Scorpio Tankers Inc. Q2 FY2020 Earnings Call

Hello, and welcome to the Scorpio Tankers, Inc. Second Quarter 2020 Conference Call. I would now like to turn the call over to Brian Lee, Chief Financial Officer. Please go ahead, sir.

Thank you, operator, and thank you, everyone, for joining us today. Welcome to the Scorpio Tankers second quarter earnings conference call. On the call with me today are Emanuele Lauro, Chief Executive Officer; Robert Bugbee, President; Cameron Mackey, Chief Operating Officer; Lars Dencker Nielsen, Commercial Director; David Morant, Managing Director; James Doyle, Senior Financial Analyst. Earlier today, we issued our second quarter earnings press release, which is available on our website. The information discussed on this call is based on the information as of today, August 6, 2020, and may contain forward-looking statements that involve risks and uncertainties. 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 that we issued today as well as the Scorpio Tankers' SEC filings, which are available on scorpiotankers.com and sec.gov. Call participants are advised that the audio of this conference call is being broadcast 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. On the call, there will be a short presentation of slides, which are available on scorpiotankers.com and the Investor Relations page, under Reports and Presentations. If you have any specific financial modeling questions, contact me later and discuss off-line. Now I'd like to turn the call over to Emanuele Lauro.

Thank you, Brian. Good morning or afternoon to all, and thank you for your time today. Firstly, I'd like to open by mentioning that we continue to stand with our employees, especially our seafarers, whose lives have inevitably been affected by the pandemic. As far as the business is concerned, the second quarter has been a very eventful one for the company. We have retired debt at a record pace, nearly $230 million this quarter alone. At this stage, we retain close to $300 million of cash on the balance sheet and have generated nearly $600 million of EBITDA in the last 12 months. We are aware and respectful of what is happening in the world. However, we do look at the future with confidence. In the first half of the year, we saw some of the highest rates ever achieved during the period. This was due to the aggressive contango trade that has persisted in the oil markets. At the same time, a significant drop into the seasonally weak summer months has been exacerbated by destocking as the mean reverts and storage patterns normalize. So we address this as much as we could through the significant work we did to manage our rate exposure during the first half of the year. Lars will talk more about this and the opportunities that the market volatility presents during his remarks. We're now in the third quarter, which is our seasonally weak period, but we made a good start, and we do believe that current spot rates have found a support level. So by the time of our next reported earnings, we expect the winter demand in the Northern Hemisphere will start to build. As other asset-backed markets are clearly already pricing in the rapid recovery in global GDP, we feel our confidence mentioned before is justified. Our capital management message has been consistent, and as promised, our priority has been to delever. We're finding chances to opportunistically create value while doing so, such as in the recent retirement of a portion of our outstanding convertible bonds. We have also refinanced some facilities, as outlined in the earnings press release. Raising liquidity and further extending the funding profile of the business as our CapEx run rate reduces and normalizes over the next 12 months. In the last 12 months, we just went through an impactful CapEx period, a massive dry docking program, probably the biggest in the industry with around 70 vessels, which have faced special surveys, ballast water treatment system installations and scrubber installations. So the next 12 months will be much less intense from a CapEx standpoint. Behind this volatility and short-termism, the big trends start to swing as powerful tailwinds to our business, namely those of new refineries and routes and the extremely constrained supply picture against the backdrop of a rapidly aging fleet. With this, my opening remarks are concluded, and I would like to turn the call over to Lars.

Thanks, Emanuele. Good morning, everyone. During the second quarter, oil and refined product markets experienced significant price volatility and logistical challenges as a result of COVID-19. Preventive measures to reduce the spread of the virus and the subsequent decline in economic activity created a demand shock for oil and refined products. These challenges for the global refined products marketplace resulted in a surge in demand for product tankers to be used as floating storage. The impetus behind the product tanker floating storage demand was twofold: the flat price in contango and the collapse in pump oil prices that pushed refined products into a steep contango curve, thereby increasing demand from traders who are looking to capitalize on profitable carry trades. Secondly, the necessity where insufficient land-based storage flexibility left limited options outside of product tankers to store excess inventory. In addition to floating storage, there were numerous examples of product tankers unable to discharge cargo who either had to be rerouted or wait at sea until land-based inventories were drawn. Logistical constraints and demand for floating storage tightened supply, driving up vessel utilization at a time when ton miles and arbitrage trades were increasing, which pushed product tanker spot and time charter rates to unprecedented levels. We knew floating storage inventories would eventually peak. However, it was unclear when and how long it would take to return to normal levels. This destocking of floating storage occurred much faster than many anticipated. Product tanker floating storage peaked in May with 105 million barrels, and as of last week, it was down to 45 million barrels of refined products. In addition, products in transit, the total amount of refined products being carried is only 20 million barrels above historical averages. This was largely due to a rapid recovery in demand and the initial lower refinery utilization rates. So as vessels reentered the spot market from concluding floating storage contracts and refinery utilization rates remained low, the future benefit of rapid destocking came at the price of lower spot rates. However, the large decrease in floating storage, rapid demand recovery, and looking forward, the increase we now see in utilization rates is encouraging. Not to mention the unprecedented level of global monetary and fiscal stimulus that has been announced. Refineries have now increased utilization rates as demand recovers, and we're seeing an increase of exports at more normalized levels. Indeed, this is evident in the relatively strong MR rates currently traded in the Atlantic Basin as Latin America and Mexico increase imports. On the larger units, we have seen potential for jet and ULSD storage themes, which is likely to continue as the marketplace tries to match an evolving demand scenario, as well as we now recognize an increase in time charter inquiries, which are often used as an indicator of general sentiment and future market expectations. Finally, the long-term fundamentals are extremely strong. Demand is expected to continue to recover with some estimates showing a 6% increase in seaborne refined product exports next year against record low fleet growth of 2% or less per year over the next 3 years. In addition, the fleet supply growth does not account for the aging fleet. Compared to today and including all newbuilding vessels on order today, the percentage of vessels turning 15 years old in the next 3 years will increase from 46% today to 69% for the Handymax fleet; 22% to 40% for the MR fleet; 23% today to 51% for the LR1 fleet; and finally, 15% today to 29% for the LR2 fleet. And with that, I'd like to thank you for your time, and I'll hand over to Robert Bugbee. Thank you.

Hi. Good morning, everybody. Lars, thank you very much. Before I hand over to Brian, I just want to say a couple of brief things. The last time we spoke in April, we were at the peak of concern related to COVID-19 and oil prices, with negative prices raising terrible concern about what would happen to demand as we moved into destocking. Would earnings go to zero? Yet, now we see a really good start to the third quarter, ironically better than the same period last year. The company is cash positive thus far through the third quarter. This has improved our balance sheet and allowed us to move from a state of concern in April to a situation where we have been able to buy back some of the more expensive convertible debt on the balance sheet. We will continue to create less expensive debt while keeping liquidity high at the approximately $80 million we intend to raise through refinancing of some of the ships. This will allow us greater freedom while maintaining strong overall liquidity and cautiously navigating the recovery in the market. As we look further into the future, our strategy remains consistent. With that, I'd like to pass it over to Brian for him to detail more on the improvements in the state of the balance sheet.

Thank you, Robert. James Doyle and I will review the presentation available on scorpiotankers.com on the Investor Relations page under Reports and Presentations. Moving to Slide 2, we achieved our best quarterly financial results ever, with the fleet daily TCE averaging $29,693 per day, net income of $143.9 million, and adjusted EBITDA of $252 million. Between March 31, 2020, and August 5, we reduced our net debt by $228.8 million. As Robert mentioned, in July, we repurchased convertible notes with a face value of $13.8 million for $12.2 million. In May, we repaid an outstanding baby bond that matured for $53.8 million, and later in the month, we reissued another baby bond for $28.1 million. Additionally, as Robert noted, we are currently discussing refinancing 8 vessels, which could enhance liquidity by around $80 million, and we have commitments for scrubber purchases and installations totaling $56 million. Regarding liquidity, at the end of business on August 5, 2020, our cash balance stood at $285.7 million. On Slide 3, we compare the third quarter guidance released today with the guidance from July 31, 2019. In each segment, the rates are higher in 2020, particularly, the LR1 and LR2 rates, which are 50% higher. Slide 4 presents various events that occurred over the last 12 to 18 months. We generated income of $159 million and EBITDA of $590 million between June 30, 2019, and June 30, 2020, alongside a debt reduction of $342 million after accounting for the Trafigura transaction where we assumed the lease liability. During this period, 62 vessels were drydocked, we installed 49 ballast water treatment systems, and now operate 86 vessels with scrubbers. Now, I'd like to hand the presentation over to James Doyle.

Thank you, Brian. Turning to Slide 5, short and long-term fundamentals. The short-term update: we saw an oversupply of refined products as a result of COVID and a subsequent increase in floating storage, which pushed product tanker rates to record levels. A strong recovery in global demand for refined products, coupled with lower refinery utilization rates, led to a rapid reduction in floating storage inventories. As we mentioned, we've gone from about 105 million to about 45 million barrels. As vessels reenter the spot market from concluding floating storage contracts and refinery utilization rates remain low, the benefit of rapid destocking came at the price of lower spot rates. However, the large decrease in floating storage, rapid demand recovery, and higher utilization rates are encouraging going forward, as well as the macro stimulus we expect. The long-term fundamentals are extremely strong. Seaborne refined product exports are expected to increase by 6% next year. The dislocation between refineries and the consumer continues to drive seaborne exports and ton-mile demand. A significant portion of the product tanker fleet will turn 15 years or older over the next 3 years and limited newbuilding orders have kept the order book at near historical lows. Turning to Slide 6, you will see that only 35 product tankers have been ordered year-to-date, which has kept the order book at 7.1% of the current fleet, slightly above the historical lows. Turning to Slide 7, as Lars has hit on many of these points, but including newbuilding deliveries, in the next 3 years, 69% of the Handymax fleet will be older than 15 years, 40% of the MR fleet, 51% of the LR1 fleet, and 29% of the LR2 fleet. With that, I'd like to turn it over to Q&A.

Your first question comes from the line of Amit Mehrotra with Deutsche Bank.

Brian, just a quick check. You said net debt had declined by over $200 million. I have it at $132 million in terms of the beginning of May until yesterday. I'm obviously missing something, but can you just clarify that?

Well, yes, I'm using from March 31.

Understood. So from March to August 5, I see. Now, I have a more crucial question for Emanuele and Robert. The past decade with Scorpio Tankers has been quite a ride, but it seems like this quarter there is a significant and real decrease in net debt, along with decreasing capital commitments. I can't recall a time where net debt has been reducing alongside prospective declines in capital commitments. It feels like there is a genuine opportunity to improve your financial situation, reduce risks on the balance sheet in a manner that enhances equity rather than diluting it. Could you elaborate on this? How are you and Brian prioritizing cash flow, cash allocation, and overall debt levels?

Robert, you might be on mute.

Yes, Amit. Thank you so much. You've observed the really key points there. It's been a long time getting to this point. But we're now at this point. All the ships are in the water. CapEx commitments are coming down to a pretty de minimis level going forward. We have been paying off debt at an amortizing speed that's higher than we've been depreciating recently. We've also kept fairly consistent. I mean, this last year, every call has been focused on using cash flow to reduce debt levels, and that's what we're trying to do for some time now. I think we're going to continue to do that. The priority for cash right now, as I said, is to start to reduce debt but to improve the cost of that debt. The actual matrix in terms of borrowing terms for lenders has improved for the company. As you reduce debt, you reduce your internal ratings related to lenders. That's being evidenced by what Brian is negotiating related to the refinancing that will free up a further $80 million in liquidity. Lenders are realizing the efforts of the balance sheet that's coming down, the consistency of management's policy, and the really new fleet that is there that's allowing us to do this. So we're going to continue as we are at this point. But our degrees of freedom are opening up every day. We're not planning to buy more ships at the moment, and we do not foresee that at all. We do absolutely foresee continuing to reduce our most expensive debt. I don't think there's anything much more to add to that.

Well, how does new equity play into de-risking the business? You obviously have more debt-funded liquidity on the way, but that's not really the answer longer term. You don't cure a debt problem with more debt. You also tapped the...

Yes, you're making a different exchange. If you simplify it, for example, if you look at it.

I talk really about the ATM. I mean you've tapped the ATM very slightly. It's not a big deal. Just talk about that ATM and how you think about new equity or the needs for new equity, if there is any or not?

Sure. I would like David to provide more details in a moment, but there isn't a need for new equity. A significant amount of time has passed, and many positive developments have occurred since a few months ago. The company has reduced its risks moving forward. This isn't a case of substituting one type of debt for another. The differences between the cost of debt and its maturity are substantial. For instance, the convertible bonds are traded with double-digit returns to maturity, which is relatively short. If you're taking on debt at a lower interest rate and that debt matures much later, that's a beneficial exchange and a solid improvement for the balance sheet. Regarding the specific question about the ATM, I would like David to address that if possible.

Yes, no problem, Robert. I hope my line is clear. Amit, thank you for the question and allowing us to address this directly as it's mentioned in the release. The best way I can explain this is that during the COVID crisis, when liquidity was disappearing in the market and as we considered what was responsible for the company, we had access to options. The Board of Directors expected us to utilize that. Clearly, we made a decision. If history were to repeat itself, we probably wouldn't make the same choice again. Additionally, as Robert pointed out, from a shareholder value and NAV perspective, we believe we've managed to offset that, even if it's just a small amount, with the transactions we've undertaken concerning the convertible bond. To be honest, we acknowledge it wasn't a significant figure as you mentioned, and I'd like you to view that decision within the context of the time it was made. Looking back, we all have things we might choose to do differently.

I appreciate that answer. That's all from me. I believe you have a great opportunity to create additional equity value. The important thing is to maintain a disciplined and consistent capital allocation strategy. I hope you can commit to that given the potential and opportunities ahead of you.

Thank you very much, Amit. We also appreciate your perspective. We agree on the importance of consistency, and we want to emphasize that this strategy has been in place for more than just this month. We have chosen not to raise dividends in the fourth quarter, first quarter, and now the second quarter. This approach is a continuation of our strategy, and we intend to maintain this consistency moving forward. Thank you for your question.

Your next question comes from the line of Ken Hoexter with Bank of America.

Congratulations on the reduction of debt and effectively restructuring the balance sheet in this market. Can either Robert or Brian discuss the operating cost aspect? It has notably come in lower than expected. While we anticipated strong rates that aligned with our goals, the costs have continued to surprise us on the downside for a couple of quarters. Have you made any changes to become more flexible with your costs? Are there any delays in vessel operating costs that might affect this, or are there any shifts in contracts that we should be aware of?

I think we'll let Cam start, and then I'll fill in some financial stuff.

Sure. Thanks, Brian. Ken, to state the obvious, nobody is flying. Although we're a shipping business, we rely on air travel to get our crews back and forth from the vessels. The immediate impact in quarter 2 was that nobody could be repatriated from the vessels. Similarly, nobody could get to the vessels to get back to work being at home. And that trickled through the income statement, of course. So a big chunk of that quarter-over-quarter cost reduction I would count as somewhat temporary. We're solving for those logistical issues in ways that won't necessarily show up with an immediate rebound in the operating expense, whether it's through charter flights or other ways to manage those problems. But similarly, it's a hard time to get anything around the world, spare parts, people, anything of that nature. However, we wouldn't expect an immediate snap back, more of an attenuated recovery of operational costs in the coming months. There are longer-term benefits of having our fleet fully integrating some of the vessels, getting them out of drydock, and operating them almost as if new, which has a beneficial impact on the operating expense line.

And Cam, I just want to add that, yes, I think we have an expectation that Q3 will be more of a normal, maybe even a little bit higher normal as Cam is saying because now we have the chance to change crews, we're flying crews around. It's a bit harder to do it because not every place you can fly to. So it's going to cost a little bit more, but the crew has to get home. We have to change. However, over the last few years, to your point, vessel expenses have been pretty consistent and coming down with — exclusive of one-time events in Q4 2019. There were a few issues there, but consistent and coming down over the last few years.

Perfect. And then just for a follow-up, Robert or maybe James, if digging into the rate outlook and maybe the LR1s, or just thoughts in general, where is storage and utilization rates looking now? I mean, you mentioned the decline in storage capacity. Is that still falling as you see now? Has that stabilized? And what are your thoughts on that impact to the outlook?

James, maybe you can have a go on and let Lars follow, if you could.

Sure, Ken. So as we mentioned, the peak floating storage was about 105 million barrels in early May. Since then, it's been quite a rapid reduction. Last week, we went from about 52% to 45%. So we've definitely seen good draws. In terms of overall refined products on the water, not just storage, but vessels carrying cargo, we're at about probably 415 million barrels, and the last 2-year average is somewhere around 390 million. So overall volumes have come down, driven by lower refinery utilization rates and improving demand. Demand is obviously the bigger driver there. With that, I'll turn it over to Lars for the LR1 question.

Lars, you may be on mute.

Okay. Sorry about that. Yes, I was on mute. The challenges for the larger units, the LR1s and LR2s, have been that they primarily have been carrying jet and also low sulfur diesel. The stay-at-home policies and demand destruction, coupled with the contango curve, have impacted the market significantly. What we've seen over the last couple of months is that there has been substantial destocking that has taken place. However, there is still an underlying resurgence in inquiry for storage taking place today. Over the last week, we've seen an increase in inquiries for larger units to extend storage or make new storage contracts, which we anticipate will continue to some degree throughout the third quarter. It'll be interesting to see when seasonal demand starts kicking in for the Northern Hemisphere how this plays out. Additionally, we've observed that refinery utilization rates bottomed out in April, but they've recovered significantly to around 85% to 90%, with jet remaining behind, probably around 50%. We're seeing increased interest and cargo moving again to other places, especially in the Atlantic Basin in the U.S. Gulf, which has seen positive developments. Furthermore, we've noticed that demand is starting to pick up for exports moving from the West back to the East, particularly into China.

I'd like to add that we believe it's essential to continue strengthening the balance sheet, even though we are seeing the market thriving for Scorpio Tankers. The cautious approach will help us during times of potential weakness. We're feeling very positive about what we're seeing in the market at present, and we remain confident about the future. Nonetheless, we continue to stay humble in light of uncertainties with COVID-19 still affecting the world. As we look forward to winter, we generally anticipate an increase in market activity, and our strategies will remain consistent as we navigate that.

So Robert, I believe in the last call, you suggested that you were looking to sign some time charter contracts for some of the vessels. I didn't see any of those on the fleet list, so I was curious about what happened regarding that. Or perhaps I just misunderstood, I’m not sure.

No. We have done that, and it's important to remember that the MR market began the quarter on a negative note, and expectations were that we would see destocking. In June, which extended into early July, the MR market remained weak. However, we have significantly outperformed the market in our third quarter guidance. Part of this success is attributed to the time charters we have implemented, which I cannot discuss in detail due to confidentiality. At the same time, we remain optimistic about the fourth quarter and next year. Consequently, you will see a reduction in our time charter coverage as we approach the end of the broader quarterly market conditions.

I understand. It's somewhat unclear within the pools, but it likely reduces the volatility of the spot rates that we should consider for the latter half of the year.

Correct. And this is notably the case as we see a positive trajectory with all our trading rates currently, particularly with the MRs and LR2s showing improvements. Additionally, the confidence in the product tanker space is becoming apparent.

Okay. And just sort of lastly on that, should we think that those charters are relatively equally spread across the asset classes? Or is there particular concentration in one of the areas relative to the other?

We have coverage on all asset classes, though percentages differ.

And, yes, we are confident that we are positioned well for the future with required operational adjustments and improvements.

Robert, you mentioned an aging fleet, a bifurcated market. How are you looking at the potential for increased scrapping to further benefit the supply side of the equation?

Not really. We don't count the scrapping as it's not that significant. It may be more relevant in the crude fleet, but not for the product market. First of all, why would anyone scrap vessels when rates are well above operating expenses? There's no incentive for that. Secondly, we aren't scrapping; we already remove older vessels from our markets before they can return to production. Therefore, we don't focus on the concept of scrapping. Our supply and demand curves do not take that into account. They concentrate solely on the demographics of our fleet along with new additions and removals. Our age profile is an advantage that will benefit Scorpio Tankers in the market for years to come.

Okay. You're building liquidity. Your new vessels are low on the capital allocation list. When we're looking at returning cash to shareholders, what triggers the decision there on how you would either increase the dividend or look at a buyback?

That's a fair question. Right now, we focus on a strategy. Phase 1 has been ensuring liquidity is there to deal with COVID-19 uncertainty. We're now moving into Phase 2, where we can focus on buying back more expensive debt, particularly our convertible notes. Once you've leveraged successfully, Phase 3 would encourage stock acquisition or paying a dividend. Therefore, we need to ensure we maintain strong liquidity and commit to the current leverages until a clearer picture emerges, notably requiring positive indications on COVID-19 vaccination or relevant treatments.

There are no further questions in queue. I would like to turn it back over to Mr. Brian Lee, CFO.

Thank you, operator, and thank everyone for joining us today. We hope to see you soon. Thank you. Have a good day.

Ladies and gentlemen, this does conclude today's call. You may now disconnect.