TORM - Earnings Call - Q4 2020

Transcript

Operator (participant)

Ladies and gentlemen, thank you for standing by, and welcome to TORM's Annual Report 2020. At this time, all participants are in listen-only mode. After the speaker presentation, there will be a question-and-answer session. To ask a question during that session, you will need to press star and one on your telephone. I would now like to hand the conference over to your speaker today, Finn Petersson. Please go ahead.

Finn Petersen (Investor Relations Manager)

Thank you for dialing in, and welcome to TORM's conference call regarding the fourth quarter 2020. My name is Finn Petersen, and I'm the Investor Relations Manager in TORM. As usual, we will refer to the slides as we speak, and at the end of the presentation, we will open up for questions. Please turn to slide two. Before commencing, I would like to draw your attention to our Safe Harbor Statement. Please turn to slide three. With me today, I have Executive Director and CEO Jacob Meldgaard, and CFO Kim Balle, and I will now hand over the call to you, Jacob.

Jacob Meldgaard (CEO and Executive Director)

Thanks, Finn, and please turn to slide four. First and foremost, good afternoon. Thank you all for dialing in. I'm truly happy to be here today as we have published a strong result here for 2020, and not least because we this morning have also announced the acquisition of eight MR vessels from Team Tankers in a partly share-based transaction, which we view as attractive. 2020 has indeed been a special year, also for the product tankers, impacted by the global pandemic and the related close downs. The product tanker market can for this year be divided into a brilliant first half and not so flattering second half. Consequently, the year ended at loss-making freight rate levels. Here in the fourth quarter, isolated, the product tanker fleet realized an average TCE rate of $12,863 per day, and for the full year 2020, the number was $19,800 per day.

In the fourth quarter, we realized an adjusted net profit of $-24 million versus a profit of $27 million for the fourth quarter in 2019. However, due to the already mentioned strong first half of the year, we realized an adjusted net profit of $122 million for the full year 2020 versus $51 million in 2019. Our return on invested capital adjusted for non-recurring items was 9.3%, and we have, over the year, distributed a total of $71 million in dividend to our shareholders. In parallel with us having the continued focus on commercial and also financial optimization, TORM has, over the past year, had a continued focus on our responsibility in terms of the environment, our social engagement, and our corporate governance, combined known as the ESG.

We have, as well as our stakeholders, experienced an increased focus on ESG over a period, and to accommodate this, we have decided to publish a separate ESG report for 2020. This report covers selected metrics which we believe are relevant for our business. In connection with the publication, we're glad to announce the CO2 reduction target for us, 40% by 2030, compared to a 2008 baseline. Here, by the end of 2020, we have achieved a 22% reduction through our continued focus on fuel savings. During the fourth quarter, we also sold one older MR vessel, acquired two 2000-built Deepwell MR vessels for a total consideration of $32.6 million. One of the vessels was delivered to us during the fourth quarter, and the second one was delivered here in the beginning of 2021.

Finally, I think I already mentioned, we're pleased to have announced a further expansion of our fleet with the acquisition of eight MR vessels from Team Tankers. Here, on the next slide, I'll elaborate on this specific acquisition. Please turn to slide five. As mentioned, we announced today that we purchased these eight 2000-built to 2012 MR vessels, a total cash consideration of $83 million, and we'll issue just around 6 million shares. With the share price as of 26th February, the total net contribution amounts to $132 million, which can be compared with the broker valuation of the fleet of $148 million. As such, the transaction is assessed as attractive to TORM. To finance this acquisition, we have obtained a commitment of up to $94 million from our existing lenders on what we deem as attractive terms.

As such, the transaction will, in large, be cash neutral to TORM. Six of the vessels we're taking over have specialized cargo tank configurations and extended tank segregations that allow for enhanced trading flexibility through chemical trading options. The vessels will still be operating within our existing One TORM integrated platform, and the increased scale will lower our admin cost by approximately $175 per earning day, thereby creating annual synergies of around $5 million. Also, what we've tried to illustrate is that this transaction will increase our operational leverage, ensuring greater potential to leverage a potential market increase. Now, let me turn to some of the drivers in the product tanker market specifically. Here, please turn to slide six. The COVID-19 has really sent the product tanker market on this roller coaster ride I mentioned before.

Benchmark freight rates, reaching the all-time highs in the second quarter of last year, and now, as we said, it's come down to the levels below the $10,000 per day mark. Obviously, there are a number of different drivers behind this development, but a large part of this can be explained by movements in the product stockpiles, and here, please turn to slide seven, so we can really talk about two phases in stock development. The first phase, which is the stock building phase, started with the unprecedented shock to the global oil demand as a result of the COVID-19, at the same time as refinery runs were slow to react to declines in demand. This led to unprecedented inventory builds, which benefited the product tanker market in the second quarter of last year in the form of floating storage and also trading inefficiencies.

The second phase, the stock growing phase, started along with the rebalancing of the oil market as lockdown measures were relaxed in many parts of the world, and the oil demand rebounded from the lows reached back in April. As refinery margins remained very weak, refinery runs did not ramp up as fast, and we moved into a stock growth phase. This meant unwinding of floating storage, which released a large number of vessels into the market and reduced the demand for transportation. This is the phase where we are right now, further aggravated by renewed lockdown measures in many parts of the world due to a second wave of COVID-19 cases and the emergence of new, more transmissible variants of the virus. This has resulted in a temporary reversal in oil demand recovery and strengthened the short-term headwinds for the product tanker market.

On top of that, a weak crude tanker market is adding the pressure in the form of two cleanups and crude cannibalization, the combined effect of which is reflected in the current low freight rate environment. Here in TORM, we primarily employ our vessels in the spot market. However, in light of the anticipated market developments, we chose to increase our coverage significantly. For our fleet of 19 LR vessels, which traditionally are the ones most affected in the weaker crude rate environment, we have covered 84% of our days in the first half of 2021. For a fleet of 52 MR vessels, we have today covered 63% of our exposure in the first half of the year. The obvious question is, when can we then expect to see the market turning?

It's truly difficult to estimate the exact timing, but the inflection point is, in our opinion, to be reached once the countries reopen, the demand recovery gains momentum, and product stocks return to more normal levels. Slide eight, please. As I already mentioned, renewed lockdowns have negatively affected the oil demand recovery in recent months. Especially Europe has been hit hard, where we've seen the oil demand declining compared to the levels seen at the end of 2020. Nevertheless, we remain confident that with the acceleration of the vaccine rollout, the virus gets under control and the affected countries reopen. This will lead to wider recovery in the macroeconomic activity and in underlying oil demand.

And indeed, if we look at countries which have not experienced a similar large-scale reemergence of infections like China, like India, these countries have seen a demand comeback to pre-COVID-19 or almost pre-COVID-19 levels in recent months. It is most likely that there will be a difference in how fast regions will progress with vaccinations, and many developing countries might lag behind here. But I think that we can presume that Europe, North America, OECD Asia will reach some kind of herd immunity by coming summer. And if we combine these regions together with China, with India, this covers as much as two-thirds of the global oil demand. Please turn to slide nine. As I mentioned earlier, we are in the stock growing phase, which is normally associated with headwinds to the tanker market.

However, if we look at the latest floating storage and onshore inventory data, we can see that floating storage is almost back to what we consider a normal level, and onshore product inventories at main trading hubs are well below the peaks reached over the summer, although not completely back to the pre-COVID levels. From a shipping perspective, this case is further strengthened by inventories largely being in the right places. A good example here is high diesel inventories in the U.S. Gulf and Asia, which are likely to be exported to other regions at a later point in time. This suggests that much of the stock growing is actually finalized, meaning less headwinds once demand recovery really gains momentum. Now, please turn to slide 10.

If we turn to more medium and long-term market drivers, the COVID-19 pandemic has accelerated the pace of refinery closures, with around 2 million bbl per day of refining capacity having closed down and another one million per day potentially at risk of closure. Most of this capacity is located in regions which already are large importers of refined oil products, such as Europe, U.S. West Coast, U.S. East Coast, Australia, New Zealand, and also South Africa. At the same time, approximately five million barrels per day of new capacity is scheduled to come online, mainly in the Middle East and China, the regions that already today are large exporters of refined products. Both these developments are positive for trade flows and for ton-mile in the post-COVID-19 world. There are only a few projects which are less positive for trade, most notably the large-scale Dangote refinery in Nigeria.

To illustrate the significance of the mentioned refinery closures, refineries at risk account for 5% of the total refining capacity in the world's largest diesel importing region, Europe, 12% of the U.S. West Coast, and 28% of the U.S. East Coast capacity. I kindly ask you to go to slide 11. For Australia and New Zealand, the figures are even more significant. Two out of four refineries in Australia are closing down, and the sole remaining refinery in New Zealand is most likely to be closed down as well. If we take just these three refineries in Australia and New Zealand, a closure of these could potentially mean the need for at least 35 and all the way up to 55 additional MR vessels per year to replace lost local supply by imports once the oil demand in these countries recovers to the pre-COVID-19 levels.

Some of this demand would likely also benefit LRs, and the additional imports will be taken over by both traditional and new suppliers in Asia, but increasingly also from new refineries in the Middle East. Please turn to slide 11. This positive outlook for the demand for product tankers in the next three years-five years coincides with the supply side, which is the most supportive for at least 25 years. The orderbook-to-fleet ratio for product tankers is currently at a historically low level and only covers 7% of the total fleet. This has been further supported by the relatively low interest for newb`uilding ordering in 2020 as a result of the uncertainties due to COVID-19, as well as the future propulsion systems of the vessels, although we recently see increasing interest for the crude tanker segment.

As a consequence, we expect the fleet in the next two years-three years to grow on average between 2%-3% a year, half the pace of fleet growth seen over the past five years. To conclude our remarks on the product tanker market, TORM expects to see volatility in the market in the short term related to the COVID-19 and its impact on the global oil markets and economic activity. Aside from the COVID-19 effects, we see that a number of key market drivers for the next three years-five years will remain positive, such as the refinery dislocation, the low order book, which will provide support to product tankers over the longer term. Following the market dynamics, I believe TORM is well positioned to both maneuver, utilize potential opportunities in the current low market environment through our strong capital structure.

As the market will return, I further believe we are well positioned to utilize any market strength through our operational leverage and integrated platform. Please turn to slide 13. Looking specifically at TORM's commercial performance, I'm pleased that we again, in the fourth quarter of 2020, in the largest segment, the MRs, have outperformed the peer group average. In the third quarter of 2020, we achieved rates of $11,243 per day compared to peer average of $9,699 per day. This translates into additional earning of $9 million in the fourth quarter alone and $45 million for 2020. In general, I'm very satisfied with that TORM's operational platform continues to deliver very competitive TCE earnings. Now, I ask you to turn to slide 14, please.

A key deciding factor for delivering the above-average TCE earnings is driven by our continued focus on positioning our vessels in the basins with the highest earning potential. In the fourth quarter, we had a slight overweight east of Suez in line with the general market, and here, I'll now hand it over to my colleague, Kim, for further elaboration of our operational leverage, the cost structure, and of course, the balance sheet.

Kim Balle (CFO)

Thank you, Jacob. Please turn to slide 15. With our spot-based profile, TORM has significant leverage to increase the underlying product tanker rates. Already by the end of 2020, we had taken a relatively large coverage for the first half of 2021 as protection for the current weak markets. We are significantly more exposed to cater for a stronger market towards the end of the year.

To illustrate this, as of 31st December 2020, a $1,000 increase in the spot rates for the first quarter of 2021 would translate into an increase in profit before tax of around $3.5 million U.S. dollars. And in the fourth quarter of 2021, the corresponding number was $6 million. And as Jacob mentioned, the acquisition of the eight MR vessels adds further operational leverage. Please turn to slide 16. Before the acquisition of the eight MR vessels from Team Tankers, we had about 27,000 open earning days annually. With the additional vessels, our earning capacity will increase to close to 30,000 days annually. And during Q1 2021, we have further de-risked our earnings downside in the current weak market by lifting the coverage to 85% of earning days for Q1 2021 by 23rd February at a weighted average level just below $13,000 per day. Please turn to slide 17.

To balance our operational leverage, a key focus for TORM is to maintain a solid capital structure with conservative leverage. Combined with our strong operational performance that has generated a solid cash flow, this conservatively has enabled us to execute on our ongoing fleet renewal program while at the same time returning a significant portion to shareholders in form of dividends. In 2020, this was illustrated through TORM returning $63 million from our earnings during the first six months of the year. We believe that this approach supports a long-term value generation for TORM and has enabled us to take advantage of attractive opportunities in the market as they arise, such as the just-announced purchase of eight MR vessels. Please turn to slide 18. I would now like to review our financial position in terms of key metrics such as net asset value and loan-to-value in a little more detail.

Vessel values have decreased by around 3% during the fourth quarter of 2020, and the value of TORM's vessels, including new buildings, was just around $1.6 billion as of 31st December 2020. Outstanding gross debt amounted to $846 million as of 31st December 2020. And finally, we had outstanding committed CapEx of $101 million related to our new building program and cash of $136 million as of 31st December 2020. This gives TORM a net loan-to-value of 51% at the end of the fourth quarter, which we consider a conservative level. The net asset value is estimated at $801 million as per 31st December 2020, and this corresponds to $10.8 or DKK 65.7 per share. And just before commencing this call, TORM's shares were trading just below DKK 49. In short, we have a balance sheet which provides us with strategic and financial flexibility.

And on the following slides, I will give some more insights into our liquidity position, CapEx commitments, and our debt profile. So please turn to slide 19. As of 31st December 2020, TORM had available liquidity of $268 million, cash total $136 million, and we had on-drawn credit facilities of $132 million. Including the financing related to our recently purchased 2010-built MR vessels that we have already drawn on in 2021, our liquidity was at $295 million. The total CapEx commitment relating to our new buildings was $86 million as of 30th December 2020. In addition to the CapEx related to our new buildings, we also expect to pay $20 million for retrofit scrubber installations on vessels on water and for the last 2010-built MR vessel. The second 2010-built MR vessel has been delivered in the first quarter of 2021 and financed, as mentioned.

We have not included the Team Tanker transaction in the overview, but you can enlarge assume that the transaction is cash neutral. With TORM's strong liquidity profile, the CapEx commitments are fully funded and very manageable, while the liquidity position at the same time provides room for purchasing new opportunities should they arise. Please turn to slide 20. After having finalized the refinancing in the beginning of 2020, we have eliminated all major refinancing until 2026, which provides TORM with financial and strategic flexibility to pursue value-enhancing opportunities in the market. As displayed, we do not have any major repayments until 2025, which remains when taking the eight MR vessels purchase into account. And with that, I will let the operator open up for questions.

Operator (participant)

Ladies and gentlemen, we now begin the question and answer session. If you wish to ask a question, please press star one on your telephone.

We have our first question from the line of John Chappell from Evercore.

John Chappell (Managing Director)

Thank you. Good afternoon, everybody.

Jacob Meldgaard (CEO and Executive Director)

Good morning, John.

John Chappell (Managing Director)

Two questions today. Let me start with Kim on the topic that you were just discussing. So with the liquidity, the CapEx commitments, even this new acquisition announced this morning and your debt amortization schedule, it does seem like you still have spread liquidity to be opportunistic. But given maybe the tale of two halves for the market this year and the depths of the downturn today, I'm just wondering how you think about your actual firepower today, whether it would be to acquire additional ships or stock or et cetera. What do you think the true spending power of the company is today when we're still bouncing along the bottom of the market?

And then maybe in 12 months' time, assuming Jacob's presentation on the market plays out and we're in a much stronger underlying market, how do you think about the leverage to continue to invest at this part of the cycle?

Kim Balle (CFO)

Thank you, Jonathan. That's a very good question. First of all, I think the transaction today demonstrates that we are in the market as we've also talked about all through 2020. So when the opportunities are there, we are also there. And we are quite happy that it is a partly share-based transaction. I also mentioned it is cash neutral as such. So while having a leverage of around 50% and with the markets we are looking into, we are still there. We still have the conservative capital structure. Of course, we constantly evaluate and test, and we have a policy on our capital structure measures.

So we actually find that should anything arise, we are still in the market for opportunities. And as also both said and demonstrated with the presentation, with the coverage and the increased, or you can say, decoverage by the end of the year, we are a firm believer in that the market will, at the post-COVID-19 or after we have seen the rollout of the vaccines, we are looking into much brighter markets. So we are definitely still there. So I think instead of putting a number on how much, it's more our leverage I would be guided by.

John Chappell (Managing Director)

Right. That makes sense. And my second one, Jacob, for you, maybe a little bit of a multi-parter, but just trying to tie everything together. So another acquisition of vessels that were built between 2007 and 2012, the two MRs from the last call were 2010.

I understand that's probably the sweet spot from a return perspective, just given the age of those vessels, the limited debt associated with those, and from a return perspective, it probably looks much better than a newbuilding or even a prompt ship today. However, you rolled out the ESG report today, and as we start to think about the next stages of decarbonization, for everything that we're to understand, you would obviously know a lot better, maybe the older ships are less efficient when it comes to that. So can you just help us tie together balancing returns on capital versus thinking about the next stage of evolution in the company when you're investing in assets across a different age spectrum?

Jacob Meldgaard (CEO and Executive Director)

Yeah. Excellent tie-up. Thanks for that, John, and obviously, in management and with our board, this is exactly the balancing act that we are constantly discussing.

I think it's clear, at least in our calculations, that currently, if you were to clear a deal, sort of the sweet spot, whether it's 10 years or just around, that's probably the age group where, on paper at least, you get most value for your buck and that the return on invested capital, as you point to, in our opinion, with the current pricing, makes most sense. Then I think we see it as two things in terms of then these vessels' suitability to the platform. One is, how does it fit with our customer needs? So will these assets for a longer period actually be something that is meaningful on a platform? And there, at least up until now, we've seen that we can spread our assets, I would say, up to somewhere between 17 years-20 years, and we get a superior return from that.

That may obviously change over time, but that's at least how we see it. That seems to be a model that is working well for us. Last year, we sold eight vessels. The average age of those eight were actually, by coincidence, just 17.5 years. So I think that's kind of we're still playing that out that we need to live up to the quality and safety needs of clients and provide the right tools for the job. And we need to combine that, first and foremost, with the economic return to our shareholders and to our owners. Now, the last piece in the puzzle is ESG. This is about efficiency. Yes, clearly, some efficiency derives from the simple fact of technology on ships becoming better over time. So let's say a vessel built in 2000 versus one built in 2022, there are certain technological advances.

But for our case, we see it as if we can make actually a meaningful difference by having our platform where we have already lowered 22% of fuel consumption from what is the benchmark in 2008 up until 2020. We have further targeted to lower it by 2030 to 40% on a relative basis. And that is not age-specific. That is something that you can do on all vessels. And another example of that is actually, I think there's two that I can tie this to, is that on ESG, that we are committed to constantly driving down the CO2 emissions, irrespective of vessel age, which is also part of our funding, where we have sort of a mechanism whereby living up to these criteria around still further decreasing on our fleet with our bank group, we will get a lower margin, whereas we will be penalized.

And we're ready to take sort of this arbitrage between getting to the right place with our existing assets, doing the right thing, lowering the CO2 footprint, and gaining an economic advantage versus, of course, that when we are not capable of living up to those targets, that we will be penalized. So all in all, I think for us, this ties well together. And strategically, I'm comfortable with this over the coming years. And of course, we need to adjust. But I don't see these vessels as being obsolete in any way in the coming years for our trading platform.

John Chappell (Managing Director)

Got it. Very helpful.

Jacob Meldgaard (CEO and Executive Director)

That was a long answer to a simple question, but I hope it puts some granularity on.

John Chappell (Managing Director)

Well, I don't know the question was that simple. That was a thorough answer to an important question. Thank you.

Jacob Meldgaard (CEO and Executive Director)

Thanks.

Operator (participant)

Thank you for your question.

We have another question from the line of Anders Wennberg from Cattela. Please go ahead. Your line is open.

Anders Wennberg (Portfolio Manager)

Hello. I'm Anders here. I just wonder about the acquisition. Why are you partly paying with shares given that your stock is trading below net asset value? And you have a 25% discount or something like that to net asset value. Can you elaborate a little bit on that? Why is that not diluted?

Jacob Meldgaard (CEO and Executive Director)

Yeah. Thanks for that. Well, we actually issue a specific number of shares. And if you go back to our announcement, it's about 6 million shares. And they are not issued at the going price in the market. If you turn to slide 5, you'll see that the net contribution with the share price is $132 million.

If you take the value of the, obviously, cash is cash on cash, and then you take the new share, TOM shares issued, then it comes to $132 million versus a valuation of $148 million. So we have this discount in the share issuance embedded in the number of shares that we have negotiated.

Anders Wennberg (Portfolio Manager)

Okay. Thanks.

Operator (participant)

Thank you. We have a next question from the line of Ulrik Bak from SEB. Please go ahead.

Ulrik Bak (Equity Research Analyst)

Yes. Hello, Jacob Kim and Finn. Thank you for taking my question. Now that the bunker spread has increased between high and low sulfur, has that impacted your view on scrubber investments? I know you have a large share of your fleet, which has scrubber installed already. But with the widening of the spread, has that changed your view? And also, if you can touch upon the day rate delta between your scrubber-fitted and non-scrubber-fitted vessels at the moment.

Jacob Meldgaard (CEO and Executive Director)

Yeah. Thanks a lot for that question. So taking it a step back, then we have looked upon the scrubber program we have where we made a total investment of about $100 million. We looked upon that as being a strategic move. That was something that we actually decided upon a couple of years ago that it would be the right thing for us to balance this strategically. And we've come up to 50 vessels in our fleet where we do have a scrubber. And then, as you point to, I think since the introduction of scrubber and high sulfur versus low sulfur in the early part of 2000, we've seen first a high spread, more than $200, close to $300 in the beginning phase. Then end of last year, it came down to $50-$70 depending on the geographical location of the world.

Now, again, we are back above $100, and it seems to be a tendency to rising. But we have really not made the decisions around this based upon the daily spot spread. We've made a strategic choice. Currently, we are very happy with this investment program, and I don't have any particular plan strategically to reopen that at this time. That may, of course, change if and when we saw that these spreads would go further up. We have, by virtue of having our own production, we have a short lead time to getting a further scrubber program and further installations. But there is no plan for that right now.

And on your point about earnings, well, then I think it's clear that on larger vessels, I think the daily spread is, let's say, around $3,000 currently between scrubber and non-scrubber, and it's somewhere between $1,500 and $2,000 in the small segment in the MRs.

Ulrik Bak (Equity Research Analyst)

Okay. Thank you. That's very clear. Then my second question is about scrapping, which has been very low historically compared to, yeah, the historical average this year so far. And that's despite having a low-rate environment, fairly high scrap prices, and also an aging fleet. So what is your view regarding the scrapping tendency and what might be the trigger point for owners to increase the scrapping?

Jacob Meldgaard (CEO and Executive Director)

Yeah.

So we have communicated throughout that we see the current average scrapping age, which is somewhere at 24 years, 25 years for this type of vessel size, that we do not see that that would materially change even in a down market. So we are still the modeling we have is that when you talk about scrapping, that our models scrap the vessels on average when they're around 24 years, 25years. And we have not lowered the average scrapping age, which would, of course, in turn, take away capacity from the market. But from our experience, what happens is that when the vessels are taken out of, how can I say, the global trading market at the age of, let's say, around 20 years, then these vessels are utilized in different segments, more as storage or as very local trade vessels.

So they only disappear from our list once they are at around the age of 24 years, 25years. So we're not taking sort of a hockey stick on this, which would, of course, be beneficial to the market, but we are not of the opinion that that is a realistic scenario.

Ulrik Bak (Equity Research Analyst)

Okay. Very clear. Thank you. No further questions from me.

Operator (participant)

Thank you for your question. I would like to remind the participants that if they want to ask a question, they have to press star one on the telephone keypad. There are no further questions at the moment.

Finn Petersen (Investor Relations Manager)

We have one question from the web regarding our coverage of LR2s and MRs in the second quarter as well as in the first quarter. Which levels are you fixed in the second quarter is the question.

Jacob Meldgaard (CEO and Executive Director)

Yeah. We can definitely touch upon that.

So as I already alluded to, we took a strategic decision to come into the year with significantly higher cover than what is usual for our platform. And for the LRs, we have a high cover for LRs in Q2, which is at freight levels that are above what we have declared today for Q1 in our announcement. In the MR segment, we have less cover. But again, the cover we have is above the Q1 quoted levels that we came out with today.

Finn Petersen (Investor Relations Manager)

Thank you very much. And there's no further question. So this ends today's call. And thank you all for participating. And we're looking forward to see you again or hear you tell you about the Q1 later this year.

Operator (participant)

That concludes the conference for today. Thank you for participating. You may hold this conference.