Okeanis Eco Tankers: The Best Fleet Plus Generous Dividends; Rating Unchanged (NYSE:ECO)

Note: I previously covered Okeanis Eco tankers (NYSE:ECO) in February 2024. In my note, I highlighted the company’s top-notch fleet, an average age below 5 years, and 100% scrubber availability. The ECO fleet consists of VLCC and Suezmax crude oil tankers. ECO distributes attractive dividends at a 14.2% TTM yield. Considering the company’s strengths, I gave ECO a Buy rating. Today, I discuss 2023 figures, the crude oil market, and the company’s valuation.

Crude tankers market update

ECO owns one of the best fleets in the tanker game. The company owns six Suezmax tankers and eight VLCCs, with an average age below five years. All ships are equipped with scrubbers. All tankers (crude and product) are in the expansion stage of the shipping cycle. The reasons are well known, such as low order books, an aging fleet, and limited shipyard capacity. The VLCC segment brings excellent risk-reward considering the growing tonne-mile demand for long hauls and VLLC supply dynamics (order book vs. age profile).

That is not to say the Suezmax or Aframax segments are unattractive—they are far from that. Aframax can carry clean products, so it benefits from product tanker dynamics. On the other hand, Suezmax tankers are more impacted by the Red Sea crisis than the other crude tanker segments.

The long-term impact on tonne-mile demand brings to attention the geographical dislocation between supply and demand. The supply is projected to grow at a higher rate West from Suez, while the demand is expected to increase faster East from Suez. The chart below from the last ECO presentation illustrates that.

India and China are the prime drivers in the East. India consumes around 5 million bpd (approximately 5% of the global consumption). As per IEA projections, India’s demand will reach 6.6 million bpd in 2030. To get context, one VLCC can carry 2 million barrels, while one Suezmax 1 million barrels.

India heavily relies on Russian oil imports. Since the last set of sanctions imposed on Sovkomflot, Russian oil imports have significantly declined. As per Vortexa, Russian oil imports reached 40% in May 2023. However, that number considerably dropped over the last months following the sanctions.

India is seeking to diversify its sources of crude oil, turning to the Middle East, Nigeria, and the US.

India’s shifting to other crude oil sources is one piece of the puzzle. The Red Sea crisis caused long-lasting effects on the shipping industry. Crue oil tankers are among the beneficiaries. Judging by the deepening strains between all involved players (Israel, Iran, and the US) and the lack of considerable success of Operation “Prosperity Guardian,” the Red Sea traffic will remain heavily reduced for the foreseeable future.

The company’s management discussed a potential OPEC+ output increase in its earnings transcript. This is bullish for tankers in general. Below is a quote from the transcript pointing to the effect of OPEC+ production recovery.

This should then lead to OPEC+ bringing back barrels sometime in the second half of this year. We estimate that the complete reversal of the voluntary and OPEC+ cuts will create an additional 48 VLCC demand equivalents, which is enormous. This will immediately impact the tanker market and can set us up for the market that we’ve all been eagerly anticipating.

As per Banchero Costa, the global fleet of VLCC tankers in January 2024 included 887 vessels. 48 tankers are equal to 5.4%, a significant number in an already constrained market.

2023 results discussion

ECO, with its new fleet, is taking advantage of favorable market conditions. The last earnings report is proof of that. In 2023, ECO delivered solid results following the rising TCE rates for VLCC and Suezmax tankers. FY23 Suezmax TCE grew by 25%, reaching $55,900/day. In 2023, ECO achieved $61,700/day VLCC TCE vs. $36,400/day in 2022. Fleetwide TCE reached $59,300/day in 2023, a 48% increase YoY. In the meantime, the company has kept the fleetwide daily OPEX in check. YoY, it grew by 10% from $8,242/day in 2022 to $9,096/day in 2023.

It is worth mentioning the revenue composition change. In 2023, ECO increased its spot exposure; 80% of its vessels were employed under spot contracts, while 20% were under time charters. For comparison, in 2022, the company employed 60% at the spot and 40% under time charters.

At the present stage of the shipping cycle, having more ships under a spot contract is beneficial. I credit ECO’s management for timing the shipping cycle. Having new ships with scrubbers further boosts the TCE rates, so I expect ECO to keep its day rates above the market averages.

For 1Q24, ECO reported that 76% of the available VLCC days are booked at an average of $73,900/day TCE, and 88% of the available Suezmax spot days are booked at $58,800/day TCE. For comparison, ECO achieved $45,200/day VLCC TCE and $45,600/day Suezmax TCE in 4Q23.

Robuts TCE rates and relatively stable OPEX results in record earnings. The table below from 4Q23 report shows ECO income statement highlights.

TCE revenue increased by 54% from $193 million in 2022 to $297 million in 2023. As pointed out earlier, ECO increased its spot exposure compared to 2022. This means higher voyage expenses (bunkering costs, stevedoring services, and canal transit dues). YoY voyage expenses increased by $35 million, reaching $109 million in 2023. In 2023, ECO realized $241 million adjusted EBITDA and $4.5/share adjusted EPS.

The cash flow statement looks equally impressive. ECO scored 112% operating cash flow growth YoY. In FY23, the company delivered $155 million unlevered FCF vs. $(116.8) million in 2022. ECO reached FCF/share of $5.41 in 2023.

The graph below compares FCF/EV yield on TNK Tankers (TNK), DHT Holdings (DHT), Nordic American Tankers (NAT), and ECO. The criterion for picking those companies is their focused approach, judging by their fleets. TNK has 25 Aframax and 25 Suezmax tankers; DHT owns 24 VLCCs; NAT owns 20 Suezmax tankers.

TNK leads the pack, but we must consider that the company has an 11% gross LTV and $363 million cash, resulting in an EV lower than the company’s market cap. The other companies have more leveraged balance sheets, so their EV exceed their market cap. That being said, ECO is the best performer with a 10.7% FCF yield.

Dividends

Ample FCF means generous dividend payments. In 2023, ECO distributed $159 million among the shareholders, leading to a 14.2% TTM yield. The company pays 100% of its FCF in dividends. Such generosity comes with its pros and cons. The dividend payment becomes tightly correlated with the TCE rates. This means the shareholders are 100% exposed to the TCE volatility. A strong market means lavish cash distributions, while in a weak market, probably zero. On the other hand, having a conservative payout ratio, around 50%, leads to lower volatility and more predictability of the dividend payments. It’s up to investors’ preference what they will favor: higher and volatile yield or lower and (relatively) stable yields.

Balance sheet

Owning a top-notch fleet comes at a price. ECO has a more leveraged balance sheet compared to its peers. The company has 170% total debt/equity and 64% total liabilities/total assets. On December 31, ECO reported a $50 million cash, $615 million long-term debt, and $693 million total debt. The company’s debt comes with an average SOFR + 3.15% interest rate. In 1Q24, ECO amended the terms on a few of the lease agreements in its favor, reducing the interest rates and pushing further the maturity dates.

In 2023, ECO incurred $57 million in net interest expenses. Over the same period, ECO delivered $201 million in operating income and $174 million in operating cash flow.

In my opinion, ECO times the market well. It is a clever move to take leverage in the middle of the expansion phase of the shipping cycle. Moreover, ECO has already received its ships, thus generating cash flows. In other words, ECO is not on the line with the other tanker owners to wait for new vessels. At one point, the new building will flood the market, causing a supply glut and leading to severe TCE contraction. This will not happen in the next few years, but eventually it will. In that window, ECO’s opportunity to reap considerable cash flows resides.

Valuation

ECO trades at higher multiples than its peers. However, we must consider company fleet specifics. The table below shows ECO, DHT, NAT, and TNK fleet specs, value, and leverage.

ECO trades at 120% PNAV and has a 49% gross LTV. In February, the company traded at 128% PNAV. Since then, its stock price has grown by 11%. The robust tanker market boosted ECO fleet replacement costs, resulting in a NAV of $820 million. For comparison, in February, it was $732 million.

When I published my previous note on ECO, the company traded at 3.6 EV/Sales and 5.9 EV/EBITDA.

ECO is not the most expensive company in its group. DHT scores the highest TTM EV/EBITDA, and NAT has the highest TTM EV/Sales. On the other hand, TNK is the most undervalued. Its major drawback is its fleet (age and lack of scrubbers), pushing the company’s valuation down. In my opinion, ECO is still attractive to buy even at PNAV, which is above 100%.

Investors Takeaway

ECO is an attractive stock for income-minded shipping investors. The company has the best fleet, considering its age and scrubber availability. Given its high exposure to the spot market, it plays the market well.

The ECO thesis comes with two more pronounced risks: declining demand for crude oil transportation and the company’s leveraged balance sheet. As pointed out in the first section, the tanker market is still in the expansion phase. An aging fleet, a record low order book, and limited shipyard capacity constrain the crude tanker supply side. Oil demand is projected to grow East of Suez, while oil supply is West of Suez. This translates into a growing tonne-mile demand for crude oil transportation. The Red Sea crisis adds more stress to the already strained tanker market.

In my opinion, ECO’s financial risk is well managed. The company generates excess liquidity sufficient to cover its debt obligations. In 1Q24, ECO amended a few of its lease agreement terms in its favor, further reducing the financial risk.

Owning a new fleet puts ECO at a significant advantage. The company is not pushed to renew its vessels. It can simply harvest cash flows while enjoying NAV appreciation caused by structural inflation.

ECO remains one of the best crude tanker stocks. Only the PNAV above 100% stops me from upgrading its rating to Strong Buy. I keep the ECO rating unchanged.