DHT Holdings' Co-CEOs On The VLCC Markets (Podcast Transcript)

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Summary

Editors' Note: This is a transcript of yesterday's podcast with DHT Holdings' (DHT) co-CEOs. We hope you enjoy.

J Mintzmyer: Good morning, everyone. Welcome to another edition of our live Tanker and IMO 2020 Forum. Quite an exciting week-and-a-half, we've hosted several tanker companies, taking a trader perspective, talk to a couple of fund managers, spoken with VLCC fixture experts. We've seen some interesting volatility in the market as the Phase 1 U.S./China deal was signed. We're now looking forward to hosting DHT. We have their Co-Chief Executive Officers on the line today, Svein Harfjeld and Trygve Munthe. They're here to discuss the tanker markets from the perspective of a VLCC Pure Play with about half of their fleet equipped with scrubbers.

Before we begin, just some disclosures. We’re recording on the morning of 16th January, 2020. So, if any stock disclosures are provided today, those may be different if you're listening at a later date. I do have long exposure to DHT Holdings at this time. Nothing you hear on the call today constitutes the official company guidance or investment recommendations in any format.

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With that said, welcome, Svein, and welcome, Trygve. Thanks for joining us.

Svein Harfjeld: Thank you for having us.

JM: Absolutely. So, we have to have you here to discuss the VLCC markets. I mean, DHT is a VLCC Pure Play, you recently dispose of the last few Aframax’s. You have about half of your fleets equipped with scrubbers. So, as we begin the call this morning, just wanted to ask you how is the IMO 2020 progressing to date? How is that impacting the tanker markets? And have there been any surprises so far to date?

SH: I think, things are progressing not too differently from what we had reason to expect. We saw it towards the end of last year that the spread between compliance fuel and old-fashioned heavy fuel oil has been coming out. What's encouraging to see is that, there seems to be only minimal issues regarding availability of compliance fuel in most ports and we’ve heard some rumors about sort of the spec issues on the compliance fuel, but have really had a hard time pinpointing what ships and what locations and in any sources. So, at this point, I think, it's more over here say that it's actual facts.

So, some people argue that it could be more in store as far as IMO effects, simply because the availability of compliance fuel has been based on inventory buildups before January 1. So, so far, we've been really been supplied from things that were put on floating storage before the start of the year. Of course, if this becomes more complicated going forward, you could argue that it will be more constructive for the freight rate picture, simply because if there are hiccups bet it [logistical] or spec-based, it is going to cause inefficiencies in the selling fleet.

JM: It’s an interesting transition. We'll have to keep watching that. And, of course, the client fuels were starting to be produced over a year ago. So, we did have that sort of inventory build up. Have you noticed any sort of changes or indications in the market in terms of the available supply? I mean, I know when we started off, we had spreads in around the 250 range in November, and then those spreads, they ramped up into mid-December and the start of January, I think, we got up to about 360 at some points, and now those spreads have started coming back down again. Do you think that's natural that those spreads are going to start tightening maybe down to 200 to 250 range? Or do you think maybe there's a chance that there'll be some sort of shortage coming up?

SH: It seems to us that these spreads have been a bit all over – it’s not all over the place. It’s varied quite a bit geographically. It’s using much bigger spreads in the Middle East into [Jira] and what you've seen in Singapore and so forth. So, I think it's still early days to having a firm opinion on where these spreads are going to move, but over time, I would certainly think that the spreads are going to start come again, but you're not going to hear a number for me and guessing on fuel spreads in the future.

Trygve Munthe: Also keep in mind that for the big ships like in the VLCCs, there’s very limited number of bunkering ports that you tend to use. So, the majority, of course, has been done in Singapore, but with a significant export south of the Middle East [Jira] is also very important to bunkering hub. And that area is sort of naturally long HFO. So, hence you have a wider spread down in [indiscernible] than what you see in Singapore and brought it up.

JM: It certainly makes sense, and we saw a huge spread initially. I think, I wish [I read] the largest spread in the world temporarily and then, of course, it was larger than Rotterdam and Houston and Singapore being some of the other major ports. Can you remind us on on the current progress of your scrubber program? I know you had a few scrubbers; I believe it was six that you ended up deferring a little bit to take advantage of the rates. Is that still the case? Or are you sending those ships into get scrubbers installed?

SH: Well, that is still the case. So, our approach to this is a bit optimistic. So, when the freight markets really came roaring in, sort of the coastal taking ships out of service was in our view being too high to do this, but we will definitely do this project. It’s more a question of timing, and we'll follow the market closely and see if there are sort of good pockets to do this. We have both equipment’s all the engineering is done. We have shipyard capacity available. So, we could really afford ourselves the luxury of waiting.

TM: We're definitely going to put these fixed subscribers on the ships. So, there's no sort of change in appreciation for scrubbers as an investment case. And it’s quite interesting to see now how the different fuel prices and the different fuel economy is on the design. So, the ships how it plays out and the – from an older or conventional tanker without the scrubber all the way up to an eco-ship with scrubbers. They're talking about the rate difference in the very high $20 per day. So, that is big money, especially when rates are lower, of course, then it could be being a difference of not meeting in cash breakeven for the older without scrubbers to actually making a very decent equity return on the other one. So, it is becoming a bit more nuanced the whole tanker market.

JM: That's a – it's a phenomenal spread there between, I guess, you would say the old vessel without a scrubber, right, all the way up to the modern eco vessel that also has a scrubber. And I think you said high 20s, right, and that complies with what we've seen with Clarksons, they put out index reading. And yes, we're talking maybe $25,000 or higher per day, which, as you mentioned, is phenomenal, right? Because you could have one ship that's pulling in 40,000, which would, say, in Q2 or something that could be holding in 40,000, which is a very strong rate for Q2. And yet at the same time, you could have an older vessel, right, without a scrubber that's only getting 15,000 and might even be scrapped. So, it's a very, very interesting bifurcated market. Just to clarify, so you have about 10 scrubbers on the water today, is that correct? And then we're waiting on the next six, is that the right number?

SH: We’ve got 12 ships in the water with scrubbers and another six to eight.

JM: Excellent. Yes, I think, I guess it was 10 that you installed scrubbers on right, and then there was two newbuilds that came with scrubbers, so 12 and then waiting on six. Is there any sort of indications for maybe like a second wave of subscribers in terms of like reassessing the market in Q2 or Q3, or do you think kind of 18 is your max?

SH: We have no current plans to add anything for DHT, but I guess, with the spreads now, sort of the economics of the project might seem attractive for people that sort of are coming late to this party. With that being said, also, of course, you're pushing out the potential payback scenario. So, if you want to plan to do this live, at least, it will take you six to nine to 12 months to get it done. And then you need to have a view of the spread in 2021 well, really, as opposed to the current spread, and that might still be good. But this may be more uncertainty than what we see now. Of course, the alternative value of the time that it takes to do the retrofit has been gone up quite dramatically.

JM: Certainly, it makes sense that there's a delay and then, of course, there's the installation cost and also the opportunity costs with strong rates. So, it would make more sense that if the spreads remained elevated, right, and then the rates kind of came back with seasonality into Q2 or Q3, then maybe some folks would make that decision. Can you remind us, because I know you're opportunistic with your shipyards? How does your optionality work? Like if you decided maybe next week that you wanted to add your scrubbers on those other six, what sort of delay would we have? Would that be a month or two months, or how long did that take?

SH: We have sort of a go to yard wherever you do all our dry docks and also where we've done all the retrofit projects, and we’re one of their top customers. And we're not really sort of sharing all the details of this relationship, but we do think it offers us ample flexibility and how to go about this. Keep in mind also these ships are long voyages. So, the average length or duration of a VLCC voyager is somewhere between, say, around 60 days easily. So, it's not like you can stop in the middle and then do if you need to finish the business, you're in before you go ahead sort of with our projects.

TM: We could say that we have penciled in….

SH: Yes.

TM: …slots for these ships. So, by keyword is pencil, but to give you an understanding that it is a bit of lead time. So, there is – there are some slots available for us. And again, the ambition is to get the work done within the year.

SH: I think, in general, we really benefit today of having planned all this well ahead of IMO 2020. Having done all the sort of acquisition equipment, all the engineering preparation with the yards, all the fuel management preparation, et cetera. So, it makes it sort of easier for us to maneuver and operate in this environment and maybe another company that is maybe less prepared than what this is.

JM: Yes, it's clear that you're a little bit ahead of the curve with at least 12 scrubbers on the water now as you look at your fleet. And you said nearly half of the fleet at this point. So, one other question kind of in the market, it kind of related to IMO 2020. We've heard some discussions of a pickup in floating storage, both of compliant fuels, but also of the HSFO, especially off of Singapore. Have you seen any pickup in that activity? And is that something that DHT is involved in?

SH: We have certainly seen reports confirming that there has been or is floating storage over different types of fuel in Singapore area, but your second question, no, this is not the only business that we are eager to do. I think this is typically older vintage ships that may be more difficult to actually trade in the freight market. And then it's sort of a latter half for these guys to do some storage business, but we are not really entertaining that. But, of course, we're enjoying the benefits of it, because it's taking some capacity out, although, there is a number of the VLCCs that have really retire into just being in the storage business rather than the trading business.

TM: The majority of those ships is around Singapore today that are storing or VLCCs that are storing are for compliant fuels and sort of either partly or fully loaded. So, there's not that much HFO that we’ve seen being stored and they’re surely some, but majority is compliant fuel.

JM: Certainly. It's certainly interesting to see that and it makes sense that the storage vessels would be the older, less attractive, less commercially viable vessels, right, that they don't have to move around and have a less efficient burn rate on the engine. So, certainly makes sense to see that and I understand you're not really interested in that part of the market, although, it does help take off some of the [indiscernible] that aren't moving around. Let's kind of shift a little bit to Costco sanctions. That brought a significant number of ships off the market last fall. Can we briefly discuss what that impact was? And and how many ships you think it was that were taken off the market? And then secondly, have you noticed any change in the last couple of days in regards to Costco sanctions? I know we had the U.S./China phase one deal. Has there been any talk about Costco in particular? Where those sanctions still on place?

SH: From the intel that we have received, we understood that there was maybe up to 27 ships that were out to service of the most, the VLCCs that is, and that there still are several ships out to service, but it's a bit cloudy the whole situation. So, we have a sense that there are some of these ships potentially involved in China into business. So, it's not like all the ships are necessary out to service, as we speak. But again, it's a bit hard to get specific information from everything. And some of these ships might opt to turn off their AIS, so it's hard to put – pull them and so forth.

JM: Yes, it seems like there's been a lot of varying news in the market we've heard, you know anywhere from 20 ships all the way up to 40s. And we've heard lots of different details about maybe some of them are doing some regional trading, some are doing storage, maybe some are just sitting empty. So, definitely a lot of information cemetery out there in regards to that nuance. Have you heard any details about those ships coming back in recent days? Are those still applied by sanctions according to your knowledge?

SH: We have no information recently that there's been a change in the situation, but, of course, it's easy to speculate that this could be part of a sort of a training, right? So, but I think if that is the case, so therefore there will be more good news for our business in a trade deal than a potential impact on a few ships coming to the market. So, I don't think that there should be such a great concern.

JM: Let's unpack that a little bit, because you mentioned that a trade deal would be positive for your businesses. Is that just in terms of the China to U.S., expected imports right out of the U.S. to China? And if so, how do you expect that to impact the market?

SH: You know, we're not saying it is – it definitely is, but I think it's easy to think that for one attribute to the support general economic activity, and that tends to be good for shipping. And then, of course, if oil is part of a particular transaction, it would be a sort of easy gift for the Chinese to ramp up purchases of some U.S. [indiscernible] and that will just add to the timeline and transportation distances. So – and practically, this theory is simply very good for our business.

TM: And I think it also importantly would bring some stability into the U.S. growth to Far East trade, because today, that is – it’s not arbitrage-driven. It depends EBITDA and relative pricing of WTI to Brent and whatnot, but if it really becomes a part of a deal, then I think it would be less spread the arbitrage sensitive and there will be a more of a steady stream of oil going that very long route from Texas to China.

JM: Yes, that would be – it would be very positive for the market to see China take a lot of volumes out of there, of course, because we're talking about double, right, the ton mileage between each cargo. So, we're hoping we'll see that, it remains to be seen, of course. We have seen the overall details of the trade deal Phase 1, and of course, it does include significant oil purchases, but we'll have to make sure and see if that deal is complied with. Pivoting a little bit, last week, when we started this conference, the sentiment in the market was very strong, right? It was almost kind of euphoric to a sense and a little unnerving at points, but as we've entered the last week or so, we’ve seen the rates come off significantly yesterday, actually, and then we've seen the stock prices sort of falter as well. Can we talk about that a little bit? What sort of indications are you seeing in the market regarding the recent weakness? And is that something that concerns you going into 2020?

SH: I think, volatility in our space is sort of par for the course, right? It's just the way the tanker shipping is and when you currently are in a strong market, as we are, of course, the nominal numbers from sort of the swings within a week, it could be daunting on people, but I think people should focus on average earnings for periods, and we are sort of still at levels, which are well above what most analysts predict for the whole of 2020. So, sort of the trade stocks just on the spot market might be a sort of a challenging task, and it could be scary for many people, but I think the underlying thesis in our space that there's simply more oil in the Atlantic going east and expanding the transportation distances and the demand is still robust. That is the underlying thesis. So, there will be volatility still in the freight market and if it comes down a bit it will very likely go up again, so.

TM: So, just as an example, in that, in 2015, and the last sort of strong tanker market are very strong, we averaged about $65,000 a day for the full-year, but nevertheless, in the mid third quarter, we saw rates in the teens. So, I think it's important that everybody that's investing in this business realize that volatility is still there even when you're in a very strong market. And, of course, you're going to see peaks and way north of $100,000 a day within the same year, but it's – for the beginner in this space, it is quite staggering to see the short-term volatility.

JM: Yes, I think a lot of – we had a lot of momentum players and traders and such that joined kind of the tanker party, if you will, kind of over the last few months and maybe they weren't expecting the seasonality. It's – the timing is good. I actually put out an update report and I'll share with you gentlemen later, but I posted a chart of the last two decades of tanker rates. And you could see that during the last super cycle, which, of course, was a phenomenal run, right, from 2002 to 2008. There was something like eight total collapses in rates, right, where rates would go from like 70,000 or 80,000, to like 20,000 in just weeks. And that was part of a supercycle, right. So, it's definitely a volatile sector and it's good to see that obviously, you understand that. And hopefully, the more – as more investors kind of join this space, there's a little bit more understanding of what's going on out there. Besides the general economic concerns, or what sort of bearish events or anything in 2020 are you looking out for? What could actually derail the market as opposed to just temporary volatility?

SH: Analyzing in shipping markets, the supply side is easy to get your hands around, and we're fortunately in a situation where there's not that many new tankers being delivered into the fleet this year. And importantly, for the first time in a long time, we do have significant numbers of ships that are ready for retirement, they're sort of reached the end of their economic life. So, that really means that we're not going to have a destruction of this market from the supply side. So, then if it is to come down hard, it's going to be because of demand. So that would be a type of a macro event that could derail it if we saw significantly weaker global economic expansion. And if we, for some reason went into further inventory draw downs for oil, that would be a negative. But to remind everyone, we've been in an inventory drawdown for quite sometime and we were not really as very high inventory level. So, we think it's a small probability of a surprisingly short-lived cycle at this point. So, we continue to be optimistic, but, of course, you should never rule out the tail end scenarios.

JM: It definitely makes sense to pay attention, right, to the global macro fundamentals, as well as looking at the order book and so on. And we're hoping the order book stays low at the order book numbers are very, very promising now, as long as we don't see a rapid pickup in orders and, of course, if we do see a rapid pickup in orders this would be for late 2021 or later, but still, right, we want to see this market stay strong as long as possible. So, that is something to look out for. As is we have the recent surge in rates and the recent surge in cash flow at DHT, you've kind of outlaid your scrubber strategy, right? But can we talk about the rest of your capital allocation priorities? I understand you're going to pay a variable dividend. What other priorities do you have in this market? Are you looking at debt reduction? Are you looking at secondhand purchases, potentially the new builds? What sort of stuff are you looking at with that cash?

SH: Our policy on this is very straightforward and it has been in place now for five years, has not been changed. It has not been changed during that timeframe. So, we're saying that minimum 60% of ordinary net income is to be returned to shareholders every quarter. And that would typically mean cash dividends. And then the question really becomes, what about the other 40%? And maybe the delta between cash flow and P&L? Well, we're pretty clear on that. In this point of the cycle, our preference or priority is to strengthen the balance sheet. We're not looking to add ship – ships to the fleet. We think the time you should buy is really now behind us, it's in the trough of the market. That's when you make the good acquisitions.

Values have come up enough for us to sort of take the foot off the accelerator, and the excess cash flow is going to be used to really prepay that. And why do we do that? Simply because we think in order to survive the cycles and in order to maximize how you do to countercyclical investments, you need to have a very strong balance sheet in the next downturn, because that's the only way you're going to be able to pick up the [dirt cheap assets]. If you pay out everything and you're dependent on raising equity at the bottom of the market, well, that's going to be a massively diluted equity offering. So, we are very focused on building the strongest possible balance sheets to the upcycle, but, of course, at the same time returning very handsome 60% to shareholders.

JM: Yes, certainly are responsible and balanced approach. Of course, your balance sheet is quite strong already. We have debt to assets sitting in the mid-40s. And then, of course, your convertible bonds are very close, right, to that takeout option. I know my understanding is, it's a 130% of the conversion multiple, which I'm not sure if we're at it today or yesterday, but the last few weeks we were at or above those levels. So, if you do the convertibles, that brings you down to, I think, in the mid-30s your leverage. What sort of target leverage do you have for the company then is it? Am I basically hearing you correctly that you're – you would strive to get as close to zero net debt as possible, or is there may be a point at 25% or 30%, where you say, okay, the balance sheet is stable enough here?

TM: I think the balance sheet is plenty stable enough where we are today, but you need to think a couple of turns ahead. And so, our objective for leverage depends on where we are in the cycle. And we would like to come into a bear market or into the next downturn ideally with zero debt. And let's be frank, if you have zero debt, you can pay meaningful dividends even in the trough market, because cash breakeven at that point is going to be around [indiscernible] a day. And if you look at historic numbers, the worst three years over the past 20, I think as per Clarksons, you have seen average rates in the very high teens.

So that means $8,000, $9,000 per day per ship in distributable cash flow, and 60% of that is not going to be so bad even in the bottom of the market, but the point is that you then have a – if you get to a debt-free fleet, you can lever up on that in order to buy the assets when everybody else is just running for cover or scrambling to make ends meet on the cash flow. That's why we're wanting to delever in the good times. When you get into the recovery, then it's fine to have leverage, of course, like we had going into this one.

JM: Yes, of course, it – in the perfect executed cycle, you would have, of course, right, zero net debt, or even just a positive cash balance right in the trough. And then as the market starts crashing, you have no debt than you would lever up by very cheap assets. And then as the market starts accelerating, your leverage would be quite high, or at least higher, right? And then, of course, that leverage comes down. So, that would be the perfect way to play it academically speaking, and it's good to see that you are taking a prudent approach to it. With a payout policy of 60% of earnings, you're retaining, like you said, you're retaining 40% of earnings, plus you're also retaining right, the delta between that depreciation. So, it's a pretty significant amount of deleveraging that plays out. I did mention the convertible notes, real quickly. Can you remind us, just from your perspective, how those come into play in your capital structure? Is there a chance that those would be converted in the near-term?

SH: And the strike is certainly well below, where the stock is trading, but I think, thinking ahead, this is sort of a type of capital that strategically doesn't need on our balance sheet. So, our game plan is to take it out when it falls to, but, of course, it could convert before that and that's not in our hands. So – but the lessons from the last one we had was that, it didn't really convert until the due date. So, it was trading in the market. And that's sort of the way for people to make money on it.

JM: Yes, we'll see what transpires in the markets there. I believe there's a provision that allows it to be taken out at 130% of the strike, which we're pretty close at this point, but I guess we'll just have to see how that transpires. We've talked a lot about the current market, we talked about capital allocation priorities. Is there anything, I guess, that we're missing, big picture here in the markets in terms of, both IMO 2020 and current rates that you think the broad market just isn't quite understanding at this point?

SH: I think all the talks about IMO 2020, Costco sanction, all these [indiscernible] sort of charities and talk in the market, but fundamentally looks very, very healthy. And so, we think we are sort of in the early phase of this recovery. And certainly, if you look at the way the business is positioned, it’s reflection of us being bullish for this year and next, at least, and everything is sort of really sort of lined up to be very rewarding for people investing in package.

JM: Yes. It’s definitely, there's a lot of bullish sentiment, of course, in the – with the owners and some of the more long-term investors, but it does seem like the broad market is far more skeptical. It doesn't seem like we've had that sort of pickup yet. We had a lot of momentum traders that sort of hopped on the last couple of months, but even with, right, even with that boost in the stock prices, many of the names are still trading at or below NAV, right? So, there's definitely a disconnect, right, between the bullishness we're seeing from the companies and from the managements and from people like myself and from what we're actually seeing in the market. So, it'll be interesting to see how we can close that disconnect?

SH: Given that we are in a market, where most of us are thinking significant amounts of cash, you also have a little delay in seeing that cash being distributed to shareholders. So, once, earnings are reported, people declare the difference us in particular. This could, of course, change people's focus and see that this [is real].

JM: Yes, we're certainly hoping that's the case. And we're hoping that when your Q4 results come out, and you provide your Q1 guidance that the investors will see the enormous, right, earnings and dividend potential. I think, investors will also appreciate your balance strategy, right? Paying the dividends, being generous with that, but also being very – really conservative. Honestly, 40% plus depreciation is a rapid pay down considering how strong your balance sheet already is. One sort of market nuance I wanted to touch on is time charters. We have not seen a lot of time charters, either in one-year, or three-year rates or two-year or any of that, right? We we just haven't seen a lot of that. Where do you think the current rates are for those time charters? And at what point would you be willing to start to take some cover and balance your chartering strategy a little bit?

SH: The term market for large tankers is not very deep. So, the little activity, I think, most owners they are a little bit sort of apprehensive to do any of these, because it's not really different from being in the stock market, given the length of these voyages. There were only a few of these ahead of the markets at very low rates that we were certainly not interested in entertaining. So, if you look back at how we behaved in the last cycle, we did do some time charters, although a limited number, but we tried to do as much as we could. And in due course, we will certainly entertain that, but we do think it's a bit early and it has to have sort of a meaningful tenor to make sense to us. So – and we're not really promoting a price tag for time charters somewhat and what we want to do. So, we will manage this as the market develops. And do you think we have a customer base that includes clients that do like time charters? So, there will be some fixed income at some point in the industry, but it's a bit early.

JM: Yes. It seems like the bid/ask spread between what companies are willing to pay and what ship owners desire in this market is very wide. And it just seems like the one-year spread just has not found any bids yet. And, of course, as you mentioned, the longer-term two, three, four, five-year time charter market just doesn't really exist right at this point. So, it'll be interesting to see how that develops. I don't know if you can answer this. And if you can't, that's fine, but have you – in terms of reporting your Q4 results and Q1 guidance and that sort of thing, is that expected to be towards the end of the month? Or is that going to be a February event? Have you have you placed any that stuff on the calendar yet?

SH: No, we have not, but if you look back in past performance, so to say, we typically been in the beginning of the second month after the quarter-end.

JM: Okay. Yes, that's definitely the historical trend. And it sounds like we can continue to see sort of that same historical trend. Is that right?

SH: Yes.

JM: Excellent. I think we've covered a lot of stuff this morning. You do have provided interesting perspective from just that VLCC outline. I think we hit some of the IMO 2020 things. I know we – we've seen a little bit of panic in the stock market with the prices of shares kind of dropping the last week and I think folks not really understanding the volatility in the markets. I think we had a pretty good call this morning. Is there anything else that you would like to leave us with in terms of DHT and your positioning for the upcoming year?

SH: No, I think we just like to say thank you for showing interest in DHT and wish you a good day.

J Mintzmyer: Alright, excellent. Thank you very much, Svein and Trygve Thank you for joining us today.

SH: Thank you.

TM: Thank you.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: J Mintzmyer is long DHT. Svein Harfjeld and Trygve Munthe are employed by DHT. Nothing on this podcast should be taken as investment advice.