International Seaways Q2 2024 Earnings: Seasonality At Play, Mixed Outlook Ahead (INSW)

Recap

Our bull thesis for International Seaways, Inc. (NYSE:INSW) is as follows:

• European Union (“EU”) sanctions against Russia and the Red Sea crisis have significantly increased the ton-mile demand, driving earnings and utilization rates.
• Fewer capacity following the global financial crisis and high newbuilding and secondhand prices resulted in few vessels entering the market.
• With the global fleet ageing and tight market supply, resulting in elevated earnings, we expect INSW to generate massive free cash flow.
• Shares were trading at a discount to NAV. Potential risks to our call are conflict resolutions which would put pressure on earnings and increase the order book.

Since our latest publication, the stock price has increased to $66 per share (+28%) before returning to $51 per share. We believe this was primarily due to 1) seasonality, 2) uncertainty on OPEC+ production cuts phase-out, 3) increasing domestic crude supply requirement for Nigerian refineries, and 4) the TMX putting pressure on demand for VLCCs.

This article will discuss the 2Q24 earnings results and whether our thesis is still playing out.

2Q24 Earnings: A Slight Dip in Earnings and Pull-Forward Off-hire Days

Please find the 2Q24 earnings summary below:

Time charter equivalent (“TCE”) revenue declined 7% sequentially and 13% (Y/Y). On a quarter-on-quarter basis, TCE revenue was primarily dragged down by the product tanker segment (-11% Q/Q; -6% Y/Y) thanks to lower LR1 and MR earnings and fewer operating days. On a year-on-year basis, however, the crude segment was the main culprit.

INSW incurred 559 off-hire days, 200 days longer than previously anticipated. Management said that of those 200 incremental days, 100 days were pulled forward from the third quarter. Another 100 days of unanticipated off-hire days, however, came from repair work (60 days) and fleet positioning on the US West Coast (40 days). Full-year off-hire days are expected to increase by 121 days from what was originally planned.

Adjusted EBITDA came in at $167 million, declining by 13% sequentially and 19% (Y/Y), with increasing vessel expenses and depreciation & amortization expenses. Free cash flow, after deducted by share-based compensation expenses, was recorded at $152 million, which marks a 28% (Q/Q) increase, implying a massive 91% free cash flow conversion (as a percentage of adjusted EBITDA).

This increase is mainly attributable to the removal of a $20 million quarterly mandatory prepayment, as INSW converted its term loan into a revolving facility in 1Q24. This allows INSW to reduce its cash break-even levels to $13,340 per day, nearly $2,500 per day lower than the previous year.

During the quarter, INSW sold two 2008 and 2009-built MRs and another 2008-built MR in July for a total net proceeds of $72 million. These nearly 16-year-old vessels were replaced by six 2014 and 2015-built MRs, reducing the overall MR average age by one year. As of June 2024, INSW ended the quarter with $537 million in net debt, representing 14% of the fleet’s market value. 78% of debt is fixed with no maturity in sight, as the earliest maturity is in January 2030. Additionally, management announced a quarterly dividend of $1.5 per share, which includes a $0.12 per share of regular dividend and a $1.38 per share of supplemental dividend. This implies a 12% annualized yield over the current share price.

Overall, we think the 2Q24 earnings results were mixed in that a decline in spot earnings and fewer operating days resulted in lower revenues. However, we like INSW’s ability to generate more free cash flow thanks to its term loan conversion, which resulted in a lowered cash break-even level. Additionally, we anticipate fewer off-hire days in the third quarter as a result of pull-forward dry docking days.

Mixed Outlook Ahead

As usual, INSW reported its booked-to-date spot earnings for each of the tanker classes. While most crude and product tanker spot earnings (excluding Aframaxes) only had a slight downtick, VLCC spot rates in the third quarter, however, declined by 31% from the second quarter from $46,400 per day to $32,100 per day.

Management said that seasonality for tankers is at play. Planned refinery maintenance typically starts in the third quarter as demand for travel wanes. However, the VLCC segment is struggling in that, besides not benefiting from the ton-mile demand increase as greatly as Suezmaxes and Aframaxes following geopolitical conflicts, uncertainty about OPEC+ production cuts phase-out also puts pressure on rates, as a VLCC typically carries crude production from the Middle East Gulf to Asia.

Additionally, China’s falling oil demand added some weight to the crude tanker market. As Reuters reported, China’s oil imports as of the first seven months of 2024 were down by 320,000 barrels per day compared to the previous year. The faster-than-anticipated transition from older Internal Combustion Engine (“ICE”) vehicles to the so-called New Energy Vehicles (“NEVs”) has provided support to the notion that the structural decline in crude demand is pretty much underway. Meanwhile, oil demand growth shifting from China to India will likely benefit Aframaxes and Suezmaxes, rather than VLCCs, per Poten.

In addition, the 590,000 barrels per day incremental oil output from the Trans Mountain Pipeline Expansion (“TMX”) attracted refiners in Asia. About two-thirds of the incremental barrels went to the Asian market, while refineries on the US West Coast received the remaining delta. However, Drewry suggests that this development will negatively impact demand for VLCCs since Canadian heavy crude oil will replace imports from Latin America and the Middle East. Recently, a portion of Vancouver crude exports to Asia was carried by VLCCs, transferred from Aframaxes at the Pacific Area Lightering zone, Argus noted. Things could change, however, once the VLCC market picks up.

Further, the Nigerian National Petroleum Company (“NNPC”) is struggling to fulfill the Dangote refinery crude requirement, leading the refiner to import crude from the US. Yet, the Dangote refinery is taking less crude oil from the US and more domestically (from less than 75% to 81%, per Bloomberg). In addition, Nigerian refineries raised their domestic crude requirement from 483,000 barrels per day to 597,700 barrels per day. This should put pressure on crude tankers: over two-thirds of Nigerian crude exports were carried by Suezmaxes, and to a smaller extent, by VLCCs.

Consequently, the discrepancy between crude and product tanker rates has prompted shipowners to “clean” their “dirty” tankers. Vortexa estimated 25 Suezmaxes and two VLCCs were trading clean, with more crude tankers estimated to follow soon.

On the other hand, the continued Red Sea crisis has maintained the ton-mile demand for product tankers at elevated levels, despite seasonality. Adding to the fuel was increased demand for Aframaxes to carry crude from the Trans Mountain oil pipeline. Drewry estimates an additional annual demand for 32-36 Aframaxes with about 40 days of round voyages. We think this development could render some Aframaxes from trading clean to trading dirty. Moreover, Far East countries have been importing Naphtha from the Dangote Refinery, increasing the ton-mile demand since the route takes longer than the Persian Gulf to Far East route.

However, the Dangote refinery started exporting gasoil to West Africa, thus reducing imports from Europe. Once the refinery ramps up its refined fuel production, it will fulfill the entire refined fuel requirement in Nigeria and leave the remaining output to be exported to European and Latin American countries. This will also reduce imports from Europe, reducing the ton-mile demand and accelerating the closure of European refineries.

Overall, we positively view the tanker market in the near term as the seasonality impact will typically wind down in the fourth quarter. Further, OPEC+ phasing out the 2.2 million barrels per day cuts should drive demand for VLCCs, although crude tankers generally travel at shorter distances than tankers from the Americas (mainly the US, Guyana, and Brazil) to Asian refineries. Nigerian refineries getting more crude domestically, however, should result in lower imports from Europe. In addition, the Dangote refinery’s production ramp-up could decrease the ton-mile demand.

Increasing Order Book Offset By Ageing Fleet

Robust earnings expectations and the need to replace older tankers prompted shipowners to contract newbuilds. According to Xclusiv Shipbrokers, the combined crude and product tanker order book increased from 4.4% in August 2022 to 12.9% in August 2024, with the Aframax/LR2 order book leading the pack. Meanwhile, the VLCC order book remains low compared to the historic averages, with deliveries extended to three years compared to the typical two years. Year-to-date, the entire newbuilds were only 7% lower than the number in 2023.

The significant contracting activity, however, is partly offset by the ageing global fleet. Riviera Martine reported the 2024 average age is one year older than the 2023 average, implying a limited new supply and minimal scrapping activity. As a result, tankers aged 20-year or older increased by 70% in just two years. Scorpio Tankers Inc.’s (STNG) earnings deck also shows that the current product fleet is, on average, five years older than the fleet in the 2014-2016 period, despite similar order book levels. While supply influx is on the cards next year, older vessels typically yield lower earnings and utilization, despite little to no scrapping activity.

As management said on the 2Q24 earnings call:

However, ships on order, as we show at the bottom left-hand of the page, are not enough to replace a fleet that is aging significantly. The average age of the tanker fleet today is over 13 years old and is likely to get older with so few newbuilding deliveries. Generally, older ships have less efficiency and less utilization.

Ben, another point is the older vessel system has a lower utilization in and of itself because of their age. So while it’s not scrapping older vessels or has less utilization. So the fleet shrinks naturally.

All in all, we believe the ageing fleet will help offset future fleet growth. While the prospect of lower earnings does not seem to be completely out of reach due to risks possibly lowering the ton-mile demand and supply influx, INSW has been lowering its cash break-even levels from $16,500 per day in 2Q22 to $13,300 per day in 2Q24. This implies that a vessel is still generating $25,000 per day in cash flow, despite “softer” spot earnings (blended average spot TCE of $37,300 per day in 3Q24).

Valuation

Shares traded at a discount relative to NAV, with an 18% Adjusted FCF yield and a 12% annualized dividend yield. We utilized Charles Weber’s present value estimates, adjusted by age, to arrive at the estimated fleet value. We think the re-rating catalysts are diminishing seasonality impact that will drive tanker spot earnings and OPEC+ production cuts phase-out that should drive demand for VLCCs.

Conclusion

The 2Q24 earnings results were relatively mixed due to lower spot earnings and fewer operating days. Yet, the company generated more free cash flow as it converted its term loan into a revolving facility. Declining spot earnings were because of 1) seasonality, 2) uncertainty about OPEC+ production cuts phase-out, and 3) increasing domestic supply requirements in Nigeria, and 4) the TMX putting pressure on demand for VLCCs. We should witness a seasonal recovery in the fourth quarter.

Nevertheless, we anticipate a negative impact on the ton-mile demand for tankers due to lower exports and imports in Nigeria. Moreover, supply influx is on the cards next year, given the increasing order book. Yet, the older global fleet will help offset future fleet growth.

Shares traded at 0.7x NAV with an 18% Adjusted FCF yield and a 12% annualized dividend yield. We like INSW’s lower cash break-even levels that propel its cash-generating ability, and the ability to withstand weak market fundamentals. Re-rating catalysts include seasonality impact winding down and OPEC+ production cuts phase-out that would drive demand for VLCCs. Maintain BUY. If you have any questions, please do not hesitate to comment below.