impact on the fleet going forward. Slide 19, please.

Next year’s fleet growth is expected to be 0.5%, the lowest fleet growth since 2000. Seaborne exports and ton-mile demand are expected to increase 3.5% and 12.1% this year and 3.6% and 6.3% next year, vastly outpacing supply. Using minimal scrapping assumptions on average, the fleet will grow less than 3% and 2% in ’25 and ’26 and less than 2% per year using higher scrapping assumption. In addition, 1- and 3-year charter rates remain at high levels, evidence that our customers’ outlook is one of increasing exports and ton miles against the constraint supply curve. The confluence of factors in today’s market are constructive individually, historically low inventories, increasing demand exports and ton miles, dislocations in the refining system, rerouting of global flows, limited fleet growth and environmental regulations.

Collectively, they are unprecedented. With that, I would like to turn it over to Q&A.

Operator: We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from John Chappell with Evercore ISI. Please go ahead.

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Q&A Session

John Chappell: James, if I could pick up where you left off a little bit on the winter preparations and especially the inventories. I think a lot of people forget that the sanctions on Russian diesel didn’t go into effect until February 5 of this year, so they effectively had access. Europe effectively had access to Russian diesel all through last winter which was warm. It feels like the inventories are just as low entering this winter. You don’t have access to Russia and I’m not sure anyone can underwrite back-to-back warmer than normal winter. So have you started to see any sense of urgency from Europe as a continent as a whole to prepare for winter? Or is there maybe a little bit of [indiscernible] expectations that have the potential to make the market incredibly tight if there’s an early cold snap this winter?

Robert Bugbee: James, I’ll answer that if you don’t mind. So John, thank you. First of all, congratulations from all of us, it’s [indiscernible] on your award being the number 1 shipping analyst. Well done on that. So the — look, I said I think we look generally across the way sort of thing is quite a lot of complacency. Whether it’s Europe or whether it’s the rest of the world, the sort of — despite the lower inventories despite the — it doesn’t matter whether you really believe in recession or not, everyone is still saying that oil and product tanker demand is going to grow. It’s just an argument as to what the rate of growth will be. And inventories, as you point out, across the whole space are low. And we’re sensing a just everyone’s pretty relaxed right now.

Now we think what will happen is that they’re acting as if it’s like any other winter. And what normally happens is that the first pulse will come and then people wake up and start to do things. So they’re denying the risk they have in their inventories, the risk that’s going on in the world, whether it’s Russia, Ukraine, whether it’s Israel, Palestine or little risk of that spreading. But I think it will come — everything comes home to roost, the moment the weather turns cold. That’s why we’re very confident — we’re very confident there’s nothing in this market. This market is just steadily got stronger and stronger and stronger without any kind of action or pre-emptive moves to the ship product.

John Chappell: Got it. That makes complete sense. Just for my second one, shifting gears to Scorpio specifically, you have a lot of debt repayment coming up in the next couple of months. As we think about target leverage, I know it’s a number that you haven’t tried to identify in the past but just watching the buyback activity accelerate, looking at the dividend moving up again this quarter, maybe unexpectedly, do you feel that you have line of sight on over the next quarter or 2 puts you in a comfortable enough leverage position where maybe the focus shifts a little bit more away from deleveraging to capital return at this point of the cycle?

Robert Bugbee: Yes, I think so. And I think that we had said previously that once we’ve crossed September and in this earnings call, we would elaborate a little bit more on leverage targets, et cetera. So I think our thinking has developed in the following way, is we’d like to get the leverage of the company pretty much down to around scrap value of the fleet. At that point, that’s around $850 million, $900 million. And at that point, I think it’s an arguable that the company would have very low leverage and be in a really safe position. And whatever it does at that point, whether it’s buying stock, whether it’s increasing dividends, et cetera, et cetera, it would be really playing with our shareholders’ money, our money. We’re not risking a bank loan, et cetera.

The other thing is the tremendous benefits going forward if we were to get there because of these interest rates, if we were to halve our interest and principal repayments or breakeven with collapse. And we would end up being not only have the newest product [indiscernible] out there but we’d always have also had the lowest operating cash. And I think that operating cash breakeven. And I think that’s great because now we’re getting even more for us as shareholders going through. I think that’s pretty achievable with very moderate positions. I mean it’s not too far to go to drop down another $400 million by — you could do that by March 31. And I think that we’ve already got $25 million. We’re selling a ship. We’ll get the net $25 million of that.

So that’s a $375 to go. And we haven’t certainly excluded selling 2 or 3 other ships. So between earning something like 35 to 40 a day, the market doesn’t even have to improve. If you ran your model and said, well, the market is going to continue just as it is that winter doesn’t come and we carry on. And we sell a couple of assets we’ll be there by that March 31. Now that can come earlier depending on if and what we sold. And if rates do what we think they will do which would be to accelerate higher.

John Chappell: Yes, that all makes a lot of sense. Yes, big time.

Operator: Our next question comes from Omar Nokta with Jefferies. Please go ahead.

Omar Nokta: Yes, just as a follow-up to that line of discussion regarding the debt reduction, it looks like that’s obviously top of mind here and perhaps the buyback takes a bit of a backseat. Robert, you mentioned perhaps $850 million to $900 million of leverage at the company. Just to frame that, just so I understand that it sounds just from your commentary with that March 31 target. Is that a net debt target? Or is that just total debt outstanding to get to that…

Robert Bugbee: That’s a net debt target. The net debt because I think that… We would all agree that if that net debt is backed by the scrap value of fleet that is still relatively new, that’s — we’re pretty damn conservative at that point. And we also, with the debt facilities we’re putting in, that would be at a very efficient rate. And we would still have — that would be well within our revolving credit line. So you — that would also imply extra liquidity, too. It’s a net debt target with a company that’s got a lot of liquidity.

Omar Nokta: Yes. And then, Robert, you mentioned the breakeven has come down. Are you able to venture sort of any kind of assuming you put down $400 million or $500 million from here, what kind of effect that will have on breakeven on a per day basis?