Scorpio Tankers Inc.

Moat: 1.5/5

Understandability: 2/5

Balance Sheet Health: 2/5

Scorpio Tankers is an international provider of marine transportation of petroleum products, specializing in refined petroleum products as well as vegetable oils and other liquids.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview:

Scorpio Tankers Inc. (STNG) is a leading player in the product tanker industry, owning and operating a fleet of tankers that primarily transport refined petroleum products. Here’s a breakdown of the business:

  • Revenue Distribution: STNG’s revenue is almost entirely derived from time and spot charters. Time charters provide a fixed rate over a defined period, offering stability. Spot charters involve ships being hired for a single voyage at the prevailing market rate. The mix of time and spot charters depends on market conditions and management’s view of the future.
  • Industry Trends:
    • The product tanker industry is highly sensitive to macroeconomic factors, global trade patterns, and supply and demand dynamics for refined petroleum products, among other things. Geopolitical tensions can create instability or unexpected swings in this market.
    • The demand for refined products is driven by global consumption, industrial activity, and seasonality. Changes in these factors directly impact the number of cargos required.
    • Regulations, especially those regarding vessel specifications and sulfur content in fuels, impact the supply side of the tanker market. New regulations could render older, less efficient ships obsolete, which creates more demand for new vessels.
    • Refining margins have a large impact on the demand for product tanker ships because as margins increase there is greater demand for refined product transportation.
  • Margins: Product tanker companies are highly volatile. Operating margins are strongly influenced by market conditions that are constantly changing. As seen in the latest reports, market conditions remain uncertain and there are a lot of headwinds for the business. Companies can be profitable in a strong market, but their profits could diminish quickly due to any changes in supply, demand or other factors, depending on their operational leverage.
  • Competitive Landscape: The product tanker industry is fragmented with many different players, including public and private companies as well as regional ship owners. The competitive landscape is driven by charter rates and therefore utilization of vessels rather than by differentiation of product offerings.
  • What Makes STNG Different:
    • STNG operates a large, modern fleet. In the tanker industry, a modern fleet is much more desirable, as it is more fuel-efficient and requires less maintenance, and can achieve higher prices.
    • STNG has a proven track record for handling its ships, and is viewed by investors as having an advantage in this aspect.
    • STNG is mostly specialized in product tankers, and has a solid presence in key trade routes.
    • STNG operates a global business model with operations from around the globe.
    • They have a very flexible business model.

Financials:

Here’s a closer look into STNG’s financials, focusing on what matters the most:

  • Revenues: Revenues are highly variable and will change depending on the state of the industry. In Q3 2023 revenues were 296.3 million dollars.
  • Earnings: STNG’s earnings depend heavily on the market conditions. They are usually profitable during strong periods, and may have high losses during weak periods. In Q3 2023 they had adjusted net income of 140 million dollars.
  • Cash: Despite having a great last few quarters, cash levels are still only decent and might not be able to sustain potential losses. Cash and cash equivalents were around $259 million in the latest earnings reports.
  • Debt: Debt is one of the most concerning issues with Scorpio. Their long term debt levels are extremely high and their ability to service this debt is largely reliant on market conditions. Total debt is about 3.8 billion dollars.
  • Leverage: The high levels of debt and its reliance on the market means STNG has very high financial leverage. This is not a positive and reduces their resilience.
  • Recent Actions: They have recently bought back a lot of debt at low valuations, as their equity has been highly diluted over the past few years. They have also invested in retrofitting and upgrading their fleet. They also have been working to reduce the debt to equity ratio.

Moat Assessment (1.5/5):

  • Intangible assets: There are no significant intangible assets, as a majority of the revenues depend on the product tanker industry.
  • Switching costs: There are no switching costs since customers can move to another competitor with few to no costs.
  • Network effects: There is no network effect in the product tanker industry.
  • Cost advantages: While STNG has an advantage in terms of the modernity of its fleet, other companies can gain this advantage as well, so it does not constitute a moat.

Based on this assessment, STNG has a very weak moat as its business depends on an industry where it’s very hard to differentiate and create long-term advantages. It relies largely on its fleet and some expertise, but these factors are not a very big moat.

Risks to the Moat and Business Resilience:

  • Industry Downturns: The cyclical nature of the product tanker industry is a major risk. A prolonged downturn could significantly impact STNG’s profitability and debt servicing capacity.
  • Regulatory Changes: New regulations related to fuel emissions or vessel requirements could lead to additional costs for the company. Although companies are generally able to mitigate the costs of these regulations, these costs could still significantly reduce their earnings.
  • High Debt Burden: High debt levels leave the company vulnerable to even slight increases in interest rates and make them reliant on market performance in the short term. If market rates worsen for a prolonged period of time, the interest expense for the company might become too heavy.
  • Competition: The highly competitive environment means STNG lacks any real pricing power. Also their advantage over other companies might be challenged by competitors building better ships and innovating.
  • Reliance on Spot Market: The business is still reliant on spot market rates, which can be extremely volatile. Reliance on spot markets means lower earnings and less predictability in earnings.

Understandability (2/5):

The product tanker industry is not a highly complicated business, since the core aspects of business are easy to understand, but there are many nuances that make it not easy to analyze and predict future earnings. Many different variables, including macroeconomic conditions, global demand, and regulations can greatly affect earnings. It requires a lot of knowledge of the shipping industry and global trade. I find the understandability of this business relatively low, even though its operation is not difficult to grasp, as a lot of things need to be tracked. I will give it a score of 2 out of 5, which means that I have to spend a lot of time in researching the trends in the shipping and transportation industry, as well as its financial and accounting statements.

Balance Sheet Health (2/5):

The current financial health of the company is not that great and gives me concerns.

  • They have large debts which makes them vulnerable. * While cash levels have improved in the latest quarters, they are not sufficient to deal with a sustained downturn. * The recent buyback of a lot of debt is promising.

These points mean that the balance sheet of STNG is not currently very healthy and gives me some concerns about their financial health. It will take a good few quarters for the debt and capital structure to get significantly better. I will give it a rating of 2 out of 5. The company also operates a very volatile business, making them much more susceptible to market fluctuations and difficult to predict, which contributes to the unhealthiness of their balance sheet.

Recent Concerns/Controversies/Problems:

  • As noted in the latest earnings report, market conditions are still very volatile, and there are a lot of uncertainties in terms of demand in certain areas of the world.
  • The global economic recession has decreased demand for transport, which can also cause downturns.
  • The recent global problems regarding inflation have resulted in central banks increasing interest rates, which increases their debt obligations and is a general headwind for the company.
  • The recent attacks in the Red Sea region have increased uncertainty and is not ideal for the company’s business. * Their revenue is mostly fixed price due to time charters, so they’re not directly benefitting from increasing transportation costs.

In conclusion, STNG is a company operating in a highly volatile industry with very little pricing power. It carries a lot of debt on its balance sheet which makes it more risky. Although the company’s ability to handle ships is commendable, their overall moat is very weak. Investors considering STNG should be well aware of the industry and its cyclical nature and should be prepared for volatility and periods of losses.