TORM: Making Sense Of The Collapse And What To Do From Here

seekingalpha11-20

Following a 30% decline since my Strong Buy recommendation, I reassess the situation among the rubble.Recent market fundamentals have been negative due to refinery maintenance and increased vessel ...

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Investors should monitor for this phenomenon in the future.There are still more positives than negatives across the short and medium terms, suggesting a recovery in tanker rates is in order.BrianAJackson  Thesis In September, I wrote two very bullish pieces on the clean product trade for both TORM plc (NASDAQ:TRMD) and Hafnia Limited (HAFN). The gist of those articles centered around the continued polarization of the global refining market, coupled with a rapidly aging fleet. These factors were leading to strong profits and record dividends. What I didn't see coming was the impact of seasonality coupled with the infiltration of crude tankers into the clean product trade. The combination has dropped rates from $42,000/d in Q2 to $29,000/d partially through Q4. Such a rapid drop may have shaken the confidence of investors, including myself, so I decided to get to the bottom of the situation. Since my last analysis on TRMD, the stock has fallen over 30%. By comparison, the Baltic Clean Tanker Index (BCTI) which provides a measure of tanker rates, has only fallen 17%. Looking back over the last decade for BCTI, it appears that rates are near historical lows, implying that further downward risks are minimal. In this analysis, I show that the market positives outweigh the negatives, positioning the clean product trade for a recovery. With a spoonful of conservatism, I still arrive at a BUY conclusion for TRMD. Market Fundamentals The extremely strong rates in the first half of 2024 attracted the rather unwanted participation of large Suezmax and VLCC crude tankers into the clean product trade. By mid-summer, crude tankers were transporting between nearly three times the normal volume in 2023. These, coinciding with increased refinery maintenance, were the primary actors in a downward shift in market rates. However, following a recovery in crude tanker rates, the delta between the two trade markets has diminished, no longer incentivizing cannibalization of the clean product market. As of October, all of the VLCC and half of the Suezmax vessels participating in this trade have left the market to return to their home turf. TRMD Investor Presentation It appears that the premium for returning home has snuffed out the gains created from a formerly undersupplied dirty tanker market. However, it is possible that the same delta that drove cannibalization returns if clean product rates display any meaningful upward improvement. The clean-up expense and lost operating time stand as the main barriers to re-entry at this time. Baltic Dirty Tanker Index (May-November 2024) (Investing.com) Seasonally, both the clean and dirty product trades are entering the two best quarters of the year. The months of November and December look to be supportive of additional exports, with 5 million barrels per day of production coming back online by year-end. Refinery Output Projections (STNG Investor Presentation) With additional volumes starting to enter the market, the Clean Index has also started to show signs of bottoming. The index hit a low of 460 points in the first week of November, followed by a positive gain this week. Baltic Clean Tanker Index (April-November 2024) (Investing.com) While it's still extremely early to call this a recovery, historical context shows that if we are not at the bottom, it must be extremely close. Since 2002, the index has only been lower than its current value for three distinct periods. Two of which were the 2008 crash and the Covid Pandemic. Using this same chart, we can also see that the current index value is also close to the cyclical bottom for the time period between 2010 and 2020. Much in the clean product trade has changed between now and then, however. Russia freely supplied Europe with energy, while the world relied on older refineries that have since been shuttered. Essentially, two of the main drivers causing the dislocation between refineries and consumers did not exist during that time. This gives me more confidence that today's rates are more of a misnomer than a reflection of long-term market conditions. BCTI 2002-2024 (Investing.com) Long-Term Drivers Remain Unchanged Despite the volatility, the long-term outlook for the clean tanker market remains favorable. Going back to the long-term trend for BCTI, 2003-2008 was the last time rates were consistently at a comparable level to 2022-2024. The order book during this period was also significantly higher than at any time in recent history. The influx of new vessels entering the market at a time with contracting economic conditions helped to keep charter rates range-bound for most of the following decade. Fast forwarding to today, the current order book is higher than in recent years, but it certainly stands out in two different aspects. First, the fleet has never been older in the last 20 years. Second, strong spot market rates have not prompted shipowners to refresh the fleet in a similar manner to the market pre-2008. With the current average age so high, the global fleet appears to be positioned in a maintenance mode more so than a growth mode. This is a characteristic that supports rates being \"higher for longer\". Global Fleet Age Vs. Order Book (TRMD Investor Presentation) In addition to fleet age, the cycle of life for refineries continues to further polarize the market. 2023 and 2024 saw several large-scale refineries come online in the Middle East, China, and Nigeria. Now, smaller refineries in the US and Europe face financial pressure due to their age and inferior economics. Phillips 66 (PSX) recently announced the closure of its Los Angeles refinery at the end of 2025. Replacement barrels into the West Coast region will likely be sourced from a combination of imports from Asia and increased production from the US-Mid Con region. This announcement is additive to the three refineries closing in Europe that I detailed in my last article. Each of these refinery additions and closures puts additional demand on the shipping markets. The supply continues to move further away from population centers with the highest energy use per capita (North America and Europe), equating to more ton-miles for the industry. Every new closure is supportive of \"higher for longer\" shipping rates. Refinery Closures (STNG Investor Presentations) Valuation TRMD's stock price has been in free fall since my strong buy recommendation. This has essentially followed BCTI (tracked under the ticker BAIT) downward. However, TRMD has diverged from the index, now down nearly 20% more than the index over the same period. Clean Tanker Index vs TRMD (Investing.com) Following the Clean Tanker Index, TRMD reported that the company has secured an average spot rate of $29,000/d per vessel thus far in Q4. This is down from $33,700/d reported during Q3. As a result, I have updated the cash flow model for TRMD to reflect what appears to be a market bottom. 10-Q The current market rates will produce a quarterly dividend of $0.84/share, assuming no market improvement and a payout ratio of 80%. At the current share price, this produces a yield of 14%, attractive for new investors. Following the price pullback, TRMD's enterprise value is now $2.94 billion. The above cash flow model puts the company's annualized EBITDA at $650 million, making the forward curve still attractive from a valuation standpoint. The forward EV:EBITDA ratio stands at roughly 4.5x, assuming an annualized market rate of $29,000 day. This makes the current valuation essentially unchanged from when rates were significantly higher several months ago. Therefore, thanks to the massive sell-off, the company is just as favorably valued as it was in previous quarters. Adding to or starting a position here looks favorable, with significantly less downside risk than in previous quarters. Data by YCharts To gauge that risk, we need to look at rates from a historical perspective. In this light, rates appear to have dropped to near the average over the past decade. However, inflation is not considered in this chart. After a decade of inflation, we now appear to be well below rates seen as far back as 2014-2019. Considering the shift in refinery demographics and the age of the current fleet, I believe this implies upside potential. As a result, I remain convinced that the clean product trade will remain fruitful for at least the next 18 months. Historical Rates (TRMD Investor Presentation) The Elephant In The Room With TRMD at a 52-week low, many investors (including myself) are probably underwater. We all need a path toward capital recovery to prevent getting stuck in a yield trap. After all, it would take three years of distributions to recoup the capital losses if the share price does not improve. That is not Seeking Alpha. Fortunately, there are still several drivers in place to increase ton-miles and in turn prices/share prices. The bulk of which centers around refinery closures in Europe and the US. These closures will take time to follow their natural course but there may be more on the way as the natural economic life cycle of refineries evolves. Below is how I view the net impact of each market variable discussed so far.  Seasonality and higher refinery output (near-term positive) Crude tanker egress out of the clean tanker (near-term positive) Increasing fleet age (long-term neutral to slightly positive) Refinery closures (medium-term positive) Reduced Chinese crude imports (near- and medium-term negative)  All in all, I believe the data points toward a recovery in charter rates. The sheer magnitude of the recovery could be limited by the cross-trade between clean and crude markets. Risks In my professional career, I've made great efforts to not make mistakes twice, and the same should be applied to investing. In my last analysis, I missed the potential for crude tankers to participate in the clean trade. The supply and demand aspects of the clean trade seemed robust and secure. However, large profits will always drag in competition. As a result, my strong buy recommendation was instead handed a 30% decline. I believe at current prices, a significant portion of the downside risk has already been absorbed. That said, the recent retrace in crude tanker rates opens the possibility of future infiltration back into the clean trade should margins widen again. This effectively puts a cap on the clean trade unless the crude trade also improves. I don't foresee meaningful improvement in the crude trade without the biggest oil consumer, China, improving the health of its economy. Therefore, the health of the crude fleet will need to be included in the same conversations as the clean trade moving forward. Investor Takeaways 1. Recent market fundamentals have been negative due to refinery maintenance and increased vessel supply through crude tankers cross-trading into the clean product market. 2. The crude fleet looks to have retreated, but in doing so has depressed their own rates. This would open the door for a future repeat event should clean product rates rebound strongly. 3. TRMD can still produce reasonable yields at this low point in the market. Upside potential could be observed when rates recover due to the return to peak seasonal rates. 4. There are far more positives than negatives after the large correction in spot rates. This bodes well for new investors and those looking to recover capital following the sell-off.  5. Despite getting handed a loss following my last analysis, I'm sticking with the market fundamentals. I believe rates will continue to recover as refineries close over the course of 2025 and the fleet ages.","kind":"highlight","is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"analysis","news_rank":0,"symbols":[],"gpt_button":0},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":2,"commentSize":0,"repostSize":0,"favoriteSize":1,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.3","shortVersion":"4.29.3","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2484399118"}