The Tanker Trade: COVID-19 + Floating Storage

The tanker trade was a very popular thematic trade in spring 2020 which led to immense trading volumes; one stock in particular: Nordic American Tankers (NYSE:NAT) enjoyed an all-time record daily volume. This ‘tanker/contango’ or ‘floating storage trade’ lasted from March 2020 to May 2020 and developed due to a COVID-19-related collapse in global oil demand in early-2020, combined with an initial Saudi ‘Oil Price War’ initiated on 8 March. I flagged this trade on Value Investor’s Edge that weekend in March, and I brought the thesis public on Seeking Alpha on Friday, 13 March.

Crude tanker stocks performed wonderfully from mid-March to end-April, but trading momentum fizzled as the enormous oil contango evaporated, and OPEC+ did an exceptional job of holding to their unprecedented export cuts. Additionally, the global economy (with the notable exception of air travel and related jet fuel demand) opened up fairly rapidly, which helped oil markets balance. We therefore had a neat boom-and-bust trading cycle over the course of three months (March-May). We then had four months of residual ‘hangover’ from June-September.

Trend Analysis & ‘Popularity’ Reflection

During the brief time period from mid-March through early-June, there was more interest in shipping trades than at any point I can recall in recent history. The only thing close was last October-November during COSCO sanctions, and if we utilize Google trends for “oil tankers” and “contango”, we can see the interest levels clearly pop out. First, “oil tankers” rose up in fall 2019, but then a massive spike in “contango” interests fueled a much longer-running trend in “oil tankers” during April and May.

Interestingly enough, “contango” peaked 19-25 April and then dropped off while “oil tankers” peaked 19 April to 2 May and then dropped off. Both these drops marked the end of the trade (i.e. stock peaks) almost perfectly. It would seem you could use Google trends to exit the trade, but not really to enter it as the trends didn’t do much from 8 March to 18 April despite stocks soaring.

Source: Google Trends, “contango” vs. “oil tankers”

This review focuses on crude tanker stocks and the importance of dividends because there is a massive performance variant between a basket of names, which can only be clearly explained by dividends, as fundamentals and corporate governance ratings didn’t seem to impact March-September results. I choose 9 March open as the starting point since that was the first public trading opportunity after the Saudis initiated their strategy, and the trade thesis was identified. This was when the idea was still nascent and well before the ‘floating storage’ trade surged in popularity/attention during April. I’ve marked 30 September as the end since that’s close to publishing and also neatly concludes Q3-20.

Entering the Trade – 8 March Call (9 March first Open)

On Value Investor’s Edge, in response to the weekend news of a Saudi-initiated ‘Oil Price War,’ I posted the following update as part of our weekly market review:

Source: Value Investor’s Edge, Weekly Report: 9 March 2020

Trade Performance vs. Medium-Term Total Returns

As I’ll illustrate below, the tanker trade was exceptional at first. The average total return from 9 March open to 30 April close was +39.0%, and the median total return was +33.0%, which of course completely blew apart the broad market returns (-6.1% to +1.7%).

This solidifies the ‘trade’ as solid, but the longer-term allocation was disappointing and can be classified as a failure in the medium term. For raw median performance (as we break down further below), the trade (March-April/May) would have produced a 33% median return and a 35.2% market outperformance, while the medium-term allocation (March-Sept.) delivered an 8.1% median loss and a 20.8% market underperformance.

In a trade, it is important to identify both the entry points and the exit points. Traders should use various mechanisms to generate profits and/or control risk, but in terms of research providers or market pundits, there needs to be clear signals. At Value Investor’s Edge, we got the entry entirely correct, but I did not make meaningful sell/exit signals due to a focus on long-term value.

Long-term value (much less energy-related) has been a horrendous place to be in 2020, and we suffered via this positioning.

Who Called the ‘Exit’ Correctly and the Loudest?

Who did call it correctly? In terms of analysts, I must give a big congrats to Jon Chappell at Evercore who made an excellent pivot call about two-thirds through the run-up, and he loudly reiterated it right at the peaks. He downgraded several firms right around their highs and clearly identified the sentiment drivers.

Source: TradeWinds News, 4 May 2020

Chappell wasn’t too strong on tankers throughout much of the cycle, but he completely nailed the thematic nature of the equities… In an earlier 8 April 2020 interview, Chappell noted:

However, as we’ve learned several times in the last two decades, sentiment can be a stronger force than fundamentals in shipping shares. Thus, if the market believes that Opec+ is taking the appropriate steps and that demand will snap back post global shutdowns, resulting in a narrowing of the contango and line of sight to a shift back toward backwardation, then the tanker trade is effectively over.

Whether Jon marked the trade ‘over’ in early-April or at the start of May is debatable, but either way, he was totally correct on the drivers and the general exit point/strategy!

It is also worth noting that George Noble, a current hedge fund trader and former Fidelity star alongside Peter Lynch, was also loudly outspoken about the trade running out. George focused almost exclusively on the global land storage capacity to argue floating storage levels and durations would disappoint. Kudos to George for nailing the inverse/unwinding on this trade. Here is one such tweet during May (100s of similar notes from early/mid-May through June).

Source: Twitter Feed, @Gnoble79

Do Dividends Matter?

Now that we’ve recapped the broad trade, let’s return to another very interesting finding from this case study: dividends are a major distorting factor for stock valuations and total returns.

If we subscribe to the belief that stock prices are an efficient reflection of discounted long-term free cash flows, then the current dividend yield or dividend payout policy of a company shouldn’t have a meaningful impact on equity valuations, short-term trading strength, nor long-term returns. Of course, most investor or traders with meaningful market experience will attest that dividends do indeed matter. However, it is not just the mere presence or immediate size of dividends, but rather a coherent payout strategy and consistency of income which are better long-term drivers.

To illustrate the difference, we’ll take a quick aside to review MLPs.

MLP Cycle Review: Dividend Strategy > Dividend Yield

The entire MLP cycle was originally driven by the fact that assets with high payouts ‘magically’ commanded wildly higher multiples from yield-starved income investors. Once the cycle began to implode in 2015-2016 and distributions were slashed left-and-right, suddenly, the market demanded significantly higher yields and valuations plummeted. Of course, this meant these firms could no longer grow accretively by raising new equity, which required even further cuts to shift to a self-funding model. Add too-high leverage into the mix and we have ingredients for the toxic/vicious cycle witnessed from 2015-2020 in which nearly every MLP has done a mixture of “simplification,” via IDR deals, privatization, restructuring, or asset sales.

Nearly every MLP has slashed their distributions with notably few exceptions of which a few notable constituents include Cheniere Energy Partners (NYSEMKT:CQP), Hoegh LNG Partners (NYSE:HMLP), MPLX (NYSE:MPLX), KNOT Offshore Partners (NYSE:KNOP), Phillips 66 Partners (NYSE:PSXP), and Shell Midstream (NYSE:SHLX). HMLP and KNOP have flat-lined their payouts leaving just CQP, MPLX, PSXP, and SHLX as successful (thus far) income growers. That is four relative ‘successes’ out of an original universe of more than 50 MLP/LP vehicles. Over the past two years, the S&P 500 index has returned 14%, while the Alerian MLP ETF (NYSEARCA:AMLP) is off by around 50% adjusted for dividends.

Source: Yahoo Finance, AMLP vs. GSPC, 2y Chart

Claim: Dividend Policy and Follow-Through Matter!

The quick review of MLPs as an asset class clearly shows how poor strategy and repeated cuts can decimate a sector. Higher leverage and the waning appetite for energy-related names in an ESG-driven investment world has only accelerated these trends.

Now, we will turn back to crude tankers to illustrate this impact.

The Tanker Stock Candidates: 9 March 2020

For this review, I am including all product and crude tanker US-listed names with a market capitalization of $50M or higher. The list is included below with historic pricing (9 March open), sorted by dividend yield/policy:

  • Navios Maritime Acquisition (NNA): $3.92 (30.6% Yield, Fixed)
  • DHT Holdings (DHT): $5.65 (22.6% Yield, Variable – 60% EPS)
  • Frontline (FRO): $7.33 (21.8% Yield, Variable – By Discretion)
  • Nordic American (NAT): $2.80 (10.1% Yield, Variable- By Discretion)
  • Euronav (EURN): $9.16 (Variable – 80% EPS)
  • TORM Plc (TRMD): $7.30 (Variable – By Discretion)
  • Tsakos Energy Navigation (TNP): $10.80 (4.6% Yield, Fixed)
  • Scorpio Tankers (STNG): $16.50 (2.4% Yield, Fixed)
  • International Seaways (INSW): $18.99 (1.3% Yield, Fixed)
  • Ardmore Shipping (ASC): $4.79 (No Dividend)
  • Diamond S (DSSI): $10.60 (No Dividend)
  • Teekay Tankers (TNK): $14.27 (No Dividend)

This basket of all names would include a list of 12 tanker stocks.

Assigning Baskets for Portfolios

If an investor bought based purely on fundamental ‘cheapness’, then the top six basket would be as such:

Value Basket: ASC, DSSI, INSW, STNG, TNP, and TNK.

Based on the top-half of corporate governance:

Governance Basket: ASC, DHT, EURN, FRO, INSW, and TRMD.

Focusing on the largest market capitalization:

Capitalization/Float Basket: DHT, EURN, FRO, INSW, STNG, TNK.

If, however, choosing directly on yields either fixed or expecting large profits and applying those to variable policies, then we’d have the following:

Dividend Paying/Promising Basket: NNA, DHT, FRO, NAT, EURN, TRMD.

In the following review, I’ll list all current prices + received dividends between 9 March and 30 September. Companies will be sorted based on returns, and we’ll also assign basket performance with both the average and the median for the six-stock baskets of fundamentals, governance, market capitalization, and dividends.

If dividends indeed play the largest role, then that basket should outperform. If dividends are a lesser role, then all 3 of the other Baskets should have more explanatory power. I’ve deliberately chosen Baskets of 6 (i.e. one half vs. the other half) to reduce the potential impact from outliers, presenting the median performance of each basket further reduces outlier impacts.

Finally, I list how many ‘baskets’ each name fit into to see if a ‘sum of all factors’ approach had any predictive power for this case:

  • DHT Holdings (DHT): 3 Baskets (Gov, Mcap, Yield)
  • Euronav (EURN): 3 Baskets (Gov, Mcap, Yield)
  • Frontline (FRO): 3 Baskets (Gov, Mcap, Yield)
  • International Seaways (INSW): 3 Baskets (Gov, Mcap, Value)
  • Ardmore Shipping (ASC): 2 Baskets (Gov, Value)
  • Scorpio Tankers (STNG): 2 Baskets (Mcap, Value)
  • Teekay Tankers (TNK): 2 Baskets (Mcap, Value)
  • Diamond S (DSSI): 1 Basket (Cheap)
  • Navios Maritime Acquisition (NNA): 1 Basket (Yield)
  • Nordic American (NAT): 1 Basket (Yield)
  • TORM Plc (TRMD): 1 Basket (Gov)
  • Tsakos Energy Navigation (TNP): 0 Baskets

Total Return Results for Individual Stocks

The following breakdown illustrates how each stock performed from 9 March to 30 September, inclusive of dividends received (marked as such). For a reference to broad market indicators, the S&P 500 and the Russell 2000 returned +17.4% and +8.0% over the same timeframe.

The 12 stocks are listed in order of total return:

  • Nordic American Tankers: +36.8% ($2.80 to $3.49 + $0.34 dividends)
  • Navios Maritime Acquisition: +25.5% ($3.92 to $4.23 + $0.60 dividends)
  • Euronav: +13.5% ($9.16 to $8.83 + $1.57 dividends)
  • Frontline: +10.5% ($7.33 to $6.50 + $1.60 dividends)
  • TORM Plc: +6.4% ($7.30 to $6.82 + $0.95 dividends)
  • DHT Holdings: +6.0% ($5.65 to $5.16 + $0.83 dividends)
  • International Seaways: -22.1% ($18.99 to $14.61 + $0.18 dividends)
  • Tsakos Energy Navigation: -23.2% ($10.80 to $7.92 + $0.375 dividend)
  • Teekay Tankers: -24.0% ($14.27 to $10.84)
  • Ardmore Shipping: -25.7% ($4.79 to $3.56)
  • Scorpio Tankers: -31.7% ($16.50 to $11.07 + $0.20 dividends)
  • Diamond S: -35.2% ($10.60 to $6.87)

The average total return from 9 March open to 30 September close was -5.3%, and the median total return was -8.1%. As we covered in the introduction, this means the medium-term allocation to this theme/trade has been disappointing and can objectively be deemed a failure.

‘Tanker Trade’ Performance Near the Peak?

The ‘tanker trade’ started as an oil price war thesis (huge demand surge from exports, coupled with limited available supply and constrained ports) in early-March and shifted into a more popular ‘floating storage trade’ into April. The floating storage trade was based on the idea that a collapse in demand would lead to a surge in the demand for on-the-water storage as available land storage capacity filled up and port terminals were jammed up.

This trade was also supported by a massive contango in both the Brent and WTI curves, which enabled traders to generate a risk-free profit by buying front-market oil and selling future market oil contracts while hiring tankers to store the cargo in the interim. The logic was sound initially, but OPEC+ agreed on an unprecedented level of cuts, and simultaneously, the lockdowns in the developed world were much shorter lasting. The peak of this trade from the oil side of the business was when we saw negative prices in the WTI quotes and VLCC tanker spot quotes were over $200k/day, while large product tanker (LR2) rates later surged to over $100k/day. When the contango evaporated in May, the trade was essentially ‘over/toasted’, and tankers reverted to a pure value proposition.

The value proposition is better than ever, and these firms have generated over 3 years‘ worth of cash flow in just 3 quarters, but both value stocks and energy-related stocks have been obliterated in this market, so unsurprisingly, tanker stocks haven’t performed well (i.e. -5.3% average return versus the market comp median at +12.7%). The below summary shows a trader’s performance between 9 March open and 30 April 2020.

30 April is selected as it neatly wraps the end of a month and also corresponds closely to ‘peak trade popularity’ of this theme: the last week of April.

For a reference to broad market indicators, the S&P 500 and the Russell 2000 returned +1.7% and -6.1% over the same timeframe (9 March to 30 April).

  • Nordic American Tankers: +115% ($2.80 to $6.02)
  • Tsakos Energy Navigation: +59.7% ($10.80 to $17.25)
  • Teekay Tankers: +42.3% ($14.27 to $20.31)
  • Navios Maritime Acquisition: +39.5% ($3.92 to $5.47)
  • Ardmore Shipping: +37.4% ($4.79 to $6.58)
  • Frontline: +33.2% ($7.33 to $9.36 + $0.40 dividend)
  • Scorpio Tankers: +32.7% ($16.50 to $21.89)
  • DHT Holdings: +28.5% ($5.65 to $7.26)
  • International Seaways: +27.8% ($18.99 to $24.20 + $0.06 dividend)
  • TORM Plc: +17.8% ($7.30 to $8.50 + $0.10 dividend)
  • Diamond S: +17.1% ($10.60 to $12.41)
  • Euronav: +16.7% ($9.16 to $10.69)

The average total return from 9 March open to 30 April close was +39.0%, and the median total return was +33.0%, which, of course, completely blew apart the broad market returns (-6.1% to +1.7%, median loss of 2.2%).

This solidifies the ‘trade’ as solid (or even “amazing”), but the medium-term allocation as disappointing/failure. In terms of raw median performance, the trade would have produced a 33% median return and a 35.2% market outperformance, while the medium-term allocation delivered an 8.1% median loss and a 20.8% market underperformance.

Return by Baskets

Now, let us shift to the basket approach. We will use baskets to compare both the peak trade performance as well as the medium-term total returns. Finally, we’ll take a ‘total factor’ approach to see if that would have helped.

Value Basket: ASC, DSSI, INSW, STNG, TNP, and TNK.

  • Peak Trade: +36.2%
  • Medium-Term: -27.0%

Governance Basket: ASC, DHT, EURN, FRO, INSW, and TRMD.

  • Peak Trade: +26.8%
  • Medium-Term: -8.8%

Capitalization/Float Basket: DHT, EURN, FRO, INSW, STNG, TNK.

  • Peak Trade: +30.2%
  • Medium-Term: -8.0%

Dividend Paying/Promising Basket: NNA, DHT, FRO, NAT, EURN, TRMD.

  • Peak Trade: +41.8%
  • Medium-Term: +16.5%

Interestingly enough, the factor which mattered the most both for short-term results and medium-term strength was higher dividend payment policies. Valuations were the second most important factor during the trade, but generated, by far, the worst result over the medium term.

The fact that the most attractively valued and fundamentally solid firms wildly underperformed over an extended holding period flies in the face of all rational market theories; however, as Keynes noted and Buffett has often reminded:

The market can remain irrational longer than you can remain solvent.

Also interesting is that both the larger capitalization and stronger corporate governance led to no real premiums over either holding period. I am certainly in favor of improving governance (and shipping is night and day versus where it was a decade ago), but dividends tend to do much more.

There is also an obsession about ‘growing the float’ and a fear of ‘shrinking share liquidity,’ often mentioned by management teams as an excuse not to repurchase shares even at wild discounts to net asset value. This obsession often extends to analysts as well.

It would seem more prudent to focus on long-term value generation, and if the concern is short/medium, then dividends are the clear standout. Corporate governance is a long-term necessity, but it doesn’t do much in the short term. I posit share liquidity is a distant concern and should not be a major factor.

Did a ‘Total Factor’ Approach Help?

Turning towards a ‘total factor’ approach, if we consider only firms that fell into the most buckets, then we would have just four firms which met at least 3:

  • DHT Holdings (DHT): 3 Baskets (Gov, Mcap, Yield)
  • Euronav (EURN): 3 Baskets (Gov, Mcap, Yield)
  • Frontline (FRO): 3 Baskets (Gov, Mcap, Yield)
  • International Seaways (INSW): 3 Baskets (Gov, Mcap, Value)

Notably three of these four ‘top all-around picks’ also had generous yield policies. The total factor allocation would have been the worst choice for the trade, generating an average return of +26.6%; however, it was the second best choice for the medium term, generating an average return of +2.0%.

If we stick to medians across the baskets to avoid high-flier (or big stinker) outliers across the time spans, the results are similar for the medium-term outcomes, but the spread is much tighter for the trade. I’ve attached a chart below showing the baskets:

Findings/Conclusions

Besides the sort of paradoxical finding of “fundamental value is meaningless, dividends are everything,” we can see the clear impact of a rising trade lifting all boats followed by a stronger residual interest and conviction in the firms which are either huge dividend payers or which are very high-quality overall (multi-factor picks).

Investors seem to have less concern over capitalization or governance in the medium term and fundamental valuations have been completely tossed out the window during 2020.

Over the long term, besides the assurance of death and taxes, we know that a mixture of capital allocation and valuations will drive the ultimate total return. However, can a trader do much better jumping around into hot trends and realizing what matters (dividends) what doesn’t (capitalization and governance) and what is a hindrance (good value)?

If looking at 2020 alone, the answer is clearly yes.

For longer-term-focused investors and the management teams who are working to deliver the best long-term total returns, the emphasis should remain on steady control and wise capital allocation. If leverage is under control and cash liquidity is strong, there is no excuse not to be repurchasing in these markets.

When markets turn strong again, management teams (and traders/investors) should learn from this cycle and press heavily into large dividends with clear payout policies. Who can ultimately provide those large dividends? The firms with the best fundamentals. If management teams can repurchase their equity at wild discount to NAV, the future dividends can be even larger yet!

Ride the Recovery Surge

Markets are offering unprecedented value investment opportunities and recovery trade setups, as volatility remains high and buyers are still scarce. Maritime shipping is a challenging sector and in these turbulent times, strong research is more important than ever to select quality firms and avoid the plentiful landmines floating around.

We’ve identified top-tier setups for the global recovery. We’ve recently rebalanced our top picks and model portfolios and have issued updated income-focused coverage as well. We’re now gearing up to cover Q3 earnings; free trials are temporarily open ahead of Q3 earnings.

Link to Zero Obligation Two-Week Free Trial

Disclosure: I am/we are long ASC, DSSI, INSW, STNG, TNK. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am short NAT. I a short-term trading position in STNG which may fluctuate rapidly.

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