$15.28 at the time of my article in mid November 2019 where I suggested this tanker stock stood a good chance of outperforming. Now, almost one year later, the price is $6.38 – a 58% decline.
So what the hell happened?
Three record quarters of fantastic earnings in a row for the tanker industry has rewarded shareholders with share prices that are more or less cut in half. Whether it is the ESG focus leading to investor flight or whether the market is accurately evaluating a high likelyhood of a multi-year prolonged downturn currently no one can say for sure. But the fact remains that almost all tanker companies have much stronger balance sheets compared to a couple of years ago so most ought to come out of the current low rate environment intact. How long it takes depends mainly on when oil inventories have been drawn down to more balanced levels.
According to Vessels Value, the valuation firm which is regarded as the go to shop in the industry, tanker vessel values have fallen 15-20% since the peak at the end of April and are still declining as of last week. At some point, and I suspect that moment can’t be too far off, values will stop falling and then the market might look at valuations and say, hey wait a minute, we threw the baby out with the bath water, this is nuts. But that is a subject for another article. Here I will look at the relative performance vs other tanker companies, which is usually my main focus, rather than the macro, which has many more factors of uncertainty. Getting the macro wrong is much more acceptable in my world than getting the micro wrong.
DSSI underperformance vs peers
And the fact remains that Diamond S has underperformed most peers, except Scorpio Tankers and Ardmore Shipping.
So what did I get wrong and what can be learned?
My current view is that I had a far too optimistic view of management based on history and significant share ownership.
Navigate around NAV
For one, the shares have traded at much larger discounts to net asset value than all other comparable peers and management could easily have taken steps to take advantage of that gap via share repurchases, which, when you trade a big discounts, increase the value per share. The steeper the discount, the more accretive it is to repurchase. This could in turn have led to a narrowing of the gap and the shares trading more reasonably over time.
A lot of talk and no action
Mangement talked about this constantly in conference calls and on panel discussion, even after the great contango trade had evaporated in May, but never did anything and now it is too late because they don’t have the earnings that will allow them to do so. Covenants state that only 50% of earnings from the prior quarter can be allocated towards repurchases/dividends and now that window has been closed for many quarters to come.
With vessel values falling hard that can now appear as a prudent action on their part conserving cash for this difficult period BUT they have always had the opportunity to sell a few of their vessels to secure a stronger balance sheet for tougher times ahead. They did not do that when times were great and they still haven’t done so. In my opinion this comes close to being abuse of us, the owners. It was such an easy course of action to take not requiring any brains at all. Currently the shares are trading at 65% discount to net asset value = P/NAV 0.35.
Bad luck on the operational front?
But that is not all. On the operational front they have drawn the shorter end of the stick quarter after quarter. My view of commodity driven businesses is that operational performance is not what you should be focusing on. This tends to converge over time. All ship owners pride themselves as being better than the next guy on that front but the reality is often there is very little difference. Bad luck in one quarter is usually evened out by good luck in another, or close to it.
But having followed them closely for four quarters now the extent of their bad luck is astounding. And this to an extent that I am no longer willing to ascribe only to bad luck. And perhaps I should have been a lot quicker coming to that assessment.
A few examples:
In Q4 two of their Suezmaxes were to have scrubbers installed (this is air pollution control devices) and they were supposed to arrive at the yard 30 days apart for maximum efficiency. Instead they arrived almost on the same day which meant unnecessary waaiting time. Could that happen easily or was it due to incompetence? I don’t know the answer to that but it is not something that I have heard in earnings calls from other companies so that was a clear warning sign.
In the first half of the year they missed out on super earnings for a few of their Suezmaxes due to being taken advantage of by charterers who had negotiated low demurage rates which meant that these vessels were sitting ducks with a lot of oil and nowhere to go when rates were great. Was this again simply bad luck? It might have been by why were other ship owners again more lucky on this front?
And in general they seemed to have missed out on more super trips in the March/April period than other tanker owners as well as having secured fewer now valuable longer time charters.
Their MR product tankers have been underperforming all along. Their ice class vessels consume more fuel but this is taken into consideration in the vessel valuations so putting them in the penalty box for that would be akin to double counting so no critique from me on that. However, given the Suezmax mishaps I am pleased they have decided to leave this side of the business to Danish ship management company Norden who have a strong and long lasting reputation. I hope they will do the same with the Suezmaxes.
Too cheap despite poor execution?
Having said all of the above I still regard the stock as too attractive to dump as I think there are still too many good outcomes relative to the share price but on the other hand until something changes such as vessel values rising again, or if they start selling some of their vessels, or if something good happens on the vaccine front, I’m not eager to have a big position either because the balance sheet is more strained than I would prefer in this uncertain environment with financial leverage around 45% currently. This is lower than most peers but I would still perfer a bit more safety.
For that reason I prefer a stock like International Seaways with a safer balance sheet (32% leverage), fine management excecution these past twelve months and at $14.15 an attractively priced share (50% discount to NAV) for bigger allocations even though it isn’t as dirt cheap as Diamond S. I might elaborate a bit more on this stock in a future article.
It is noteworthy that there are tanker stocks that are much more highly leveraged and dangerous in a prolonged downturn. Scorpio Tankers is close to 70% and Ardmore Shipping 60%. If values don’t improve soon those may have to dilute shareholders via equity raises and I find that scenario much less likely with Diamond S (and practically impossible for INSW and EURN).
For those following the space: Am I being overly harsh here and were the odds truly less favorable than what I thought back on November 20th? Did I miss something obvious? Also, have they truly been unlucky and was their decision to not go for share repurchases a wise decision?