I am the Captain Now, Tanker Edition: Hafnia $HAFN, TORM plc $TRMD, and Okeanis $ECO

Probably Not a Value Trap

Welcome back to the “Probably Not a Value Trap” series where I discuss businesses with a 10%+ dividend yield which I believe probably won’t get cut and why, but don’t come after me on Twitter if they do.

This is also a part of the “Riddle of Steel” series where we focus on different shipping sectors.  While I personally prefer gold, oil, and land to mitigate inflationary risks, another popular strategy is to own “embedded energy” purchased at a discount to replacement cost. 

There are two critical aspects to the shipping industry, the newbuild orderbook for a category of ship, and disruptions from geopolitical events which increase the demand for ton miles.  Today the newbuild orderbook is heavily dominated by cargo container ships, LNG carriers, and RoRos.  My two previous “Riddle of Steel” articles were about LNG carriers and RoRo companies, but they have such long-term locked in contracts that their dividend should weather the incoming newbuilds for five years or so.  I wouldn’t touch a cargo container company probably for a decade.  But there are two categories which still have a low orderbook and an aging fleet compared to historical averages, oil tankers and dry bulk carriers.  

There are two kinds of oil tankers, crude oil and finished products.  You can see from the order book above, tankers for finished products to carry gasoline, diesel, and jet fuel do have more newbuilds coming in the next few years compared to crude carriers. 

Despite the low orderbook and aged fleet, the geopolitical disruptions of both the Ukraine war and the Houthi blockade of the Red Sea could go away just as quickly as they arrived.  If this were to occur, day rates for all types of shipping would fall in the near term.  However, with the limited new supply, even at the current elevated stock prices, either tankers or dry bulk are a reasonably safe type of shipping company to buy even without long-term fixed contracts.  

With the sudden divorce between the West and Russia, however, the demand for tankers specifically is much higher.  Instead of bringing oil from Russia to Europe, oil now has to go from the US and Saudi Arabia to Europe and from Russia to China, and those routes are much longer.  Will the West reunify with Russia within the next five years?  I have strong doubts.

It doesn’t feel like value at the moment because prices have gone up 3x to 4x since the start of the Ukraine war in February 2022.  But keep in mind that at least some of that price increase can be attributed to the wave of inflation that came from the Covid stimulus, and I predict sustained inflation, even if it comes and goes in waves.  If peace were to break out in the world, a significant stock price drop would not surprise me, but a drop in the day rates of tankers enough to crush their dividends below the 10% cutoff would surprise me.  I still would not fill a complete position at these prices unless you have a ten year time horizon for your investment, but a placeholder position in order to watch for dips to buy is very prudent. 

According to

Mihail Stoyanov

, one of substack’s shipping enthusiasts, in his article “Shipping 101,” some signs to look for to know you are at the top of the cycle are:

• Day rates which exceed operating costs by at least three times

• The price of a 5-year old ship is the same as ordering a newbuild

• Shipping companies are at the center of investor attention

Day rates for tankers are around $40,000 per day at the moment, and operating costs are about $15,000.  We aren’t at the bottom of the cycle, but analysis of the fleet age and the orderbook indicate that ship scrapping should outweigh newbuild deliveries for at least the next 4 years, although there is the caveat that if day rates stay high enough, scrapping slows down.  There are 297 tankers in the orderbook to be built by 2030, but there are 510 vessels over 20 years old, with 105 of them over 25 years old. 

In the world of oil tanker stocks, Mihail tells me that TORM plc (TRM) and Hafnia Limited (HAFN) are the market leaders.  Hafnia owns 117 tankers, and charters in an additional 16 at the moment with an average fleet age of 8.8 years.  TORM owns 93 tankers with an average fleet age of 11.3 years.  Hafnia is 42% owned by the Sohmen-Pao family of Singapore, and TORM is 55% owned by Howard Marks’ Oaktree.  Both have current dividend yields of over 15%.  Hafnia is trading at a market capitalization just below the current resale value of their fleet, TORM is trading at just above the current resale value.  Of course if day rates fell, the resale value would fall as well, so those values don’t tell us much except that I am two years late to the party to buy them at a significant discount to replacement cost, but I am probably not so late that it is already the top of the cycle.

The fleet age is an important metric, and there is a major cutoff at 20 years.  Past the 20 year cutoff, insurance rates skyrocket, and some clients simply won’t allow their cargoes to be transported by older vessels.  Fuel efficiency is dramatically higher on newer ships, and mandatory dry dock maintenance is more frequent, so profitability falls off quickly.  After the 20 year mark, the rate of scrapping starts to speed up, but during a period of high day rates, can be stubborn.

Another important aspect of shipping is the presence of scrubbers which remove the sulfur dioxide from the ship exhaust.  Ultra low sulfur diesel is a very expensive and highly refined fuel, but bunker fuel is much cheaper.  In order to combat acid rain, developed economies don’t allow ships to dock in their ports that are emitting sulfur dioxide in their exhaust, so this means that those ships either need to burn very expensive diesel, or have scrubbers equipped.  TORM has scrubbers equipped on 72% of their 93 ships, but Hafnia seems to be going a different route for their environmental concerns, experimenting with dual fuel newbuilds that can run on LNG instead of diesel.  Hafnia is tight lipped on their percentage of scrubber equipped ships, I have seen estimates as low as 18%, but precise numbers escape me at the moment.

Given that both Hafnia and TORM have a strong capitalist in control to prevent incentive misalignment, but Hafnia is trading at a slight discount compared to TORM’s slight premium, and Hafnia has a younger fleet by over 2.5 years on average, I would choose Hafnia between the two market leaders that Mikhail recommended.  

But there is a much smaller company with only 14 ships, trading at exactly the resale value of their fleet.  The average ship age is only 4 years, and the fleet is 100% equipped with scrubbers.  The company is called Okeanis Eco Tankers (ECO), and it is 56% owned by the Alafouzos family from Santorini.  The dividend yield is only around 12% at the moment, but the company is 100% exposed to the spot market, avoiding time charters completely, and they distribute 100% of free cash flow in the form of dividends.  

Also, while Hafnia and TORM are primarily product tankers, Okeanis is a crude oil tanker company. We saw from the orderbook above that crude tankers are likely to be in particularly short supply even compared to product tankers.

It is very hard to buy a stock on the way up, but it generally leads to better outcomes than buying something on the way down.  I believe that tanker stocks are in a long term uptrend that still has several more years to go, but I would not be surprised if prices still have a bit to fall from here in the short term.  Call me superstitious, but October is a weak month for the stock market, and winter is a weak season for crude oil prices.

Out of all of the stocks mentioned, Okeanis Eco Tankers is my favorite by far, but I wouldn’t fault anyone for buying Hafnia instead if they have a different tolerance for the risk of small caps.  If you prefer TORM, it would probably be because of the desire to piggy back along with Howard Marks’ celebrity status.  Without a reunification with Russia, the fleet age makes me somewhat confident that day rates should support some generous dividends for years to come.  I am much less confident that the stock prices will trend up before they trend down, so save some ammunition to buy the dips.