Teekay Tankers Ltd. Q1 FY2024 Earnings Call

Welcome to Teekay Tankers Ltd. First Quarter 2024 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.teekay.com, where you will find a copy of the first quarter 2024 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 those 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 of 2024 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 2024 Earnings Conference Call. Joining me today on the call is 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 $151 million, up from the $127 million we generated last quarter. The company reported adjusted net income of $132 million or $3.86 per share, an increase from $100 million or $2.91 per share in the fourth quarter of 2023. With our fleet of midsized tankers trading almost entirely in the strong spot market, Teekay Tankers' high operating leverage enabled us to continue generating significant earnings. As a reminder, for every $5,000 increase in tanker rates above our free cash flow breakeven of $16,000 per day, we expect to generate approximately $2.40 of annual free cash flow per share. Stewart will provide further information on this later in the presentation. In March, we completed the repurchase of the remaining 8 vessels on sale-leaseback arrangements for $137 million, reaching the major milestone of being debt-free. With our balance sheet strength, recent financial performance and the positive market outlook, we continue to take a balanced approach to capital allocation. In line with our capital allocation plan, we have declared a fixed quarterly cash dividend of $0.25 per share for the first quarter of 2024. In addition, we have declared a special dividend of $2 per share. Including these dividends, Teekay Tankers has declared cash dividends of $4.25 per share since updating our capital allocation plan last year. Teekay Tankers' midsized spot rates for the first quarter of 2024 were the second highest in the company's history, second only to last year's spot rates. These firm spot rates have continued through the first half of the second quarter as well. The recent expansion of the Trans Mountain pipeline to Vancouver with first cargoes planned for this month will create a new source of Aframax demand, which is expected to support Aframax spot tanker rates as volumes ramp up over the coming months. I will talk more about this important development later in the presentation. Looking ahead, tanker supply and demand fundamentals remain positive and point toward continued tanker market strength in the medium term. Finally, we completed the previously announced sale of one 2004 built Aframax during the first quarter for total proceeds of $23.5 million, recording a gain on sale of $11.6 million. Turning to Slide 4, we look at the dynamics in the spot tanker market. As mentioned in the highlights, Q1 saw the second highest midsized tanker spot rates for a first quarter in Teekay Tankers' history, second only to the exceptional rates recorded in Q1 of last year. Rates were supported by a combination of factors, including firm tanker tonne-mile demand, limited fleet supply growth, normal seasonality and trade route disruptions due to geopolitical events, which led to an increase in average voyage distances. These factors have continued to support spot tanker rates during the second quarter, with rates remaining at firm levels. Looking to the second half of the year, we expect the rates will remain well supported by rising oil demand and expected increase in crude oil supply from non-OPEC countries, predominantly in the Atlantic Basin and the start of exports from the newly expanded Trans Mountain pipeline. Turning to Slide 5, we provide an update on our Suezmax and Aframax size spot rates for the first quarter and the second quarter to date. With about 59% and 54% of revenue days booked, Teekay Tankers' Suezmax and Aframax vessel bookings have averaged around $45,100 per day and $43,900 per day, respectively, for the period. I want to emphasize the value created by Teekay Tankers' fleet of 8 chartered vessels, of which 7 are active in the robust spot market. With an average charter rate of $25,400 per day, this fleet has a current mark-to-market value of roughly $54 million. Turning to Slide 6, we look at the impact of the Trans Mountain pipeline expansion, or TMX, which we believe will provide a significant boost to Aframax specific demand going forward. On May 1, the Trans Mountain pipeline expansion commenced commercial operations, with first cargoes expected later this month. The new pipeline has the capacity to carry 590,000 barrels per day of Canadian crude oil for loading onto Aframax tankers, which is the maximum size of vessel that can load from the terminal due to draft restrictions. Given that the first cargoes have yet to load, there is still uncertainty regarding the ultimate destinations of the crude exported from TMX. However, we have identified four potential trades which could develop to bring this oil to market. First, given the characteristics of Canadian crude, we believe that the barrels are well suited to refineries on the U.S. West Coast, particularly in California, where cargoes would be transported directly on Aframaxes. Secondly, we expect Asian buyers will look to acquire Canadian oil given its price discount to equivalent grades from other sources. This oil could be transported directly to Asia on Aframaxes, and we've already seen one customer booking an Aframax for May loading dates with discharge in China. Alternatively, Asian buyers may find that there are economies of scale to be gained from parceling up Aframax cargoes to a larger VLCC or Suezmax. The most likely locations for these reverse lighterings are in the Pacific area lightering zone off the coast of Southern California or off Panama, where other grades of Latin American crude may be co-loaded. Again, we have already seen a customer taking this latter option, with reports that a major refiner has booked Aframaxes from TMX for parceling up to a VLCC off Panama for onward delivery to India. These new trade routes are expected to increase Aframax demand going forward, particularly as Vancouver is relatively far from the main Aframax trade lanes in Asia and the U.S. Gulf, meaning that vessels will have to be pulled in from these regions to meet demand. To give some context, the distance from Vancouver to Southern California is around 1,200 nautical miles or 12 voyage days on a round-trip basis, including loading and discharge time. While the distance from Vancouver to China is around 6,000 nautical miles or 44 voyage days. Assuming a 50-50 split between these two destinations, we estimate that the Trans Mountain expansion could create incremental demand for around 25 to 30 Aframaxes once the pipeline is at full capacity. Turning to Slide 7, we look at supply and demand factors which we believe support continued tanker market strength over at least the medium term. Fleet supply fundamentals continue to look positive. Despite an increase in the pace of new tanker orders in recent months, the tanker order book is small by historic standards at 9% of the fleet delivering over the next 3 years. The order book is particularly small this year with just 2.4 million deadweight tonnes of new tankers delivering into the fleet during the first quarter of 2024, which is the lowest delivery total for a first quarter since 1989. Furthermore, the tanker fleet is aging, with the average age of the global fleet at its highest point since 2003, coming in at 13.2 years. While ships are not being scrapped in the current high spot rate environment, vessels that trade beyond age 20 are seeing a significant drop in utilization compared to the vessels below 20 years of age, thereby reducing effective fleet supply. As a result, we project close to 0 tanker fleet growth in 2024, with modest growth of around 1% in 2025. Looking at demand, the average forecast for the major oil agencies projects healthy oil demand growth of 1.5 million barrels per day in both 2024 and 2025. The majority of this demand growth is expected to be met by increasing oil supply from the non-OPEC countries, particularly from producers in the Atlantic Basin, which suggests that tanker tonne-mile demand will continue to benefit from an increase in long-haul movements from the Atlantic Basin to Asia. As shown by the chart on the right of the slide, tanker tonne-mile demand growth is expected to outstrip fleet supply growth both this year and next, continuing the trend that started in 2022. This compounding impact of demand growth exceeding supply growth should continue to support high levels of tanker fleet utilization and firm tanker rates through at least the medium term. I'll now turn the call over to Stewart to cover the next slide.

Turning to Slide 8, we highlight how well Teekay Tankers is positioned to continue creating significant shareholder value in 2024, a year that we expect to be another strong tanker market. With 98% of our 51 vessel fleet operating in the strong spot tanker market that is being supported by the various factors we have talked about today, we feel confident in our ability to continue creating significant shareholder value. In the first quarter, TNK generated $156 million or $4.54 per share of free cash flow. If we use the trailing 12-month average of TNK's realized spot rates and project that forward, our annualized free cash flow would be approximately $14 per share or a free cash flow yield of approximately 22%. As Kevin mentioned in his opening remarks, Teekay Tankers has reached a milestone by becoming debt-free after repurchasing our eight vessels on sale-leaseback arrangements during the first quarter. Based on a holistic assessment of the company's position, including being debt-free, continuing strong operating results, our desire to retain capital for fleet rejuvenation and a very positive market outlook, the Board has declared a special dividend of $2 per share for a combined dividend of $2.25 per share, including our regular quarterly dividend of $0.25 per share. With these dividends, Teekay Tankers has returned capital to shareholders totaling $4.25 per share since announcing our revised capital allocation plan in May of last year.

Thanks, Stewart. In summary, the key drivers of the strong markets for midsized tankers remain firmly in place. As we look ahead at both supply and demand, we are increasingly upbeat on the prospects over a multi-year period. In this environment, our high operating leverage continues to create significant value for Teekay Tankers' shareholders. Our Board of Directors' decision to declare a special dividend reflects our balanced approach to capital allocation. While we continue to prioritize building capacity for fleet rejuvenation, the special dividend reflects our optimism about what lies ahead for our industry segment and our company. With that, operator, we're now available to take questions.

We'll go first to Jonathan Chappell with Evercore ISI.

Starting with the market, maybe Christian can address this, and Kevin could also provide input. I find Slide 4 on the right side quite intriguing. There's a lot happening in this industry currently, alongside considerable geopolitical unrest. However, when I examine the Suez and Aframax rates you've presented in Slide 4, they have remained within a very tight range over the past six months, obviously at high levels but still constrained. Can you share your thoughts on why the volatility typically seen in this sector, which one might expect to be heightened in today's environment, is instead resulting in such stable yet strong rates in these two asset classes where your company is mainly involved?

Yes, I agree with that observation. Despite the global events, it's notable that spot tanker rates in our sectors have remained quite stable since winter. Typically, we would expect rates to decrease seasonally at this time of year as refineries enter maintenance periods. However, several factors have positively influenced tonne-mile demand since the beginning of the year. Disruptions in the Red Sea due to attacks on merchant shipping have caused some tankers to take longer routes, which has impacted both crude and product, with a more significant effect on products in the LR2s. We've also seen some crude being diverted. Additionally, despite the attacks on Russian refineries in Ukraine, Russian exports have remained high. These factors have supported tanker rates during what is usually a weaker seasonal period, which bodes well for the second half of the year. As Kevin mentioned in his remarks, the Trans Mountain pipeline will be coming online and ramping up in the second half of Q2, which we expect will boost Aframax demand. More oil volume is also anticipated in the second half. Overall, it has been encouraging to see rates remain elevated through Q2, instilling confidence for the remainder of the year.

Okay. That's helpful. And then just for my follow-up in the interest of playing the hit. Kevin, I think the special dividend is being widely applauded today. You're down to a net cash position. So I'm just not asking you to completely show your hand, but maybe just a clarification on the path from here. If you could just prioritize kind of how you think about this massive cash flow that Stewart pointed out in the coming quarters? How would you prioritize the uses of capital, let's call it, to the rest of '24 and through '25?

Yes. It's obviously a fantastic situation to be in after the markets that we've had to come through over the last few years. But it's something that, as a management team in conjunction with our Board, we're always looking at and always trying to discuss. We do have fleet renewal to look at. And although pricing today is elevated on both newbuilds and secondhand, there is a need for us to replenish. As we sell ships, we still want to keep exposure to the spot market because of the confidence we have in the underlying fundamentals of the market. So as we roll off some of the older ships, you may see us use some of that capital to reinvest and keep our spot exposure at a high level. So some of the cash may be used for that. We also have to look beyond that and look to the future as to doing larger fleet rejuvenation exercises, which we're not advocating to do now. But we are cognizant of the cyclicality of our market. And keeping that powder dry for that use is important for us to be able to provide long-term value to shareholders. And then obviously, we understand and fully respect that shareholders would like a yield. And in that respect, our capital allocation plan that we came up with last year, we felt was a prudent long-term oriented plan that satisfied both the rebuilding of the fleet as well as replenishing some capital back to shareholders in the meantime.

We'll go next to Omar Nokta with Jefferies.

I wanted to follow up on Jon's question. It's something that comes up often. Now that you're completely debt-free and in a net cash position, congratulations on that achievement. It has taken a long time. However, I noticed that you've listed two ships as available for sale at the end of the quarter, suggesting you plan to continue scaling. Kevin, with 42 tankers currently in the fleet, selling those two will leave you with 40. You mentioned plans to replace ships as you sell them. Regarding your fleet size after these sales, do you have a particular minimum number you aim to maintain to achieve these kinds of rates? Should we anticipate a quicker replacement of vessels compared to what we've seen over the last few years?

No, I think obviously, scale provides us a lot of optionality to trade in different markets and be able to be in different places as the volatility that is inherent in strong markets plays out, and we want to have enough scale to be able to play across several markets. So as we look at some of the older ships that we sold at the end of last year, we do currently hold a Suezmax and Aframax for sale. Looking just to take value off the table for that older class of ship. If there is an opportunity to find a newer, more modern vessel, yes, we would redeploy that capital to keep the exposure on. But we're not looking at a set number or anything of that nature. It's more around being able to distribute a large enough fleet across several markets to make sure that we can capitalize on the volatility that we expect to continue to see. So that's really how we think about it, Omar.

How does TCN fit into that? A while back, you increased your number of ships to benefit from spot exposure stabilization, but your fleet hasn't really expanded since then. Is that something you're considering, or do you prefer to grow through ownership?

No. We have many options and tools available. We have built a strong in-charter book, having gotten in early before the market surged, and we've benefited from the profits that this fleet has generated. However, we are currently facing a significant gap between what other owners want for their ships and what we are willing to pay, resulting in a slowdown. This is a natural response to the current market conditions. Nevertheless, we are still looking to add more ships; it just requires finding the right ship at the right price and often in the right location, which greatly affects our overall earnings. Several ships will be coming off charter soon, and we've begun discussions with the owners to see if we can agree on a fair price to retain those ships. This remains a tool in our toolkit that we plan to utilize. Similarly, when asked about locking in our own ships at current market levels, the answer remains the same. If the right opportunity arises that offers an appropriate price, we will certainly pursue it and report back.

And maybe just one more from me. Regarding TMX, as you've been highlighting over the past couple of quarters, we are getting closer to having an impact. You mentioned the different potential trade lanes and reverse lighting, but could you provide some perspective on how you envision that market developing? You pointed out that it is somewhat of a remote location compared to the usual trade routes for Aframaxes. How do you see the spot market evolving for cargoes in that area in terms of attracting ships to remain there, considering it's relatively isolated? How does the spot market operate in that region? I know that's a bit like looking into a crystal ball, but if you can't do that, could you share what you're currently observing regarding the rates offered in that area compared to global averages? Any insights you can provide on pricing in that region would be helpful.

Well, first, I think we've got to be honest. As we laid out in our presentation, it's early days yet. The cargoes are starting to come. We've seen a couple of fixtures in the market. From a positive standpoint, for us, they seem to be long haul, both to China and then down to 15 days down to Panama. So where the cargoes go at this point, we don't know. We have to wait and see. We think that there are four main options that the customers will take. A lot will depend on oil pricing and the differences between oil prices in different regions, which again, I'm not going to stand here and in any way, try and predict that. What I do think will happen though is the oil will have to move, and it will be priced into the right market. And that will include shipping cost. And if that means that ships in the Far East have an option as they come into North Asia for discharge, they now have an option to look to ballast across to Vancouver and pick up a nice long-haul voyage from there. Similarly, ships that do end up trading into the West Coast or through Panama, they now have the option to go up. So I think it's something that owners will have to wait and see as the trades develop. I don't think necessarily will mean that you'll have ships that will station themselves there. I think they will move in from other regions as and when the requirements pick up. And from the freight standpoint, it will be priced according to the earnings that the owners expect versus relative to what they can do in other markets. But I think the real benefit we are going to see is the additional tonne miles specific to the Aframaxes because the Aframax is the largest ship you can move into Vancouver. You can put in a smaller Panamax but stem sizes are too big for a Panamax, and you don't have a lot of storage up in Vancouver. So the Aframax really is the vessel that this port needs to use. And I think whether it does go into the West Coast or to Light Ridge or Panama or to Asia, the Aframax is going to be the ship that's going to have to service that. And it's going to cause dislocation. It's going to pull ships from the U.S. Gulf. It's going to pull ships from Asia, and that's going to benefit possibly Suezmaxes and other Aframaxes in those regions as the supply diminishes.

Yes. It will be very interesting to see how it starts to develop here in the next few months. I really appreciate that perspective.

We'll move next to Ken Hoexter with Bank of America.

And Kevin, I guess, just to follow on that thought process, right? If we get those moving down into California, I guess then you'll still have a product that needs to move the longer haul that replaces that, right? The product that California would have been sold in you'd make up with even longer hauls?

Yes. At the moment, you can observe Canadian crude replacing some of the long-haul Arab barrels, which will be displaced and will need to find new markets. This development is quite exciting. It will primarily and initially affect the Aframaxes, but there may be subsequent impacts in other areas as well. It will be interesting to watch how this evolves and how we can respond to it.

So I guess a follow-up, Christian talked about rates earlier to Jon's question, but Afras seemed to be getting hit, I guess, relative to your quarter-to-date rates that are booked, right? So going from about $48,000 to $44,000 a day, while Suezmaxes are flatter at 47 to 45. I guess just is the market not anticipating or adjusting for that potential Aframax tightening yet? Or is it just too early to react to TMX at this stage?

I wouldn't put too much emphasis on such a small change in the rate, particularly at levels around the mid-40s, which we haven't experienced in 20 years. This seems to be related to the fluctuations in fleet capacity. The U.S. Gulf market is likely one of the most unpredictable; rates can plunge to $30,000 a day, only to rebound to $65,000 within a week. Therefore, to truly understand the trends, we need to observe over a longer timeframe. I wouldn't read too much into short-term fluctuations. The market won't preemptively adjust to the rates based on expected cargoes; we need to wait for the TMX volumes to align with what the pipeline owners have projected. Once those volumes are in, I believe we will start to see an effect on the Afras.

Yes, gradually. Once operations begin in May and the volumes start coming in throughout the year, you mentioned the challenging discussions regarding charter-in rates and your perspective on charter-outs. What is your view on the purchase price of new vessels? Stewart discussed the fleet renewal process. What are your thoughts on entering that low order book? Are the rates just not economical? If we're considering mid-40s, at what point does it become economically viable?

Yes, it's definitely a noteworthy challenge because we recognize that both secondhand and newbuild pricing are high. However, as you mentioned, so are the rates. Currently, we haven't placed any orders for new ships at these price levels. If we decide to make any moves, it would likely involve exploring the secondhand market first to replenish the lost spot exposure from the sale of the two ships in December and January. If we sell more, we would likely look to the secondhand market to replace those ships, as we prefer to ensure that if we're paying these prices, we want those ships generating revenue from day one, aiming for earnings around $40,000 to $45,000 a day like we are at present. So, the focus would be on prompt purchasing rather than long-term replenishment.

And with no other questions holding, I would like to turn the conference back to the company for any additional or closing comments.

Thank you for joining us, and we will speak to you next quarter.

Thank you. Ladies and gentlemen, that will conclude today's call. We thank you for your participation. You may disconnect at this time.