Teekay Tankers Will Be Owned By Creditors for a While

• TNK stock has been down more ~50% year to date. It trades at less than 3x earnings and this has shareholders calling for buybacks.
• However, management is paying down debt instead. They have to do because of lower cash flows in 2016 and 2017, as well as demanding debt maturity schedule.

Back in December 2015, Teekay Tankers (TNK) announced a $900 million refinancing, including a term loan and a revolver that are both due in 2021. I thought the deal was bullish for the stock, since it cleared out near term maturities and allows TNK to buy back stocks.

This is not the case. That deal did push out a lot of near term maturities, but a substantial amount remains. In addition, the new term loan actually has an onerous principal payment schedule.

The $525 million term loan matures in 2021 but demands principal amortization of $31.94 million per quarter for the first few quarter and $24.845 million per quarter thereafter. This amounts to $99-106 million of principal payment per year.

What’s more, a sizeable chunk from old loans remains. The annual report has a maturity schedule pro forma for the refinance. Backing out the January 2016 loans, and assuming the debt payment made during 1Q16 was toward near term maturities, the current debt schedule would look like the below.

The big question is the $215 million due 2017. To put that in context, TNK only generated $167 million of cash flows from operations for the entire 2015, and that’s with peak tanker rates! So far in 2016 we are already seeing lower tanker rates and lower cash flows.

More headwinds are coming in 2017. Tanker supplies will come on line second half of 2016 and through 2017. So rates in 2017 will likely be lower. In-charters will expire so TNK will be operating with a lower number of vessels.

So forget about TNK paying off the entire $215 million out of cash flow from operations. It will struggle to even pay the ~$106 million term loan scheduled principal in a weaker market. It will certainly have to refinance the rest of 2017 maturities; failure to do so means another round of equity raise, or even bankruptcy.

To entice lenders for the 2017 refinancing, TNK will need to demonstrate credit worthiness and deleverage in the near term. This explains management’s focus on deleveraging, why the company has not repurchased any shares despite the ostensibly low P/E ratio, and why an equity offering is still on the table.

So creditors will get most of the cash flows for now. This is not to say avoid the stock, but investors should recognize the credit situation, and be willing to hang on for a couple years for their big pay day.

Advice for Investors

In this situation, demanding share buybacks is to demand a short term boost in the stock price while risking equity dilution or even bankruptcy down the line.

Instead of pushing for buybacks, big boy activist investors can provide the refinancing themselves. Just to toss some ideas around, with $250 million of 10% senior notes, weighted average cost of debt would still be under 5%.

Even after the 2017 maturity is addressed, TNK will still face a demanding term loan amortization. But by late 2017, it should have shown progress in deleveraging and tanker rates should have stabilized. Management can then refinance the January 2016 loan into another with easier principal payment schedule, and finally release free cash flows to shareholders.

There is also a lesson here. P/E ratios and free cash flow yield (free cash flow divided by market capitalization) are meaningless measures for companies loaded with debt. “Free cash flow” is not really “free” in terms of using it to reward shareholder, especially if there are near term maturities/obligations that can’t be funded from operation.

Week Ending 5/2/2015: Random Notes and Portfolio Review

I missed a home run last month and it hurt. Impac Mortgage (IMH) was the one. I’ve been following that stock on and off for 3 years. A week before earning came out, I had a hunch 1Q15 was going to be a good quarter, so I sat down, went through a rather detailed model and looked over my projected 1Q15 earnings. I passed, thinking the was not worth the risk and reward. When the actual earning came out it was a multiple of my forecast!! I was stunned  (I got the volume pretty much right on but was way off on the margin!). The stock ran up 100%+ in past month alone. Never have I put in that much work in a stock and turned out that wrong before. I mean if I was a portfolio manager at some fund and had a hunch about this stock, and I got my sector analyst to take a deep dive. He comes back saying it's a no go, then the stock goes up 100%...this is the sort of stuff that could get you fired.

So that hurt my confidence. That and the fact that I’ve been very uneasy with the market made me go through my portfolio again.


Healthcare portfolio.  This is a multi-leg investment to capture the long term trend in America’s aging population. I have a mix of managed care, hospitals, pharmaceuticals, and supply chain players that balance out each other.

Managed care ran up a lot in 1Q15 and was a major contributor to my out performance year to date. I decided to cut this down a little bit due to full valuation. I also see near term risk in the next year as we get closer to election year and Republicans will undoubtedly make some noise about Obamacare. But overall this healthcare portfolio is a very long term play and there’s nothing here that I would think of selling if the overall market drops 50% tomorrow.

That said, after a very successful run the past year, my expected return in the next few years is not great – maybe mid/high single digit annualized return. So if something with better risk and reward comes alone I could pare this down further.


Housing portfolio.  This is really more like housing finance and is a mix of title insurance, originator/servicers, mortgage REITS and mortgage heavy banks. The big picture idea is to go long household formation and existing home sales in the next 5-10 years. Unlike the healthcare portfolio, there are some pretty speculative names in here like Nationstar, PennyMac Financial, AGNC…etc. But I’ve cut them down to a point where I’m pretty comfortable for all remaining positions, and certainly on a portfolio basis. 

The core group here is title insurance, which I went through recently thinking about adding. Unfortunately the group look fairly valued. In terms of technicals, Fidelity National Financial (FNF) is a name showing some weaknesses. It is hovering around its resistance level and could see a big break on the downside if next Monday’s earning turn out to be a bust. If that happens I will simply take it on the chin. 

Tankers. I cut down some TNK and bought some more DHT. In the past few weeks TNK stock price has moved up to a point it became too large of a position. I'm also worried that Aframax sector (which TNK is heavy in) will not benefit as much as say VLCC or Suezmax sector. Hence the rotation into DHT, which owns mostly VLCC and Suezmax ships. Luckily, I did this adjustment right before TNK stock took a beating the past few days. The tanker trade is ~6% of my total portfolio and I have 4 stocks sharing the risk. What's preventing me from getting bigger here? 1) This is obviously a very speculative trade and cannot be long term. 2) Global crude oil demand is highly dependent on China, so the tanker trade is to some degree a long China trade -- and I'm already very long China in the portfolio.


Beijing Enterprises Holdings (392.HK). This ran up some 20% and I kept adding to my position on the way up. Although the gain is mostly due to extremely lucky timing, this is a very long term investment for me. I would consider adding more Chinese gas distributors, but only at the right price.


One big China/HK trade basket. Welling (382.HK) has ran up dramatically and I also added on the way up. But I see less upside here and will likely take my profit if the HK market takes a turn for the worse. In recent weeks I piled in and added a mix of indices and (mostly infrastructure) stocks to capture an expected spike in liquidity as well as A-H share premium.

But now that H-shares momentum has flattened out, I’m very worried about the A-share bubble popping and how that might spill over to H-shares. I'm actually investigating ways to short China as a whole while staying long in my current H-share positions, which are all reasonably valued if not outright cheap. I have tight stop losses on every one of these trades and will let the market decide for me.

Updating my views on Apple and Google:

Apple. I’m kind of surprised that the stock did not move that much given the very strong quarter. Demand for the stock could be exhausted. Part of my thesis is a "short squeeze" for those who still don't own AAPL and lags the index as a result. I now see that even a $200bn capital return plan cannot scare the implicit shorts. My original thesis could be flawed and I may cut down or exit instead.

Google. I’m holding on despite the temptation to exit given the persistently negative market sentiments here. I did some rough numbers again. My timeframe is 5 years for this. What’s the worst case? Conservatively, I think EPS can grow 8% a year. It is unlikely to be less given the solid top line growth runway and how much room they have to cut cost, and everything I know of Google.

• 5 years from now EPS would be up 47%. But let’s say 1yr forward multiple (ex-cash) goes down to 17, that would be roughly an -18% hit. Combine EPS gain and multiple loss yields ~29% total return in 5yr, which would be about 5-5.5% CAGR. That is my worst case. 
• On the other hand I think the upside is double in 5yr or about 15% IRR. 
• Given the strong expected EPS growth, forward PE would have to drop to 12x at 2020 for me to lose money. 
• So I’m holding on to this. But maybe get smaller if price moves against me.

The exposures I listed above add up to almost 70% of my portfolio. I’m in the process of revisiting my entire investment approach and don’t expect to add new names. If the market crashes 30% tomorrow, the exposures I'm less sure about (roughly half of what I listed above) would be stopped out, leaving the real long term positions intact. 

Sizing up the Tankers - Supply and Demand in the Medium Term

“Reminiscences of a Stock Blogger” is one these blogs I regularly mine for ideas. The writer “Lsigurd” has an amazing track record of picking cyclicals upturns. Because he traffics in some of the crappiest companies out there, he not only covers the fundamentals, but also tends to be very opportunistic and flexible. This is what I imagine Michael Burry in his days would do. Anyways, after reading LSigurd’s idea on tankers here, I did some research into the sector and ended up buying Teekay Tankers (TNK), Frontline Ltd (FRO), and Capital Product Partners (CPLP).

Of the three, TNK is my biggest position. And I added more after the strong earnings today. Unlike some of its peers where earnings are mostly eaten up by depreciation charges, TNK actually has a solid earning, not just cash flows. Taking into account new ships and higher rates, Teekay can get ~$1 of EPS in 2015 and cash flows (before capex) of ~$1.5/ share. Those cash flows give TNK the option to pay a higher dividend and be valued on that basis. The stock is trading at $6.1/share. Put a modest 8-10x multiple on cash flows and I see 100%+ upside.

The Industry

Beyond TNK and consider the tankers industry as a whole, these are just about the most leveraged companies you can find. You got a cyclical industry, high fixed cost/operating leverage, and on top of that high financial leverage. Clearly, I want to make sure the industry is on the upswing. For that I tried to separate out short term vs. longer term factors, and then define my investment time frame – Is this a trade or an investment? Can I take a 2-3 year view? Or is this quarter to quarter?

The media tend to focus on the shorter term positives: lower bunker costs, China accelerate their ramping up of strategic crude oil reserves, and the “contango trade” – the use of tankers as storage, which limits the supply of ships and increase prices. These are all great bonuses but not necessarily sustainable beyond a couple quarters.

Intermediate/Longer Term dynamics – How Far to Look Out?

What’s more interesting to me are the intermediate/longer term supply and demand dynamics. On the supply side, these companies just went through years of depressed economics and capacity rationalization. For the next year or 2, fleet growth now look well under control at low single digits or even negative. I would not project earnings out more than 2 years, and even that might be a stretch. The industry is not known for supply constraints and firms can convert their other ships to tankers.

On the demand side, increases look to be structural:

1. Vast demand. China consumes roughly 11.1mm barrels per day (mmbd) of crude oil, and but produces only about 4.6mmbd. The rest have to be plugged by imports. Put this in context, the U.S. consumes ~19mmbd, with 1/4 the population. China’s crude oil demands have a long way to go.

2. Longer trade routes. Crude oil from Middle East and Africa are increasingly going to east Asia instead of say United State. The longer routes mean higher utilizations for tanker fleets. This is not just because U.S. is increasingly energy self-sufficient. Refineries capacities too have increased dramatically in East Asia the past few years. In China you actually have over-capacity of refineries. Those trade routes should be there to stay.

For me, what limits the time frame on the demand side is the threat of competition from other types of infrastructure. For example, a China-Myanmar oil pipeline just opened recently. Under this scheme (see maps below), tankers would arrive at Maday Island in the Bay of Bengal; oil would then travel via a pipeline through Myanmar into China. This would cut short tanker routes from the middle east, which currently travels through the Straits of Malacca and then northward along the coast of China. Another potential source of competition is China getting more oil from Russia through pipelines. I’m sure there are many other examples, but the point is for tanker demand I wouldn’t look out more than a couple years, as these things change.

Current Middle East to East Asia route

An example of a threat for tankers - The new Myanmar-China pipeline could cut that trip shorter

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Source

So yeah, from a fundamental perspective, I can only look at the tankers one year at a time. It’s simply not possible to get hold a long term, 5-10 year view on these things. This is why I hesitate to put more than an 8-10x multiple on cash flows. Also, given my lack of experience in this area - there will be days when stocks are down 5%, 7% without any news, and I will have to respect the market and cut my losses when necessary, and add on the upswing – a bit of a momo play. Definitely a trade, not an investment. Tankers are currently 6.5-7% of my portfolio.