Teekay Corp Ltd Q1 FY2023 Earnings Call

Welcome to Teekay Tankers Ltd's First Quarter 2023 Earnings Results Conference Call. As a reminder, this call is being recorded. Now for opening remarks and introductions, I would like to turn the call over to the company. Please go ahead.

Before we begin, I would like to direct all participants to our website at www.teekaytankers.com, where you'll find a copy of the first quarter 2023 earnings presentation. Kevin and Stewart will review this presentation during today's conference call. Please allow me to remind you that our discussion today contains forward-looking statements. Actual results may differ materially from results projected by those forward-looking statements. Additional information concerning factors that could cause actual results to materially differ from those in the forward-looking statements is contained in the first quarter 2023 earnings release and earnings presentation available on our website. I will now turn the call over to Kevin Mackay, Teekay Tankers' President and CEO, to begin.

Thank you, Ed. Hello, everyone, and thank you very much for joining us today for Teekay Tankers First Quarter 2023 Earnings Conference Call. Joining me on the call today are Stewart Andrade, Teekay Tankers' CFO; and Christian Waldegrave, our Director of Research. Moving to our recent highlights on Slide 3 of the presentation. Teekay Tankers generated total adjusted EBITDA of approximately $206 million in the first quarter, an increase of approximately $26 million from the fourth quarter of 2022. We reported our highest ever quarterly adjusted net income of nearly $175 million or $5.13 per share, an increase from a record fourth quarter of 2022 adjusted net income of approximately $148 million or $4.36 per share. Our strong results have enabled us to reduce our net debt by almost 50% since last quarter to $182 million. We've also finalized our revolving credit facility for up to $350 million to refinance 19 vessels as we continue to exercise purchase options on vessels and sale-leaseback arrangements. Due to the strong third quarter spot rates and our high operational leverage, Teekay Tankers generated almost $194 million of free cash flow, including approximately $19 million from our 80-invedels. As previously mentioned, for every $5,000 above our free cash flow breakeven of approximately $15,000 per day, we expect to generate $2.64 in free cash per share annually. Given the substantial progress the company has made in building financial strength and how well we are positioned to benefit from a strong tanker market, Teekay Tankers has transitioned to a capital allocation approach under which our existing focus on financial strength and disciplined future fleet reinvestment is supplemented by returning capital to shareholders. Namely, from this quarter, we have initiated a fixed quarterly dividend of $0.25 per share. In addition, based upon a holistic assessment of the company's position, including the last few quarters' performance and our expectations moving forward, the Board has also approved a dividend of $1 per share. Finally, we've put in place a $100 million share repurchase program, which provides us with an additional lever to create shareholder value. For midsized tankers, spot rates during the first quarter of 2023 were the highest ever in the first quarter of the year, remaining firm, albeit volatile in the early part of the second quarter. We've recently seen record high U.S. crude oil exports, and crude volumes out of Russia remained strong, adding significant support to midsized tankers. Overall, global oil demand remains on track to increase by 2 million barrels per day this year, driven in large part by China's economic recovery and increased travel following the relaxation of COVID-19 restrictions. Perhaps most importantly, fleet supply fundamentals remain in excellent shape with low fleet growth virtually assured for at least the next few years. Turning to Slide 4. We look at recent developments in the spot tanker market. Both tanker rates remained at historic highs in the first few months of 2023. As mentioned, spot rates in Q1 were the highest ever recorded in the first quarter of the year, driven by record high crude oil exports in the U.S. Gulf, an increase in long-haul movements in the Atlantic to the Pacific, boosted by rising Chinese crude oil imports and an increase in Russian crude oil exports, which are now moving almost exclusively on long-haul voyages to Asia. Midsize tanker spot rates have remained firm at the start of the second quarter, albeit with high levels of volatility, which is typical in a tight tanker market environment. We anticipate spot rates to remain volatile due to continued strong fleet utilization interest. Turning to Slide 5, we provide a summary of our spot rates in the second quarter to date. Average second quarter-to-date rates have remained historically strong. Based on approximately 44% and 41% of revenue days booked, Teekay Tankers' first quarter spot rates for Suezmax and Aframax size vessel bookings have averaged approximately $62,400 per day and $58,500 per day, respectively. Importantly, I would highlight that TNK has ships currently chartered in at an average cost of $24,300 per day with a mark-to-market value of approximately $68 million. Six of these vessels are currently trading in the spot market. Turning to Slide 6. We look at some of the factors that have been supporting midsized tanker demand over the past few months. Firstly, U.S. crude oil exports have been on a rising trend in recent months, and in Q1 reached a record high average of 4 million barrels per day, with some weeks reaching over 5 million barrels per day. Almost half of these volumes were shipped to Europe directly on Aframax and Suezmax tankers, leading to an increase in midsize tanker on-loan demand, with additional volumes being transported long-haul to Asia on VLCCs. Secondly, Russian seaborne crude oil exports have increased since the start of the year, with exports in Q1 reaching 3.4 million barrels per day, an increase of 0.5 million barrels per day from Q4. Furthermore, over 90% of these volumes are now flowing long-haul to India and China, following the implementation of the EU ban on Russian crude oil imports, creating significant ton-mile demand for midsized tankers, given that VLCCs cannot load directly from shallow draft ports. While Teekay Tankers does not transport Russian oil, the stretching of the midsized tanker fleet as a result of new trading patterns to replace imports into Europe, coupled with a growing shadow fleet of ships, conservative trading patterns, which typically trade less efficiently than the regular fleet, have benefited the wider midsized tanker market. Although Russia announced a supply cut of 0.5 million barrels per day from March of 2023 onwards, this is currently not being reflected in Russian crude oil export volumes, which remained firm in the early part of Q2. Turning to Slide 7, we look at the outlook for oil demand and supply through the remainder of this year. According to the IEA, global oil demand is projected to grow by 2 million barrels per day in 2023 to a record high of just under 102 million barrels per day. Non-OECD countries, led by China, are expected to account for 90% of this growth, with OECD demand being impacted by slower economic growth due to high inflation and rising interest rates. Oil demand is expected to accelerate during the second half of the year, with Chinese economic growth catching pace, with reported GDP growth of 4.5% in the first quarter, providing a positive sign of an accelerating economy. Looking at oil supply, the OPEC+ group announced a surprise oil production cut of 1.16 million barrels per day from May through the end of the year in response to lower oil prices and uncertainty in the global economy. While this may negatively impact overall volumes, and although the impact will primarily be felt in the VLCC sector, given that the majority of the cuts are from Middle Eastern producers, there could also be a negative knock-on effect for all crude tanker segments in the coming months. Turning to Slide 8, we look at the positive tanker supply and demand fundamentals, which we believe lay a strong foundation for extended market strength over the next few years. Fleet supply fundamentals remain very positive. The global tanker order book, when measured as a percentage of the fleet, remains at a record low of approximately 4%. Although the pace of new tanker ordering has picked up since the start of the year, most shipyards are now effectively full through the end of 2025. Furthermore, the number of new orders placed is relatively small when compared to the fleet of older vessels that will need replacing in the coming years. Therefore, at this stage, we do not feel this recent uptick in ordering is having a material impact on overall fleet supply in the medium term. The combination of a small order book and limited shipyard capacity through mid-2026 virtually ensures low fleet growth over the next 2 to 3 years, with approximately 2% fleet growth expected this year and negligible levels of fleet growth in both 2024 and 2025. As shown by the chart on the right of the slide, tanker demand growth is expected to far outweigh fleet supply growth over this time period, setting the stage for increased fleet utilization, which should drive an extended upturn in tanker spot rates over the medium term. I'll now turn the call over to Stewart to cover the financial slides.

Thanks, Kevin. Turning to Slide 9. We highlight the company's high operating leverage and what that means for TNK's capacity to generate cash flow and create shareholder value in a strong tanker market. With 96% of our fleet trading in a firm spot market, our earnings in recent quarters demonstrate the power of having 51 vessels trading in the spot market, generating significant free cash flow. If Q1 2023 spot rates continue for the full year, we would generate approximately $24 per share of annual free cash flow, equating to a free cash flow yield of over 60%. Our strong cash flows have been used to strengthen TNK for the long term by rapidly paying down debt. In addition, they've allowed us to optimize our capital structure by exercising purchase options on vessels we had previously put into sale-leaseback financing agreements. By Q4, we expect this optimization to have reduced our breakeven rate by approximately $400 per day. Turning to Slide 10, we look at Teekay Tankers' updated capital allocation plan. As we have previously communicated, throughout 2022, our capital allocation was focused on building balance sheet strength, and I'm pleased that we have made excellent progress in that regard. Since the beginning of 2022, we have generated over $480 million of free cash flow, reduced our net debt by over $400 million to $182 million, and reduced our net debt to balance sheet capitalization from about 40% to less than 13%. Highly supportive market conditions and our operating leverage enabled us to accelerate our progress, and we are now pleased to revise our capital allocation plan. Our updated capital allocation plan will maintain a focus on building financial strength for future fleet reinvestments when market conditions are supportive. In addition, we are initiating a $0.25 per share fixed dividend. This dividend enables us to continue building financial strength while also consistently providing a return of capital to our shareholders. A holistic assessment that considered the company's performance in recent quarters and our outstanding progress in building financial strength, combined with our tanker market outlook and the company's future capital needs resulted in the board declaring a special dividend of $1 per share. While it is not our intention to utilize special dividends as a regular recurring supplement to our fixed quarterly dividend, we have chosen to do so at this time, providing not just immediate value to our shareholders, but also establishing a further means by which TNK can optimize its capital allocation. Finally, we have put in place a $100 million share repurchase program, which provides us with another capital allocation tool, enabling us to act opportunistically to take advantage of equity market dislocations when TNK has excess capital. I will now turn the call back to Kevin to conclude.

Thanks, Stewart. In summary, Teekay Tankers is in a great position with our sizable fleet of well-maintained quality Aframax, LR2, and Suezmax tankers to benefit from the strong tailwinds supporting the midsize tanker market. Robust tanker market fundamentals indicate multiyear support for a healthy tanker market environment, which should enable us to continue creating shareholder value by generating meaningful cash flows, returning capital to shareholders, and seeking opportunities to reinvest in our business and fleet in a disciplined manner. With that, operator, we are now available to take questions.

We will now take our first question from Jon Chappell with Evercore ISI.

Before I start, I want to make a point not to pander on these calls, but I have to say after several quarters of questions around your capital allocation, it's great to see a result there, and that's really great. So congrats on that. Stewart, if I could start with you, a lot of the work that you've done on the balance sheet has put you in this position now to change the capital allocation strategy. 19 vessels that you've taken back from sale and leaseback that will be done by, I guess, the third quarter of '23. Can you just remind us how many would remain then starting in the fourth quarter under the sale and leaseback arrangements? Again, any timing on the ability to exercise options to end that structure as well.

Jon, yes, thank you very much. We will have 8 vessels left in sale-leaseback structures as of the end of the year, and those come up with purchase options available towards the end of Q1 2024. So we'll be in a position if we think it's appropriate to buy those back early next year. There will be 8 remaining in total under sale leasebacks at the end of this year. All 8 of those will be available for purchase options by the end of Q1 '24, so within 12 months, in March 2024, we have purchase options on all 8 of them.

Okay. Great. Kevin, for you, you mentioned the volatility. And obviously, there has been a lot of volatility in headline volatility, so to speak, as well. But it seems that every time we get a little mark-to-market update, it's like the VLCCs and the MRs, kind of the barbell have been more extreme, where the Suezmaxes and the Aframaxes although they have been volatile, at a much higher range and a much tighter range. What do you ascribe that to? And is it strictly the most direct beneficiaries of a lot of the redrawing of the trade map have been those two midsized crude asset classes? And do you think that sets a stage for a higher high and higher low scenario within those two specific segments going forward?

Jon, I appreciate your earlier comments. It's intriguing to discuss volatility, especially in relation to the comparisons between the VLCCs and MRs. Just looking at Aframax, there was a period just 10 days ago when operational expense levels were around $120,000 a day in the U.S. Gulf, which illustrates volatility. However, this trend is evident across all segments, not only at extreme points. On average, the monthly and quarterly figures for midsized tankers, particularly Aframax and Suezmax, have consistently performed better. This indicates the significant impact of new trade routes stemming from the Ukrainian conflict, highlighting the flexibility that Aframax and Suezmax vessels provide. As mentioned previously, while we don't engage directly in Russian trade, its disruption has shifted others away from traditional markets. Our strong presence in the U.S. Gulf and our layered business strategy in the Atlantic and Far East have enabled us to maintain our position in the Aframax market during price spikes, delivering the returns we are sharing today. Over the last year, the story has primarily revolved around midsized tankers, rather than all sectors simultaneously, which have experienced intermittent strength. The OPEC reductions will mainly impact the VLCCs, while I believe the positive sentiment for Aframax will likely persist through the summer and into Q4.

And we'll go ahead and move on to our next question from Omar Nokta with Jefferies.

Kevin, Stewart. Maybe just to touch on that point from my angle as well. I would say congrats because you guys set off on this strategic approach maybe at least 5 or 6 years ago looking to balance or strengthen the balance sheet, and you really ignored a lot of risks in taking advantage of the uplift that we saw in 2019, 2020, you just stayed the course. Now we've got Teekay in this position of being almost in a net cash situation. So kudos to you guys! I did want to ask about clearly, you have the buyback, you've got the special dividend that you just declared, and you've got the ongoing $0.25 dividend. You're generating a lot of free cash flow based on the way this market is. How are you thinking about how that free cash gets utilized? Obviously, you just announced this capital allocation, so I'm not expecting you to start discussing what to do with the excess cash. But just in general, how do you think about that free cash as it gets generated? Does it just go straight to the balance sheet? Your debt is almost gone, so does the cash just build? Or do you now start to look at acquisitions and fleet renewal?

Thanks for the comments, Omar. Yes, we're very happy with the progress we've made over the last few years, and we think we're in a good position. In terms of the excess cash flow that we'll generate, I do expect that if the tanker market stays strong, we'll quickly find ourselves in a net cash position. As we mentioned in our prepared remarks, it's really with an eye to making disciplined reinvestments in our fleet going forward. We can step back a little bit now and look at a bit more of a longer-term view of what's going on with the company over the last several years. We try to be very disciplined and focused on building our balance sheet strength. We haven't invested in the tanker since the end of 2017, so we do need to reinvest, but we're going to be very disciplined as we do that. Going forward, we want to continue to operate from a position of balance sheet strength, which means it will require a fair amount of equity to make those reinvestments. So we'll be patient. We'll look for opportunities, and when those opportunities arise, we'll be positioned to take advantage of them.

That's good. And I guess just in terms of those opportunities, I don't want to press too much because you do have the flexibility to take your time. But in terms of fleet additions, you can do the charter ins as you've done here recently. You can buy ships out in the open market or you can order new ones. Euronav earlier this morning mentioned looking at new buildings within the Suezmax segment. How are you guys looking at new buildings in general? Is that something that is compelling at this point? Or if you were to put capital to work, is it more towards secondhand or do you continue with the in-charter approach?

Omar, yes, and thanks as well for the comments. I think we've said this before. When it comes to our fleet renewal task, we're really agnostic. Historically, TNK has bought secondhand ships, ordered new ships, and done mergers and acquisitions. I don't think that changes going forward. The challenge at the moment is, in our view, newbuilding prices relative to historic terms are expensive compared to our secondhand value. Obviously, different owners have different views, but from where we sit, we don't have plans on our books right now to go into the new build market at these current price levels.

And maybe just one final follow-up. Just on the new credit facility, the $350 million that will refinance the 19 leaseback vessels. You're going to be winding those down obviously over the next couple of quarters. How much of that $350 million are you expecting to draw initially for the full term once you've paid off the leases on the 19?

Well, it depends on how cash flow goes into Q3 and Q4, but we are able to reacquire the vessels from the sale-leaseback arrangements initially with just a small draw on our existing revolver without needing to draw anything on the $350 million. So it will be either a very small draw on the existing $90 million revolver or nothing. If we continue to see strong cash flows into Q3 and Q4, I would expect that we wouldn't need to draw anything.

And our next question is going to come from Ken Hoexter with Bank of America.

Great. And again, I'll echo congrats on the reshaping of the balance sheet, great job sticking with it. Kevin or Stewart, you're 96% spot exposed. I don't know, maybe your view of how long this lasts for in terms of obviously, you're confident by sticking with the spot. Do you look for some time charter opportunities to lock in these rates? Maybe your thoughts on the longevity of this kind of market.

Yes, as we said in our prepared remarks, the way the fundamentals have set up and as we've said on previous calls, the change in the trade patterns as a result of the Ukrainian war, we feel in our opinion are durable. So yes, we do have confidence that the spot market is going to be the best place for our assets to trade and for us to maximize our cash flow generation. However, we always keep an eye out for opportunities. We haven't seen any of late where we thought it was worth putting vessels out. We feel we can outperform the market over the next 12 months by staying spot. But we have done some short-term 3-month deals that sort of outperformed the spot market. So we're always looking for opportunities. But in terms of the longer-term 12-month-plus types of deals, we don't feel that the market is rewarding us enough for committing the assets at this point in the cycle. And that's based on the confidence we have in the spot market going forward.

Great. And I guess maybe to take that one step further, right? The confidence in the order book, right? I think it was just mentioned that you're hearing some peers start to place orders. You're still looking at it as historically expensive. Does that fear of the rising eventual order book start to pressure your rates in your view? Or does that change your outlook on things as you get more carriers going in and placing orders? Or maybe just walk us through your thoughts on how you see the market panning out.

Yes. I think we recognize that there has been an uptick in ordering in recent months. But our view for the next 2 to 3 years is that we are going to enjoy a very strong period of minimal or non-existing fleet growth. Beyond that, nobody knows. As I said, there has been an uptick. When you compare the uptick and annualize that, there are numbers around it. But when you compare it to previous years or historical norms, the order book still isn't large. And as long as that remains the case, we also look at where the fleet profile is for tankers, and there is a significant grouping of ships approaching 20 years old and beyond that will eventually leave the fleet. When you compare the numbers to a fleet that needs to be ordered to replace that fleet, we can take a lot more pressure from here before we have a large negative impact.

Great. My last question is about the OPEC cuts. Do you see any risk of VLCCs affecting the market?

Yes, it's a good question. OPEC cuts will definitely impact the VLCCs because most of the cuts are coming from the Middle Eastern producers. They will look for other markets to penetrate, and we will see them start to move into West Africa. We have, over recent months, seen more VLCC volumes being picked up in the U.S. Gulf going to Europe. But as we struggle for alternative markets, they will start to trade into other areas, which, in our view, could put a lid on how high the spot market could go in terms of the midsized tanker space. But overall, our confidence is that especially for the Aframax sector, they are not vessels that can be readily replaced, and we think that the Aframax market will continue to benefit. As for the Suezmaxes, it's just that they may be capped out a little bit, where the highs don't go as high as we think in the fourth quarter during the summer. But they'll still be on a relative basis, extremely healthy returns for Suezmaxes compared to historical norms.

With that, that does conclude our question-and-answer session. I would like to hand the call back over to the company for any additional or closing remarks. Thank you for joining us today, and we look forward to speaking to you next quarter. With that, that does conclude today's call. Thank you for your participation. You may now disconnect.