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Rally in product tanker stocks to be short-lived

Product tanker stocks have climbed in the last month (23 October to 25 November) mainly driven by a rally in the global equity markets and seasonal strengthening of product tanker freight rates. DMFR product tanker index rose 16.9% since 30 October, while S&P 500 increased 11% and Baltic clean tanker index grew 19.2% in the same period. After record high earnings in 2Q20, company earnings dipped in 3Q20 as spot shipping rates declined. We delve deeper to find whether fundamentals support the recent rally in product tanker stocks.

Earnings coming off from the peak in 2Q20
Results of product tanker companies benefited from higher TCE in 3Q20 compared to 3Q19. However, their net income in 3Q20 was lower compared to 2Q20 with declining freight rates. Product tanker freight rates fell in 3Q20 mainly because the tankers that were earlier employed for floating storage are returning to active trade at a time when their demand has weakened. Product tanker trading fleet has grown at 4.3% between end-2019 and October 2020, which is resulting in oversupply. We believe TCE rates for product tankers companies were closer to their cash flow breakeven in 3Q20. We expect cash flow breakeven to range between USD 13,500pd and USD 16,500pd.

Fixed chartering strategy pays off
In 3Q20, D’Amico recorded the highest operating margin among the major product tanker companies due to its strategy of deploying the majority of its vessels on long-term charter. D’Amico had 63.5% of its total employment days in 9M20 covered through time charter at an average daily rate of USD16,041pd. In comparison, other product tanker companies (Ardmore, Scorpio Tankers and Hafnia) had the majority of their vessels employed in the spot market. Shipowners with larger product tanker vessels such as LR2 and LR1 benefited from the demand of these vessels for floating storage.

Product tanker stocks surge in line with global equities
After lacklustre returns for the majority of the year, DMFR product tanker index has surged 16.9% in November (as of 26 November 2020). Ardmore is the best performing stock, having gone up 17.1% during this period. While we believe the rally in product tanker stocks is in line with global equity markets, part of the rally is attributed to the seasonal strength in product tanker rates. Global equity markets have rallied on the hopes that the COVID-19 vaccine will soon be available as well as the potential stimulus with the new government taking charge in the US. The Baltic clean tanker index (BCTI) has gone up 19.2% from the lows of October because of seasonal demand, but product tanker rates are still lower for 4Q, which is considered a strong quarter for these vessels.

Product tanker prospects remain weak
Despite the recent strength in the product tanker market, we expect it to weaken in 2021 due to low demand for oil products. We project the rates for these tankers to dip in 2021 on average as in 2020 rates benefited from the cushion of supply inefficiencies. The ongoing lockdown in the UK and other parts of Europe will hamper product tanker demand in the rest of 2020 and in 1H21. Moreover, oil products demand is unlikely to return to 2019 levels before 2022. In such a situation, the medium-term outlook is also bearish for the product tanker market.

Rally in product tanker stocks to be short-lived
Given our expectations of a weaker product tanker market in 2021 and bearish medium-term outlook, we believe the ongoing rally in product tanker stocks is unlikely to last. In 1H20, product tanker owners saw a massive jump in profits, but we project earnings to be lower in 4Q20 and in 2021.
Source: Drewry

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