Last year was among the best for oil tanker companies with spot-rates surging through the year. Teekay Tankers (TNK, Financial) also benefited from spot rate upside as the company’s free cash flow surged and several new tankers were acquired. This year has started with some pessimism, however, and Teekay Tankers has declined by 49% year to date.
The first reason to remain cautious on the stock is the meeting of OPEC members and Russia on April 17 to discuss capping oil production at January levels. This is a reason for concern because in 2015, the demand for oil tankers was driven by lower oil prices as the demand for strategic reserves increased. However, if there is an agreement on production freeze, it is likely that oil will trend higher and it also implies that the demand for storing strategic reserves will decline on a relative basis. This event can trigger lower spot market rates.
The second reason for remaining cautious on Teekay Tankers is there is significant new supply of tankers coming in the second half of 2016. In my view, this factor is largely discounted in the stock with the stock declining by 49% year to date. If this factor combines with the factor of higher oil prices, the impact on spot rates can be significant.
The third important reason for remaining cautious on Teekay Tankers is the fact that the company’s key revenue and cash flow driver is spot rates that tend to be volatile. With more than 75% exposure to the spot markets, Teekay Tankers risks sharp decline in cash flow if the above two factors were to impact spot rates. Therefore, the free cash flow visibility can decline meaningfully.
While these factors are bearish, the factor that can partially offset these negatives is global economic weakness (including weak GDP growth in the U.S.). Economic weakness can translate into lower consumption demand for oil and renewed weakness in oil prices even after the production freeze. It remains to be seen if the demand for storing strategic reserves sustains as many countries are short of strategic reserves infrastructure.
I must also mention here that economic weakness can work both ways as central banks will pursue expansionary monetary policies, which translates into dollar weakness. A weak dollar is a positive for all hard assets, and there can be a case for oil trending higher even in a relatively weak economic environment.
From a financial perspective, I don’t see any concerns in the near term even if day rates remain weak as compared to 2015. In January, Teekay Tankers refinanced a majority of the company’s fleet with a new five-year $900 million debt facility. With no significant debt refinancing concerns in the near term and with smooth debt servicing likely, the company’s credit metrics are likely to remain robust. I will be concerned if there is a significant slump in day rates and term contracts offer rates that compress EBITDA margins meaningfully.
In conclusion, even after 49% downside year to date, investors need to remain cautious on Teekay Tankers. While it’s not all gloom for the stock in terms of financials, there are several challenges that need to be closely watched before considering fresh exposure to the stock.
Disclosure: No positions in the stock.
