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Hafnia (OTCQX:HAFNF), the operator of the world’s largest fleet of products and chemical tankers, has reported relatively soft results for Q3. The stock is down 13% from its highs. Although this is a very modest sell-off, and the stock is still up more than 30% year-to-date (excluding dividends), I believe there is still considerable value embedded in the current valuation when the fundamentals of the company (and of the overall clean tankers market) are properly considered. Therefore, I do not view the recent weakness as a provoke for concern. In fact, I expect to remain invested in the stock for the next couple of years, as the fundamentals of the tanker bull thesis fully unfold.
Production Cuts, Price Hikes, Recession Fears
For product (and crude) tanker demand, the main risks include increased production cuts by OPEC+ (which would provoke prices to rise, thus hurting demand) and a reversal of sanctions on Russian exports. With the uncertainty of the OPEC+ meeting now in the rearview mirror, and the cuts being largely cosmetic, the first risk has been considerably reduced. In fact, the recent price action in crude appears definitely bearish, which suggests that demand destruction is far from being a concern.
On the other side of the coin, the weakening in crude prices points to a refuse in demand and an increased likelihood of a recession. While the US economy has proven to be remarkably resilient thus far, the outlook for the Chinese economy remains clouded. Monetary policy is also a concern. The market is now pricing in significant interest rate cuts over the next 12 months, yet Fed Chairman Jerome Powell has stated that hikes may not be over. Therefore, there is still a possibility that the Fed could overtighten, potentially sparking a global recession.
Geopolitical Black Swans
Being long on tanker equities implies being exposed to geopolitical volatility. In recent days, there have been reports of multiple attacks by the Houthis in the Red Sea, specifically targeting Israeli-linked vessels. While there is currently no reason to believe traffic is significantly impaired, the probability of a serious incident is increasing. If vessels start actively avoiding transit through the Suez Canal, the addition of ton-miles would be significant (7 to 10 days of shipping time, depending on the ship’s speed). This is effectively equivalent to a contraction in tanker supply and, therefore, bullish for tanker earnings.
Panama Canal Situation
Disruptions around the Panama Canal persist as a rainfall crisis has led officials to reduce the number of vessels that can pass through. This has prompted some operators to reroute their vessels on longer transits. The increased transit times are effectively reducing supply in the Atlantic, spurring a rally in MR tanker rates.
Tightening of Russian Sanctions
The Urals oil price is currently trading above the price cap of $60 per barrel (it is now quite close to it and might trade below it in the coming days). To limit Russian revenues, the US has been targeting individual vessels for alleged oil price cap breaches. This enforcement of sanctions against the so-called dark fleet also reduces supply and is bullish for tanker companies.
Oil Price War
Despite recent pledges by multiple OPEC+ members to preserve cuts, there remains the possibility that Saudi Arabia will attempt to regain market share by flooding the market. This would decisively tilt the supply/demand picture for oil in 2024 towards oversupply. A repetition of the 2020 Russia-Saudi Arabia oil price war would be incredibly bullish for tankers.
Chinese Refinery Quotas
While growth remains sluggish in China as attempts to deflate its massive construction bubble are underway, Chinese officials have approved increased exports of CPP volumes. In Q3, tanker earnings were adversely impacted by refinery maintenance and stock draws. These forces are now expected to reverse, just as Europe enters the winter season.
Environmental Regulations and Orderbook
The product tanker fleet is projected to grow by 1.9% in 2024 and 4.4% the following year. This is slightly faster than the crude tanker fleet (0.7% in 2024 and 1.1% in 2025), but still represents a modest boost, especially considering that the global fleet has aged significantly in recent years. As of October, the product tanker orderbook stands at 10.6%, with the majority of deliveries scheduled for after 2025. A significant number of vessels are due for scrapping, which is already reflected in the substantial reduction in utilization rates for vessels older than 15 years. A number of older vessels are currently kept in the fleet specifically to take advantage of strong market conditions. Tightening environmental regulations will advocate constrict tanker supply over the coming years.
Inventories and Seasonality
Inventories in the Northern Atlantic are below historical averages. Therefore, a gradual rebuilding of inventories is expected, facilitated by increased imports from the US Gulf and the Middle East.
An overall bullish setup
Overall, the fundamentals for the tanker trade remain strong. A reversal of Russian sanctions is highly improbable. While a recession is still a possibility, I see many more potentially bullish drivers. The probability of events such as an oil price war or a disruption of passage through the Red Sea is fairly low. However, the potential upside is enormous, making the risk/reward profile quite attractive, especially considering that the downside in equities may be limited by the current undemanding valuations. In any case, tanker companies are likely to encounter a couple of years of sustained high earnings, which will be reflected in asset values and consequently lift valuations. This assessment does not rely on any boost in demand, which is difficult to anticipate, but rather on a contraction in supply, which is inevitable given the status of the orderbook, the impending environmental regulations, and the advanced age of the global fleet.
Hafnia: A High-Quality Choice
Arguably, the most important differentiator between shipping companies is “quality.” In my opinion, Hafnia is one of the highest-quality names available in the product tanker space (second only to Torm). For example, Hafnia claims to be the lowest-cost operator in the sector, as shown by the following visualization (the peer group consists of Torm, Ardmore, and Scorpio).
OPEX, Hafnia vs peer group (Company’s Presentation)
Over the last year, Hafnia has achieved significant deleveraging of the balance sheet, which has enabled an boost in dividend payments. The dividend policy is clearly set out and is a function of leverage (i.e., the loan-to-value, or LTV, ratio). As the LTV has fallen below 30%, the dividend payout has now been increased to 70% of net income.
Q3 2023: A Relatively Soft Quarter
For Q3, the company reported relatively soft results compared to the previous two quarters, as rates remained historically strong but volatile, affected by refinery maintenance and stock draws. Nonetheless, Q4 is expected to be a stronger quarter due to seasonality and the need to rebuild inventories, particularly in Europe. In Q3, the company reported TCE income of $310.3 million, EBITDA of $220.8 million, and net profit of $146.9 million. TCE came in at $28,954 per day. This value is mostly in line with peers: it is slightly better than Scorpio but worse than Torm. The most concerning news from this quarter’s results is that 65% of Q4 days have already been fixed at a relatively unexciting rate of $29,893 per day. For comparison, Torm has fixed a similar percentage of days (64%) but at a significantly higher average rate of $38,822 per day. Even Scorpio has locked in slightly better rates.
Coverage for Q4 2023 (Company’s Presentation)
Upcoming US Dual Listing
Hafnia’s main listing is on the Oslo Stock Exchange (ticker: HAFNIA.OL). However, Hafnia’s Board has authorized management to commence work toward a potential secondary listing in the US. The dual listing would supply a bullish catalyst for the stock by providing access to a wider pool of investors and improving liquidity.
Undemanding Valuation
The company is currently trading at a market capitalization of $3.1 billion. It is guiding for FY 2023 EBITDA of around $1 billion and net income of around $770-790 million. With a payout ratio of 70%, this implies an annual dividend yield of around 18% at current prices. This certainly suggests that the stock is not expensive.
Conclusions
Hafnia remains a top choice in the product tanker space (along with Torm, which is also one of my holdings). My reason for staying invested is my belief that the current earnings can be sustained for a few years. The market still seems to disagree, as evidenced by the stock’s discounted valuation. I foresee that asset values will rise and dividend payments will boost. I don’t place too much emphasis on quarter-to-quarter results, as I am primarily an investor, not a trader. The current status of the orderbook and geopolitical scenario are my main motivations to believe that the risk/reward profile in the tanker space continues to be incredibly attractive.
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
