Teekay Tankers Ltd.

Welcome to TK Tankers LTD's third quarter 2020 earnings results conference call. During the call, all participants will be in a listen-only mode. Afterwards, you'll be invited to participate in a question and answer session. At that time, if you have a question, participants will be asked to press star 1 to register for a question. For assistance during the call, please press star 0 on your touchtone phone. As a reminder, this call is being recorded. Now for opening remarks and introductions. I'd now like to turn the call over to the company. Please go ahead.

Before Kevin begins, I'd like to direct all participants to our website at www.tktankers.com, where you'll find a copy of the third quarter 2020 earnings presentation. Kevin and Stuart will review this presentation during today's conference call. Please allow me to remind you that our discussion today contains forward-looking statements. Actual results may differ materially from results projected by those forward-looking statements. Additional information concerning factors that could cause actual results to materially differ from those in the forward-looking statements is contained in the third quarter 2020 earnings release and earnings presentation available on our website. I'll now turn the call over to Kevin McKay, TK Tanker's President and CEO, to begin.

Thank you, Ryan. Hello, everyone. Thank you very much for joining us today for TK Tanker's third quarter 2020 earnings conference call. and I hope you and your families are all safe and healthy. Joining me on the call today are Stuart Andrade, TK Tankers CFO, and Christian Waldegrave, Director of Research. Moving to our recent highlights on slide three of the presentation, TK Tankers generated total adjusted EBITDA of approximately $46 million during the third quarter, an increase of $18 million from the same period of the prior year. We reported adjusted net income of approximately $3 million or $0.09 per share in the third quarter, up from an adjusted net loss of $21 million or a loss of $0.63 per share in the third quarter of 2019. Our improved results are largely due to higher revenues, several lucrative fixed rate charters secured during periods of market strength at rates substantially higher than third quarter spot rates. We have continued to build financial strength this quarter, generating free cash flow from operations of $31 million. Net debt has been reduced by nearly $50 million to $502 million, and we continue to have a strongly accredited position, which was $470 million at the end of the quarter. Our net debt total capitalization declined to approximately 30% at the end of September, compared to 32% last quarter. and 52% a year ago. As mentioned in the earnings call in August, the company finalized a three-year $67 million term loan at an attractive rate to refinance a debt facility secured by four Suez Maxes that had been scheduled to mature in 2021. With the completion of this refinancing, the company does not have any debt maturities until 2023. Lastly, As highlighted at our investor day in November of 2019 and in recent quarters, one of our 2020 strategic priorities is to reduce our cost of capital. I'm pleased to report that in October, we repurchased two Afromax vessels previously under sale leasebacks for $29.6 million, reducing our exposure to this relatively higher cost debt capital. The vessels were acquired using existing liquidity and are now unencumbered. In the freight market, third quarter crude tanker spot rates decreased compared to the first half of this year, primarily due to knock-on effects of COVID-19, which I will touch on in more detail in the next slide. We were able to significantly mitigate the impact of these weaker rates by securing fixed-rate chargers for a number of our vessels during the periods of market stress, which enabled us to have 22% of our fleet on fixed-rate chargers in the third quarter at an average rate of $37,600 per day, well above the prevailing spot market rates. Turning to slide four, we look at recent developments in the spot tanker market. As mentioned, spot tanker rates declined during the third quarter of 2020 due to the continued impact on oil demand from the COVID-19 pandemic. Global oil inventories built rapidly during the first half of the year due to the large mismatch between supply and demand. leading to a sharp correction in both crude oil prices and refining margins. In response, OPEC and its partners slashed production by a record 9.7 million barrels per day in May. Although they have returned 2 million barrels per day of production in August, global oil supply remains well below pre-pandemic levels, and this has been negative for tanker trade. Refinery runs have also been significantly cut as refineries respond to weak margins and this has further dampened demand for crews and hence crew transportation. At the same time, some of the ships that were placed into floating storage earlier in the year have returned to the fleet, adding to the supply-demand imbalance. Although TK tankers saw a drop in earnings compared to the first half of the year, our third quarter results were higher year on year, as shown by the chart on the left of the slide. This was particularly true for our Suez Maxes, where rates were further bolstered by the fixed-rate time charters that we entered into during late 2019 and the first half of 2020 at rates much higher than current spot market. The chart on the right of the slide shows the extent to which spot rates have fallen in recent months. Looking ahead to the winter, we're currently facing a challenging rate environment due to the fundamental headwinds that I described earlier. However, we could see some support for midsize tankers due to the return of Libyan crude oil exports, which have risen to around a million barrels per day, having averaged only around 100,000 barrels per day last quarter. Libyan crude is predominantly moved on Afromaxes and Suezmaxes, so the return of exports could provide some support for rates in the Mediterranean. Furthermore, we expect that normal winter seasonality may provide additional support later in Q4 in the form of winter winter heating demand and an increase in vessel delays due to bad weather. On the flip side, the resurgence of coronavirus cases and fresh lockdowns, particularly in Europe, may weigh on demand. On the whole, we anticipate that the typical winter market strength will be moderated compared to prior years. Turning to slide five, we give a summary of our fixtures in the fourth quarter of 2020 to date. Based on approximately 49% and 45% of spot revenue days booked, TK Tanker's fourth quarter to date who is max and after max bookings have averaged approximately $10,100 and $7,700 per day respectively. For our LR2 fleet, which are predominantly trading dirty, based on approximately 44% of spot revenue days booked, fourth quarter to date bookings have averaged approximately $8,500 per day. TK Tankers has been proactive in managing its fleet by locking in attractive fixed rate charters during periods of significant strength in the tanker market over the last few quarters. As a result, the company's combined rates for fixed and spot fleets so far in Q4 have been significantly higher than current spot market rates. Our series max fleet has 62% of its Q4 revenue days booked at $24,200 per day. Our AFMAX fleet is 54% booked at $12,400 per day, and our LR2 fleet is 52% booked at $13,500 per day for the fourth quarter of 2020. For further details on our fixed rate charters, please refer to the appendix of the presentation. Turning to slide six, we turn to the outlook for the tanker demand over the next 12 months. Global oil demand has recovered sharply from the low point in Q2, though demand remains several million barrels per day below pre-pandemic levels. We expect demand will grow through the course of 2021, particularly during the second half of the year, and this will help bring oil inventories back to more normal levels. As shown by the chart in the slide, the oil market moved into a deficit during the third quarter, Stock draws are expected to continue for the remainder of 2020 and in 2021. However, depending on the speed of the demand recovery, it may take the majority of next year to fully reverse the large build of inventories, which took place in the first half of 2020. As demand recovers and all inventories are drawn down, we expect an improvement in refining margins, which will lead to a recovery in refinery throughput. This will create additional crude demand and give support to crude oil prices. It should then lead to higher oil production from both OPEC and non-OPEC sources. As this happens, tanker demand is expected to recover and give support to freight rates. The exact timing of this recovery, however, is uncertain and will depend to a large extent on how the coronavirus pandemic evolves next year. We remain hopeful that a coronavirus vaccine will become widely available during 2021. and that this will accelerate a return to more normal demand patterns in transportation and travel sectors, leading to higher oil and tanker demand. Turning to slide seven, we look at the positive fleet supply fundamentals. The outlook for fleet supply continues to be very positive due to a significantly reduced level of new build ordering, diminished tanker order book, and the potential for higher scrapping due to an aging tanker fleet. As of October 2020, the tanker order book totaled 47 million deadweight tons, or just over 7% of the existing global fleet. When measured as a proportion of the total fleet, this is the lowest tanker order book seen in over 24 years. Tanker scrapping has been very low over the past two years, and this has resulted in the buildup of older vessels, which face removal in the near future. As shown by the chart, the tanker fleet currently has an average age of almost 11 years, which is a 17-year high. A potential period of weaker rates in the coming months, combined with ballast water treatment system installations and dry dock costs, could encourage higher scrapping in 2021, which will help to limit overall fleet growth. Finally, new tanker ordering remains very low due to a more restrictive financial landscape and uncertainty as to what type of also consistent to order given upcoming environmental regulations. Around 12.5 million deadweight tons has been ordered so far this year versus an average annual order rate of around 34 million deadweight tons over the past 20 years. We believe new build ordering will remain relatively low in the near future, and this will help keep the order book at or near historic lows. When taken together, combination of low ordering, small and shrinking order book, and the potential for higher scrapping should help keep fleet growth low over the next two to three years. This will help facilitate tanker market recovery once the demand side normalizes. I'll now turn the call over to Stuart to cover the financial slide.

Thanks, Kevin. Turning to slide eight, over the past year, TK Tankers has transformed its balance sheet which provides us with financial strength to be resilient in any tanker market. Over the last 12 months, TK Tankers has generated over $400 million of free cash flows from operations and completed over $100 million of asset sales, creating a resilient financial platform for the company. This strong free cash flow has had an enormous impact on our overall financial position, decreasing our net debt by nearly $500 million, or 50%, to $502 million, while improving the company's liquidity position by $375 million to a total of $470 million at the end of September. We currently have 13% of shift days on fixed rate charters for the next 12 months at an average rate of $33,500 per day, which is well above the current spot market. Our fixed rate charters, combined with our almost $500 million of debt reduction and the unwinding of our sale leasebacks, has resulted in a low free cash flow break-even for our spot fleet of approximately $13,500 per day through the end of Q3 2021. As Kevin mentioned in his opening remarks, we closed the refinancing of our 2021 debt maturity in August and now have no debt maturities until 2023. We have taken steps to reduce our cost of capital by starting to unwind our sale leasebacks with the acquisition of two vessels previously under sale leasebacks in October. In addition, we intend to declare two more sale leaseback purchase options later this month, which will further reduce our cost of capital when the vessels are acquired in May 2021. Over the past year, we have reduced our quarterly net interest expense by $4 million, or 26%. Lastly, as shown at the bottom of the slide, having prepaid a significant amount of debt in 2020, our debt repayment profile is very manageable in the coming years. With our efforts to delever and reduce our cost of capital, along with a manageable debt repayment profile, we have positioned ourselves financially to weather potential market headwinds. With that, I will turn the call over to Kevin to conclude.

Thank you. In closing, I would like to say thank you again this quarter to all of our seafarers and shore-based staff for their continued extraordinary efforts in bringing energy to the world with TK Spirit during the COVID-19 pandemic. I'm extremely proud of our team for continuing to execute despite the unprecedented global challenges. Operationally, we continue to focus on the safety and well-being of our seafarers, all the while continuing to deliver TK's high quality of service to our customers. Commercially, the impact of the weakness in spot market has been mitigated by our well-timed fixed rate charters. Financially, we have transformed our balance sheet over the last 12 months and have built resilient financial position. The strong financial foundation, a low free cash flow breakeven, and our midsize fleet profile, we believe that TK Tankers is well positioned to continue to create shareholder value, even in these unprecedented and uncertain times. With that, operator, we are now available to take questions.

Thank you, sir. At this time, we'll open the floor for questions. If you'd like to ask a question, Please signal by pressing star 1 on your telephone keypad. If you are using a speaker phone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, press star 1 to ask a question. We'll pause for just a moment to allow everyone an opportunity to signal for questions. We'll take our first question. This comes from John Chappelle with Evercore. Your line is open. Please go ahead.

Thank you. Good morning, guys. Stuart, if I can start with you. You mentioned two more leases that you hope to have done by the fourth quarter. Can you give us the magnitude of those leases? And then also, just to continue on that theme, what's the timeline look like into 2021 when you have the opportunity to maybe to pursue the further removal of those higher cost of capital pieces of paper?

Hi, John. Yeah, so the two that we intend to exercise later this month are total lease balance of about $58 million. And those, we would declare those in November, but we would actually acquire them in May, just in terms of timing. So it's about $57, $58 million. And the rate on those is about 9%. So quite significant savings from buying those back. And then moving into 2021, By the end of 2021, actually, all the remaining 14 leases are available to us through purchase options. The various leases have different terms. Some of them have specific dates during the year when we can exercise, and others are a little more flexible in terms of exercising when we'd like. But by the end of the year, all of the remaining $367 million are available. The average financing cost across all of those is about 7.5% roughly, so there's quite a substantial opportunity for savings.

Great. And then that kind of leads to my second question for both you, Stuart, and Kevin. You guys were in New York almost a year ago to the day laying out your plan for 2020, and certainly this year hasn't turned out like anyone would have expected. But as far as you executing your plan, it's gone up probably better than you would have even hoped. What's kind of the next steps now for the next 12 months? Is it continue to pay down those leases, continue to bring the leverage down, you know, even further, raise more liquidity? Do you think that now we're in this period, although uncertain, where things are about as dire as they can be, and now you shift a little bit more to offense? How do you think about the path to November 2021?

That's a good question, John. I think, you know, to close out this year, really, we're sticking to plan. It has, as you said, been a very different year than what we anticipated coming into it when we spoke to everyone in November last year. But I think we've been very successful in executing along the lines that we wanted to. And as a result, I think we can look forward you know, from a position of strength. However, I think as we've mentioned in our remarks, 2021 is an uncertain year. We're not clear on the timing of the recovery. The fundamentals are there on the fleet supply side, but demand and, you know, potential resurgence for COVID. does leave question marks. So as we look to go into next year, I think we'll sit down with our board at the end of the year, we'll assess what we've managed to achieve this year. And I think I'm looking forward to a robust discussion with them about what sort of plans we lay out for 2021. At this point in time, we haven't had that conversation yet. So come back to the market when we have further clarity and direction.

We should assume until that point that it's just continue to do logger, number one priority.

Yeah, I think as Stuart mentioned, you know, we've got some upcoming sale leasebacks that we'd like to eliminate and get rid of that higher cost of debt. So until that plan is finalized, Should it differ from what we're doing now, we'll come back to the market. Okay.

Thank you, Kevin. Thanks, Stuart. Thanks, Sean.

Our next question comes from Randy Givens with Jefferies. Your line is open. Please go ahead.

Howdy, gentlemen. How's it going? Doing well, thanks, Randy. Good, thanks. All right. Well, yeah, looking at your kind of operating leverage, Right. Are you content with your current fleet or looking at possibly expanding it further, you know, following your debt repayments that you kind of just alluded to? And when it comes to that expansion, would it be by acquiring secondhand vessels or maybe additional time charter ends?

Yeah, good question, Randy. I think first and foremost, we're very comfortable with our fleet profile. both with its scale and its makeup. I think in terms of where we go from here, given where the market is, given the uncertainty, I don't think you'll see us do anything in terms of, you know, further fleet building or anything of that nature. I think we've got the scale we like. We have sold some of the older assets earlier in the year. So I think where we stand now is more of a wait and see. Let's figure out where this market is going, where the demand recovery comes into play, and take care of the sell-leaseback opportunities that we have to lower our cost of capital. In terms of new buildings, you know, e-book prices have come off. It's something that we monitor as we do with the second-hand sale and purchase market and you know over time those are decisions that we weigh up and compare and contrast what is the expected long-term return for either new builds or second hand and to be honest with you we're agnostic as to which one we would go after at the appropriate time um it's based on you know which which uh which passive growth provides the best value to shareholders. And that varies during various points in a cycle. So I think for now, we're not active. We're not looking to add a lot of ships. It's more wait and see how things play out.

Okay. I guess following that, you know, your balance sheet liquidity is clearly rapidly improving, evidenced on, I guess, slide eight there. Now, one thing that has been removed from slide 8 and also the appendix is your NAV calculation, which was, I think, $28 a share at the end of 2Q. So with that, what is your current NAV today, and how have secondhand AfroMax and SuezMax asset values fared here in recent months?

So we haven't actually – run the NAV recently, like since probably the last quarter, so I don't have an accurate NAV to provide, but I do know that asset values certainly have been under pressure. If you look at based on Clarks, probably over the last quarter, depending on the age of assets, they're probably down between 5% and 10%, so they have been under pressure. Of course, there's a lack of liquidity in the market. So there's not a lot of transactions, which always makes it difficult to really know what the values are. But I guess as a rough guy, probably down 5% to 10% in the last quarter. And that would translate as expected into our NAV, but I don't have an exact number for you.

Got it. All right. So maybe mid to low 20s at worst, it sounds like. I think that's the right ballpark, certainly. Okay. Well above 1043. All right. Well, that's it for me. Thank you.

Our next question comes from Ken Hoekstra with Bank of America. Your line is open. Please go ahead.

Hey, good afternoon. Kevin, maybe just talk a bit about your thoughts on where storage is now, the impact you're seeing from COVID to those spot rates. I guess ultimately just to wrap that up, When do you typically see the seasonal pickup? Is it, you know, not until Thanksgiving? And you mentioned kind of a delay in that. Maybe just to expand on your thoughts on rates.

Sure, Ken. On regards to the first part of your question on floating storage, it's interesting. On the crude side of the ledger, it's really a tale of two different sort stories one the vlccs and interestingly they have maintained a fairly steady level of um vessels in in that uh in that play the peak of the market um you had about 84 vlccs and i think as of last week there was some 87 so it it it dropped a little bit in mid summer and picked up again so On the B side of this, the ledger is, I would say, it's fairly steady. Where we have seen the declines is behind the Suez Maxes and Afro Maxes. And as a relative comparison, you had over 80 Afro Maxes that were in storage at the peak in May. And I think now the latest figure is down sort of in the low 20s, 23, 24 at last count. Similarly, Suez Maxes were down about 60% from where we were at the peak. So the mid-size spaces, given that the cost per barrel storage on those is obviously higher than the VLCC, those are the first classes of ships that you'd seen unlined. And that's why I think you've seen mid-size rates on sewage maxes come off earlier than what you saw the VLCCs come off. In terms of the typical pick up and seasonality, you know, a lot of it will depend on weather. And we've had Q4s that have picked up earlier than now. But typically, you run into, when you start getting delays in places like the Bosphorus Canal, you start getting the fog rolling in and out of the U.S. Gulf. That tends to gum up the works, the logistics, especially on the Afro-Mexico, but also on the Suez Maxis. and that sort of eats into supply and at least puts a floor, if not bolsters, the supply dynamic, which we're hoping to get some of during this winter month. But so far, it's been relatively benign. I think the hurricane season has extended longer than we've seen in recent years, so perhaps the fog season in the U.S. Gulf will be a little bit delayed this year. We'll have to wait and see. Thanks for that.

Any thoughts on moving any of the LR2s to clean versus dirty? Do you view the product market as having better fundamental outlook or not?

We are actually in the process of moving one of our LR2s that is coming out of dry dock. We're going to move that. She has been trading dirty, and we're going to move her into clean Asian markets. And we're doing that really because the cost is absolutely minimal given the fact that she's coming out of dry dock. So, seeing where the markets are, it's unclear which one, you know, crude versus clean is going to increase first. So, given the fact that it wasn't going to cost us anything to do the changeover, we decided to shift some of our eggs from the crude basket starting with this one ship. So, it's something that we, you know, monitor daily. Obviously, the pandemic resurgence in Europe may drive some short term storage and felt that that might come into play over the very near term. But at the moment, it's just the one ship that we're moving over. And if we do do future ones, it would be on the most efficient and cost efficient way that we could possibly do it, rather than just to spend a lot of money to change over with no certain prospects of demand pickup.

And I know it's really early for my last one, but, you know, obviously new, I guess, discussion of rules on IMO 2030 and beyond. Any early read on kind of ability to adapt to those proposed targets and thoughts on costs, or is it just too early days?

It's, yeah, absolutely right. It is very early days. But, you know, we have had a history of upgrading our fleet and putting in capsule into our fleet to make them more efficient. We've had a very successful program around our hull coatings, which has saved 2% to 3% of our fuel bill over the last several years. Whether it's fitting wheeze ducts or propeller boss cap fins or various things technical upgrades that we do to our ships when they go into dry docks. You know, we've made some serious inroads into reducing our carbon footprint already, and that's something that we'll continue to do. Great.

Thanks for the time. Thanks, Ken.

This marks the end of the question and answer session. I would now like to turn the call back over to the company for any closing remarks.

Thank you for joining us today, and please keep yourselves and your families safe during these difficult and dangerous times. Speak to you next quarter. Thank you.

This concludes today's call. Thank you for your participation. You may now disconnect.