Nordic American Tankers Ltd (NAT)

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Nordic American Tankers: A Taste Of Peak Oil Demand And It's Not Nice

Mar. 31, 2021

Summary

Nordic American Tankers reduced their dividends done to the bare-bones early in 2021 following a very rough end to 2020.
During the fourth quarter of 2020 they saw their earnings and operating cash flow turn negative.
Whilst this downturn is due to the oil market rebalancing, the bigger implication is that it provides an insight into their medium to long-term future.
One day oil production will peak and thus demand for oil tankers will terminally decline and likely cause significant financial pain since the industry lacks the ability to coordinate.
Whilst they might make a suitable short-term contrarian rebound investment, given the cloudy long-term outlook, I believe that a neutral rating is appropriate.
Introduction
Since last discussing Nordic American Tankers (NAT), they have reduced their dividends once again and thus suppressed their yield down to a low 2.50%. Even though they seem superior to other oil tanker companies they could not defy the worst industry-wide downturn in over two decades, as my previous article discussed. A follow-up analysis is provided within this article that now includes their subsequently released financial results for the fourth quarter of 2020, which provide insights into their medium to long-term future.

Executive Summary & Ratings

Since many readers are likely short on time, the table below provides a very brief executive summary and ratings for the primary criteria that was assessed. This Google Document provides a list of all my equivalent ratings as well as more information regarding my rating system. The following section provides a detailed analysis for those readers who are wishing to dig deeper into their situation.


*There are significant short and medium-term uncertainties for the broader oil and gas industry, however, in the long-term they will certainly face a decline as the world moves away from fossil fuels.

Detailed Analysis
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Instead of simply assessing dividend coverage through earnings per share, I prefer to utilize free cash flow since it provides the toughest criteria and best captures the true impact on their financial position. The extent that these two results differ will depend upon the company in question and often comes down to the spread between their depreciation and amortization to capital expenditure.

On the surface 2020 appears to have been a blockbuster year with operating cash flow of $111m surging well above the $53m generated during 2019, but alas this only tells half the story. Their time during 2020 saw two extremes, earlier in the year they generated boatloads of cash as the historical oil oversupply lead to a massive demand for floating storage. Whereas later in 2020 they saw a severe downturn as oil production was reduced and thus demand for oil tankers plunged. During the first nine months of 2020 they generated $125m of operating cash flow, thereby meaning that they burnt $14m of cash just to operate during the fourth quarter of 2020.

This very rough quarter was not simply limited to their cash flow performance since it clearly translated over to their accrual-based earnings, as the financial statement extract included below displays. It can be seen that their operating income for the fourth quarter of 2020 was a loss of $22m versus a profit of $21m during the equivalent time of 2019.



It was of little surprise that they reduced their dividends to the near barebones following this painful end to an otherwise profitable year. Although they will one day see a recovery, sadly the timing is impractical to ascertain given the high underlying volatility of daily oil tanker charter rates that underpin their industry, as was further discussed in my previously linked article.

Whilst this downturn is already less than ideal, it should only prove temporary as the oil market normalizes following the historically unprecedented Covid-19 inspired crash of 2020. This means that the bigger implication from this downturn is actually catching a glimpse of their possible medium to long-term future once the world passes peak oil demand and thus causes seaborne oil trade to enter a terminal decline. Although the exact timing of peak oil demand remains unknown, it certainly is coming and could easily eventuate this decade, as per the graph included below.

Admittedly oil tanker companies may be spared some of the initial pain as the higher-cost oil producers in North America face the majority of the early supply reductions. Although given the overall terminal decline, the oil producers in the Middle East and elsewhere will still be forced to slash their production and thus reduce seaborne oil trade.

There is no OPEC cartel for oil tanker companies to coordinate the retirement of vessels and thus it stands to reason that the industry will fight itself with an ‘everyone for themselves’ attitude to keep their vessels in service in order to capture more of the remaining market. This will naturally force the weakest companies out of the market first, which is essentially the basic idea underpinning how market-based economies function.

It should also be remembered that once reaching this point where oil demand has peaked, it will be continuously declining and thus presenting a scary reality that the downturn for oil tankers will be permanent. Instead of having the occasional bad quarters that they currently face, it would likely flip the other way whereby they have the occasional good quarter that is separated by far more bad quarters. The final and most important aspect to remember with any investment is that even though they might survive, it does not necessarily mean that they will provide a suitable investment versus other options.


Following their very rough fourth quarter of 2020, their net debt increased to $299m versus its previous level of $272m at the end of the third quarter. If nothing else, at least they have retained a sizeable cash balance that should help ensure that their liquidity remains strong and thus provides a buffer to help them remain a going concern despite seeing negative earnings.

Whilst one quarter of negative operating cash flow is already undesirable, if this were to last for a prolonged period of time then their net debt could easily spiral quickly out of control. If they were to continue burning cash at the same rate as the fourth quarter of 2020 at $14m per quarter, this would equal negative operating cash flow of $56m per annum and once including even modest capital expenditure, it would see them burn upwards of $75m of cash and thus increase their net debt by approximately 25%.


Their highly volatile earnings also complicates assessing their leverage since it too varies significantly. It was no surprise that their financial metrics all deteriorated during the fourth quarter of 2020 following their weakening earnings and increasing net debt, as primarily evidenced by their net debt-to-EBITDA increasing to 2.59 versus its previous result of only 1.32 and interest coverage dropping from 4.17 to only 2.59.

Due to the continued volatility in their earnings and thus their financial metrics, their leverage was once again rated as high since their net debt has increased slightly. If this downturn continues during 2021 then their leverage will almost certainly soar to very high levels, which would prove dangerous if they fail to maintain strong liquidity.

When looking further into the medium to long-term, once they reach the point whereby their demand has peaked the combination of permanently reduced earnings could possibly threaten their ability to remain a going concern, especially when their net debt likely increases in tandem. At least at the moment, this downturn should only prove temporary as it relates to the oil market rebalancing and not necessarily a structural permanent change.


Thankfully their previously mentioned sizeable cash balance has helped ensure that their liquidity has remained strong with a current ratio of 2.51 and most importantly, they have a cash ratio of 1.46. When looking further into the medium to long-term, they could easily see this strong liquidity drained once they reach the point of continuously shrinking demand since a continued cash burn would eventually deplete their currently sizeable cash balance. The extent that this endangers their ability to remain a going concern will not be known until this point is reached but realistically, it presents a very concerning prospect.

Conclusion

On one hand, they have sufficient financial strength to help them traverse this current temporary downturn but when looking into the medium to long-term, this may not necessarily be the case once they see continuously shrinking demand. Whilst they might make a suitable short-term contrarian rebound investment at the moment, given the cloudy long-term outlook, I believe that a neutral rating is appropriate.