Teekay Tankers: When Cheap Valuation and Strong Balance Sheet Are Not Enough (NYSE:TNK)

Note: We previously covered Teekay Tankers (NYSE: TNK). My 1Q24 article discussed Aframax/Suezmax market dynamics, the TNK fleet and the company’s financials.

I liked TNK’s clean balance sheet, sub 10% LTV, Aframax/Suezmax fleet and reasonable valuation at 89% PNAV. A disadvantage is the age of the fleet; TNK ships are 14.7 years. Dividend yields are not impressive compared to other tank owners. In short, TNK’s strengths offset its weaknesses, and the company has found a place in my portfolio.

The company’s stock price peaked at $73.8/share in May, but fell back to $52.1/share in the following months. This was due to seasonal weakness in daily rates. Anyway, TNK is no longer part of my portfolio. I believe that VLCC shipowners are a better proposition given the market fundamentals. In today’s article, I discuss 2Q24 results and TNK’s rating.

Introduction

Teekay Tankers has the best balance sheet in the tank game. The company currently has a 4% LTV. Minimum debt is great, but it comes with a price – an aging fleet. The average age of TNK’s fleet is 14.7 years, much higher than its competitors. Another disadvantage is the lack of scrubbers. None of the TNK ships have EGCS, a glorified name for scrubber, which stands for Exhaust Gas Cleaning System.

The company’s latest report is neither bad nor good. TNK reported earnings of $3.11 in 2Q24 versus $4.23 in 1Q24. On the other hand, operations and FCF increased by $17 million and $7.0 million QoT. Another positive change is the updates to the TNK fleet. The company sold two vessels built in 2005 and acquired one built in 2021.

The rear macrowinds further support the tanker’s thesis. However, not all tanks are equally attractive. The VLCC segment brings more growth potential than Suezmax and Aframax.

Fleet

The TNK fleet consists of 25 Suezmax and 17 Aframax tankers. In addition, the company owns 50% of VLCC Hong Kong Spirit. 96% of the fleet is employed through spot contracts.

The table below from the 2Q24 report shows TNK’s fleet status.

2Q24 fleet numbers: $44,758/d TCE, $8,523/d OPEX and $15,000/d cash flow.

Despite its aging fleet, TNK maintains competitive daily operating expenses. For comparison, NAT (an all-Suezmax company with an average fleet age of 12.7 years) reported OPEX of $9,000/day.

TNK excels at breakeven cash flow, $15,000/day is significantly lower than most companies in the crude oil segment. Frontline Plc ( FRO ) reported cash flow of $25,700/d in 2Q24 and DHT Holdings ( DHT ) $23,600/d. The reason for this stark contrast is TNK’s balance sheet. The company has 3.8% total debt/equity and 4% LTV. For reference, DHT has 21% LTV and FRO 48% LTV.

TNK also operates charted vessels. I am not a big proponent of chartering additional vessels, especially in a market with not very good fundamentals such as the Suezmax and Aframax segment. In my opinion, hiring additional vessels works best in markets with apparent shortages such as the VLCC or Capesize segments. In these cases, chartered vessels add additional leverage.

The company has seven Aframax/LR2 tankers on lease and one Suezmax. Aframax pots have a dual purpose. They can carry clean and dirty oil cargo, which means they follow different market dynamics compared to VLCCs and Suezmaxes.

TNK sold two tankers built in 2005, one Aframax and one Suezmax, for $64.8 million in gross proceeds. The vessels are expected to be delivered to the buyer in 3Q24. TNK reported a realized gain of $27 million from both sales. In June 2024, TNK agreed to purchase an Aframax vessel built in 2021 for $70.5 million.

In short, TNK’s fleet is competitive considering daily OPEX and cash flow without breaking even. Additionally, a fleet upgrade is a step in the right direction.

TNK Report 4Q23

The following table shows the 2Q24 results.

In 2Q24, TNK reported revenue of $296 million, down 12% from 1Q24. Vessel operating and charter expenses remained almost unchanged. In 2Q24, TNK achieved operating income of $102 million, compared to $127 million in 1Q24. EPS was disappointing. 2Q24 EPS is $3.11/share vs. $4.23/share in 1Q24.

Now the good news. TNK reported quarterly growth in operating and free cash flows. For 2Q24, the company generated $146 million in operating cash flow and $136 million in FCF.

Below is a quote from the 2Q24 presentation about the company’s FCF generation abilities:

As a reminder, for every $5,000 increase in tanker rates above our free cash flow breakeven point of $15,000 per day, we expect to generate approximately $2.36 of free cash flow per share.

TNK reported $426 million in cash and $287 million in the undrawn credit facility. The company has total debt of $63.7 million, so interest expense is almost non-existent, resulting in net interest income of $4.7 million for T224.

Impressive numbers. The question is what the company will do with the spare firepower. It has a few options: raise dividends, start buybacks, renew its fleet or do nothing. With TNK stock trading below 100% PNAV, I’d like to see proactive share buybacks.

Fleet upgrades are another viable option for capital allocation. At that point in the tank cycle, buying a few years old ship delivered in a few weeks/months is better than buying a brand new one with an estimated delivery in 12-18 months. The used tanker will immediately start generating cash flow, plus inflation will work its magic, increasing the company’s NAV. Otherwise, the shipowner must commit massive upfront payments to a shipyard in the hope that when the ship is delivered, the market will be strong.

TNK pays dividends with an LTM yield of 5.52%, which is mediocre compared to other tank owners. For 2Q24, the dividend payout is $0.25/share, resulting in an LTM payout ratio of 15%.

As pointed out, TNK generates massive FCF and maintains an impressive balance sheet. So increasing dividends or starting a share buyback program would attract more investors. I would focus on share buybacks. In this way, the company increases the dividend yield by simply reducing the number of shares outstanding. More fleet upgrades would be nice.

TNK assessment

To estimate TNK NAV, I use data from Fearnley’s weekly reports. The inputs to the NAV equation are:

• Fleet replacement value: $1,628 million
• Current assets: $689 million
• Total Debt: $184 million
• Total debt: $63.7 million

TNK’s market capitalization is $1,890 million, while its net asset value is $2,133 million. TNK therefore trades at 89% P/NAV.

TNK is the bottom fish among large-capacity tanker stocks. It is even cheaper than Tsakos (TEN). To be precise, TEN is not an oil company only. It owns 98 vessels, including crude oil and product tankers, bulk carriers, containers and LNG carriers.

TNK is trading at 1.9 EV/Sales and 2.9 EV/EBITDA, which is very cheap for a company with a 4% LTV and $15,000/day cash flow. However, TNK has an old fleet and pays dividends with a mediocre yield.

TNK’s strengths already have prices. For stock re-rating, we need to see an improved shareholder return policy and more fleet improvements. If this becomes a fact, TNK stock could reach DHT multiples of 4.6 EV/Sales and 5.9 EV/EBITDA. This means 100% growth potential.

Small multiples are not enough to stay invested. ECO and DHT already offer everything I need: top class fleets, attractive dividends and exposure to VLCCs. Moreover, given PNAV, TNK is not really cheaper than DHT. The latter trades at 94% PNAV. Meanwhile, ECO trades at higher PNAV and EV multiples, but brings more value for the price paid.

Investors to the package

I still like TNK. The company has been deleveraging over the past few quarters, has started to modernize its fleet and is trading at low single-digit electric vehicle multiples. However, this is not enough.

Every company has advantages and disadvantages, and TNK is no exception. Its unattractive dividend yield compared to other tanker operators is a main reason for me to change my mind. Furthermore, I see more growth potential in the VLCC segment than Suezmax and Aframax. This means that investing in TNK comes with the opportunity cost of not investing in VLCC-focused shipowners.

As investors, we must consider the risk-reward cost and opportunity cost of each trade. The opportunity cost of TNK outweighs the risk-reward, so I prefer to park my cash with ECO and DHT. In conclusion, I give TNK a Hold rating.