Ardmore Shipping Corp Q3 FY2023 Earnings Call

Good morning, ladies and gentlemen, and welcome to the Ardmore Shipping's Third Quarter 2023 Earnings Conference Call. Today's call is being recorded, and an audio webcast and presentation are available in the Investor Relations section of the company's website, ardmoreshipping.com. A replay of the conference call will be accessible anytime during the next two weeks by dialing 1-877-344-7529 or 1-412-317-0088 and entering passcode 8126419. At this time, I will turn the call over to Anthony Gurnee, Chief Executive Officer of Ardmore Shipping.

Good morning, and welcome to Ardmore Shipping's Third Quarter 2023 Earnings Call. First, let me ask our CFO, Bart Kelleher, to discuss forward-looking statements.

Thanks, Tony. Turning to Slide 2. Please allow me to remind you that our discussion today contains forward-looking statements. Actual results may differ materially from those projected in the forward-looking statements. Additional information concerning factors that could cause the actual results to differ materially from those in the forward-looking statements is contained in the third quarter 2023 earnings release, which is available on our website. And now I will turn the call back over to Tony.

Thank you, Bart. Let me first outline the format for today's call. To begin with, I'll discuss highlights, current market conditions and capital allocation. After which, Bart will provide an update on tanker fundamentals and our financial performance. And then I'll conclude and open up the call for questions. So turning first to Slide 4 for highlights. We're pleased to announce strong third quarter results with adjusted earnings of $20.3 million or $0.49 per share, reflecting robust product and chemical tanker markets, which are continuing to strengthen into the fourth quarter, as you can see in the chart on the upper right. Our MRs earned $28,500 per day for the third quarter and $30,100 per day so far in the fourth quarter, with 50% booked. And our chemical tankers, on a capital adjusted basis, earned $22,100 per day for the third quarter and $25,800 per day for the fourth quarter, with 60% booked so far. We believe we are now at a market inflection point with rates building into the winter period. In particular, we're seeing broad strength across all tanker sectors, including crude and chemicals, which is a very good sign. Meanwhile, Ardmore continues to execute on its long-standing capital allocation policy. We have today declared a quarterly cash dividend of $0.16 per share, consistent with our policy of paying out one third of adjusted earnings. And we continue to invest in energy-saving devices in accordance with our Energy Transition Plan, thereby reducing carbon emissions but also boosting cash flow. Overall, we continue to focus on optimizing our spot trading performance while managing costs and maintaining and even lowering breakeven level, which now stands at $14,000 per day. And as a final point, our entire fleet is exposed to the spot market, including our time-chartered vessels, allowing Ardmore to fully capture the benefits of the strengthening market. Moving to Slide 5. Our optimism is backed by some important near-term factors. The EU refined products embargo, which commenced in February of this year, is continuing to impact the market by creating additional tonne-mile demand. Also, as the winter market sets in, we expect to see, as always, weather delays, daylight transit restrictions and localized rate spikes driven, for example, by cold snaps, while constricting supply or boosting demand. And as you can see in the graph on the upper right, global refined product inventory levels remain very low, leaving little margin for error in the oil product supply chain. Despite the significant levels of refinery maintenance in 2023 as compared to 2022, as shown in the chart on the lower right, product tanker demand has remained very strong. And as we expect to see fewer refineries offline going forward, we should anticipate further incremental demand. As well as this, reduced Panama Canal transits for the next few months are likely to increase traffic by up to 40%, thereby extending voyage times and keeping ships out of the market. And the implementation of the EU Emissions Trading System, which starts January 1, in which Bart will expand on later, we think could lead to logistical inefficiencies in the market, further supporting TCE rates. And finally, it's also important to remember that low scheduled newbuilding deliveries should limit fleet growth for at least the next two years. Moving to Slide 6, we will discuss the EU refined products embargo in more detail. As highlighted in the chart on the upper right, EU diesel demand has remained consistent, while diesel imports have declined over the past several months. As a consequence, we've seen a substantial draw on inventory since the implementation of the embargo as highlighted in the chart on the lower left. As inventory levels normalize, we believe that imports to this region are poised to increase significantly. These additional volumes are likely to be sourced from far away, resulting in increased tonne-miles, thus further supporting the overall market. And then turning now to Slide 7 on capital allocation. We remain fully committed to our long-standing policy, which has a big influence on how we approach decision-making. As a result of our strong financial position and low breakeven levels, we're now able to pursue all of our priorities simultaneously, namely: maintaining our fleet over time by investing in our ships to optimize performance, thus boosting earnings and cash flow; sustaining low leverage through the market cycle, which of course improves the quality of earnings and provides the company with the financial strength needed for well-timed growth; evaluating growth opportunities while maintaining a patient and disciplined approach; and returning capital to shareholders, where at present we're paying out one third of adjusted earnings. And as an aside, with the current market outlook and our significant operating leverage, we see the potential for much higher earnings and thus, dividends in the coming quarters. The essence of our policy is an acknowledgment that this is a cyclical business, where financial strength can pay off hugely if it permits well-timed investment. But we must balance that with returning capital to shareholders, consisting of a portion of earnings in a manner that's conventional across industries. While we don't rule out special dividends or share repurchases, at the moment, neither are part of our near-term plan. And with that, I'm happy to hand the call back over to Bart.

Thanks, Tony. Building upon Tony's comments on market conditions, we'll further examine the industry fundamentals. Overall, the supply-demand dynamics remain highly favorable. On Slide 9, we discuss the significant supply-demand gap. The multiyear supply-demand gap remains wide, with shipyard berth availability continuing to be limited to 2026 and beyond. The strong tonne-mile growth, which is highlighted in the green bars in the chart, is driven by positive underlying fundamentals and, in 2024, is enhanced by the full year impact of the EU embargo, which Tony has discussed in detail. Despite low scrapping levels, the charter market has remained strong, with the aging fleet representing further scrapping potential, creating additional market support through the cycle. So overall, we believe the limited net fleet growth across the product and chemical tanker sectors, combined with increasing tonne-miles, supports current market strength. Moving to Slide 10, where we highlight how the low MR product tanker order book contrasts sharply with the rapidly aging fleet. As just discussed, supply fundamentals remain highly supportive. Although we have seen some moderate ordering of product tankers, this represents only a fraction of the natural replacement cycle of the aging fleet, with only 18 million deadweight tons on order versus nearly 70 million deadweight tons within the scrapping age profile in the next five years. Specifically for MRs, the gap is even more pronounced. The current MR order book stands at a low 6.5% of the existing fleet compared with the overall product tanker order book at 10%. As we mentioned on our last earnings call, it's important to point out that the Aframax crude tankers' net fleet growth is forecast at near zero levels. This implies that an increased proportion of LR2s, most likely older vessels, will naturally transition to trading crude to cover the shortfall in Aframax tankers. This is a trend, in addition to the transition we have seen this year, of more LR2s shifting from clean to dirty trade. On Slide 11, we depict the strong underlying demand growth in the product and chemical tanker markets. As discussed, the Russia-Ukraine conflict has heightened concerns around energy security and led to a persistent reordering of global product trades. Meanwhile, the long-term trend of refinery dislocation between East and West, supported by increasing consumption forecasts, will continue to drive incremental tonne-mile demand. While acknowledging that there are macroeconomic pressures as a result of the high interest rate environment and uncertainties in the Chinese economy, we believe they are currently outweighed by the positive factors in the tanker markets. Moving to Slide 13. Ardmore continues to build upon its financial strength. As a reminder, the chart on the bottom left notes that we have reduced our cash breakeven levels by $2,500 per day in a rising interest rate environment as a result of our effective cost control, lower debt levels and access to revolving facilities, with the potential to further reduce breakeven levels in 2024. In addition, we have a strong liquidity position with $50 million of cash on hand and $220 million of undrawn revolving facilities at the end of the quarter. As always, Ardmore is focused on optimizing performance, closely managing costs in this inflationary environment and preserving a strong balance sheet. Turning to Slide 14 for financial highlights. As noted, we are very pleased with our performance during the summer season as we report results of $0.49 per share for the third quarter. We are correspondingly reporting strong EBITDAR for the quarter and continue to frame EBITDAR as an important comparable valuation metric against our IFRS reporting peers. There's a full reconciliation of this presented in the appendix on Slide 25. Our significant revolving capacity has allowed us to manage our debt levels intra-quarter and minimize our interest expense, even in this elevated rate environment. Please refer to Slide 26 in the appendix for our fourth quarter 2023 guidance numbers. Moving to Slide 15. As Tony mentioned earlier, in accordance with our Energy Transition Plan, we're making some exciting investments in our fleet to further optimize operating performance and improve earnings. We are now on schedule to complete an updated seven dry-dockings this year, and this reduces to five dry-dockings in 2024, four of which are in the first quarter, setting the stage for having our fleet refreshed and upgraded and producing full earnings. As discussed, and within the bounds of the scheduled dry-docking periods, we're installing new generation scrubbers and other efficiency-enhancing technologies which have high return profiles. Meanwhile, we have successfully completed the technical management transfer of eight vessels, fully consolidating our fleet with our joint venture partner, Anglo Ardmore. Also noteworthy, we had very strong on-hire availability for the third quarter as a result of the continued close coordination of our teams at sea and onshore. Finally, we are prepared for the implementation of the EU Emissions Trading System, or ETS. While certainly a lot of planning has gone into this by our chartering and operations teams, from a financial perspective, this results in a pass-through voyage expense. Moving to Slide 16. Here, we are highlighting our significant operating leverage. As you can see in the chart, for every $10,000 per day increase in TCE rates, earnings per share is expected to increase by approximately $2.30 annually, with free cash flow increasing by nearly $100 million over the same time period. Given the range of TCE rates shown on the slide, it is important to remember that in this elevated, highly volatile market, dramatic shifts are possible. Just as we experienced last winter, there is the potential for the market rates to strengthen significantly in a short period of time to level towards the upper end of this scale and even beyond. We certainly like Ardmore's positioning heading into this winter market.

Thank you, Bart. So to summarize, first, regarding the market. TCE rates continued at elevated levels through the third quarter during the normally weaker summer and then strengthening into the winter season. Meanwhile, there are a number of near-term drivers, including, among other things, very low refined product inventory levels in Europe expecting to drive long-haul imports into the region and further contribute to overall demand. The wide gap between tanker supply and demand should continue to underpin the market for at least the next couple of years. Regarding the company, we're continuing to achieve strong TCE performance while managing costs in an inflationary environment. We're investing in our fleet to further improve operating performance and reduce carbon emissions. Our strong balance sheet and low breakeven level serves to enhance the quality of Ardmore's earnings while also allowing us to pursue all of our capital allocation priorities simultaneously. And with that, we're pleased to open up the call for questions.

Our first question comes from Omar Nokta with Jefferies.

Tony, I was actually going to ask about the dividends, but you preempted my question in your opening remarks. I think when you mentioned buybacks and specials in the near term aren't on the horizon. Just I guess in general, when you think about Ardmore and growth potential from here, I know we've talked about this in several quarters in the past. You've done some low-hanging fruit here recently, and you're working on that further with the scrubber installations and efficiency upgrades on your existing fleet. But when you think just generally about growth for here and expansion for Ardmore, any updated thoughts or views on how that looks for the company?

Sure, Omar. Yes, great question. To reiterate, we are distributing one third of our earnings as dividends. Currently, for the quarter we just reported, about half of that is allocated to capital expenditures. The amount we're using to reduce our debt is significantly less than it was last year. The key point is, what exactly are we investing in? The incremental returns are quite impressive. We estimate that the upgrades we are implementing on our ships will yield about 30% to 35%. Once we complete this program, which will extend into the second quarter of next year, our fleet will be upgraded and expected to generate significantly more cash flow, especially from ships that will be returning from dockings. Looking ahead, we'll continue to focus on the sectors we're involved in, particularly on improving fuel efficiency and reducing carbon emissions. We're planning for well-timed growth depending on market conditions. We are also open to increasing capital payouts if it makes sense at that time. For now, we've thoroughly discussed our capital allocation, and we believe this approach is best for long-term value.

That's helpful. And I guess, generally speaking, when you think about the growth opportunities, do newbuildings make sense in this context? Or is more of your focus on, say, targeted secondhand transactions?

I don't think we would exclude any options because, clearly, discussions about chemicals and MRs involve a wide variety of ship types, shipyards, and secondhand sellers. We hope to have shown over the years that we are very focused on value and quite disciplined in our approach.

Just one final point. Operationally, I noticed that your Eco-Mods significantly outperformed at $36,000 in the third quarter compared to the Eco-Designs, which were at $26,000. That's a substantial difference of $10,000. Can you provide any insights on why there was such a deviation?

No. It's really just a small sample set on the Eco-Mod side. We had a particularly strong performance, and it could easily have been Eco-Design ships in those positions for fixing.

Our next question comes from Ben Nolan with Stifel.

Following up on a couple of Omar's questions regarding the modifications being made to the vessels, Tony mentioned the expected rate of return. I'm interested in understanding, once these modifications are completed and their efficiency is improved, how do your modified ships compare to newbuilds in terms of efficiency? Additionally, how do you view the useful life of these assets in your fleet as more efficient vessels?

Yes. The latest designs coming from shipyards are highly fuel efficient, a standard that is likely unreachable with any secondhand ships, particularly those that are five years or older. We are focused on enhancing our TCE performance, and we've been successful in that over the past year or two compared to our peers. Part of our improvement is due to upgrades. We're currently installing new generation scrubbers that are both cost-effective and efficient, which also have some positive environmental benefits that we appreciate. This installation is expected to increase the earnings of the equipped ships by $2,000 to $3,000 a day based on current spreads.

Right. Once they are fully equipped, does it make sense for you to keep them in your fleet for another 10 years, or for a prolonged period?

Yes, I apologize for not addressing that question as well. It's a good question, and we’re going to wait and see. Our current policy is to operate the ships until they reach around 15 years of age. The distinction is that these are ships we built ourselves. We have been operating them for a long time, and we have a higher level of confidence in their condition, meaning they will be very fuel efficient for their type. It's very likely that we will continue to operate them beyond 15 years at this point.

Just to add to the different CapEx upgrades, the payback periods on them are one to two years. So as we consider this, there's a lot of flexibility going forward, but we're receiving our returns quite quickly.

And to add to that, the point is that there are considerations for new buildings today that we just can't apply to ships that are eight years old.

Sure. That ties into the second question I wanted to ask. Newbuilding prices are quite high, and I understand you're not ruling anything out. Clearly, you have the financial flexibility to consider various options right now. My question is, given inflation, the current state of the order book, and other factors, do you assess the risk profile differently? Is the appropriate mid-cycle asset value significantly higher moving forward? Or is there something else at play, suggesting that buying or ordering a ship at the current prices, which may have seemed unfeasible a few years ago, no longer presents the same level of downside risk?

You bring up an important point regarding the long-term trend of inflation over the past 20 years, which can help us assess our current situation. It's evident that newbuilding prices have surpassed historical levels. However, unless there are significant changes in the shipbuilding industry, we are not likely to return to the pricing levels we experienced 10 to 15 years ago. This is an interesting consideration. We are definitely aware of what constitutes a fair price today, or a reasonable mid-cycle price for newbuilding, and it's quite different from what it was around 12 or 13 years ago when we were constructing our ships.

Right. Okay. So we'll see.

But at the moment, certainly in key shipbuilding regions, the current prices have overshot.

I understand that a rising tide is going to lift all boats. However, it seems like many of those trades, whether from the Middle East or the Gulf Coast to Europe, would be more favorable for LRs compared to MRs. Am I incorrect in that assumption? How do you view your positioning in relation to the restocking of European diesel?

No. I mean, it's clear that depending on where the cargo is coming from, there is a common misconception that LRs handle all the long-haul trade. That's not even the meaning of LR, but that's aside from the point. The reality is that MRs also handle very long distances, and a significant portion of the liftings from the U.S. Gulf is done by MRs. If you're coming from the Far East or the Middle East with an LR2, for instance, the number of ports you can access is quite limited. This leads to lightering, which alters the cost structure. So I believe they'll both benefit equally.

This concludes our question-and-answer session. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.