Teekay Tankers Ltd.

Standby, we're about to begin. Welcome to TK Tankers LTD's fourth quarter 2022 earnings results conference call. During the call, all participants will be in a listen-only mode. Afterwards, you will 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 would like to turn the call over to the company. Go ahead.

Before we begin, I would like to direct all participants to our website at www.tktankers.com, where you will find a copy of the fourth quarter and annual 2022 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 fourth quarter and annual 2022 earnings release and earnings presentation available on our website.

I will now turn the call over to Kevin McKay, TK Tanker's President and CEO, to begin.

Thank you, Ed.

Hello, everyone, and thank you very much for joining us today for TK Tanker's fourth quarter and annual 2022 earnings conference call. Joining me on the call today are Stuart Andrade, TK Tanker's CFO, and Christian Waldegrave, our director of research. Moving to our recent highlights on slide three of the presentation, TK Tanker has generated total adjusted net income of $147.5 million, or $4.33 per share, up significantly from a strong third quarter adjusted net income of $57.9 million, or $1.70 per share. To put this in context, it is TK Tanker's highest ever quarterly adjusted net income. We have given notice to exercise purchase options on nine vessels currently in sell-leaseback arrangements for a total of $164 million. Related to this, we have also signed a term sheet to refinance 19 vessels under a $350 million revolving credit facility. By taking these actions, we will eliminate some of our more expensive debt, thereby reducing our already competitive fleet break evens, and we will improve our ability to optimize our balance sheet on an ongoing basis. We expect to complete the facility by the second quarter of 2023. With 51 vessels or 96% of our fleet operating in the spot market, we have high operating leverage that has served us well in this very strong market. To illustrate that point, we generated $4.84 of free cash flow per share in the fourth quarter alone. This equates to more than a 50% annualized free cash flow yield based on our closing share price yesterday. As a guideline, for every $5,000 increase in rates above our $15,000 free cash flow break-even level, we expect to generate approximately 65 cents per quarter, or $2.60 per year of free cash flow per share. I would also highlight that we generated $20 million in free cash flow during the quarter from our four in-chartered vessels. In the tanker market, spot rates have been very strong through the fourth quarter and first quarter to date, with Afromax and Suezmax rates outperforming all other tanker sectors, as the mid-south segment has been the primary beneficiaries of increased hand-miled demand from the EU ban on Russian crude oil imports. Even after the imposition of the price cap mechanism, Russian crude oil export volumes have remained strong, with exports in January at an eight-month high. Additionally, early indications are that the rapid reopening of China should support global oil demand growth in 2023, which should ensure that tanker demand remains at robust levels. Finally, the order book for new tankers remains at record lows and should see negligible additional deliveries through at least the second half of 2025 due to limited available shipyard capacities. A period of very low freight growth over the next two to three years, coupled with firm levels of demand growth, point to a continued strong tanker market over the medium term. Turning to slide four, we look at recent developments in the spot tanker market. Spot tanker rates significantly improved over the winter months, with the company recording its highest ever rates for a fourth quarter since our IPO in 2007. This strength was driven by a mixture of positive demand fundamentals and seasonal factors, including longer voyage distances, a rush to book cargoes ahead of the implementation of the price cap, and the EU ban on Russian crude oil imports, which came into effect on December 5th, an increase in Chinese crude oil imports, and weather-related vessel delays in key load regions. Afromax and Suezmax rates averaged significantly higher than other tanker asset classes in Q4, including VLCCs, as shown by the chart on the right. This strength is carried into the first quarter of 2023, and we anticipate another very strong quarter for spot rates. Turning to slide five, we provide a summary of our spot rates in the first quarter to date. Average first quarter to date rates, in particular driven by Aframax-sized vessels, have improved further from the very strong levels of the fourth quarter. Based on approximately 69% and 57% of revenue days booked, TK Tanker's first quarter to date Suezmax and AfriMax size vessel bookings have averaged approximately $50,600 per day and $67,600 per day respectively. For those who regularly participate in our quarterly calls, you will notice that we have decided to combine our AfriMax and LR2s into a single reported category, which we believe brings the presentation more in line with how we think of and utilize these assets. Importantly, I would highlight that we have doubled the size of our in-charter portfolio to eight ships, having welcomed an additional four ships between late Q4 and early Q1 this year. Of these, One is a new-built Eco-Afromax, which is chartered in at $18,700 per day for seven years, with multi-one-year extension options thereafter. These eight vessels are currently chartered in for an average of $24,300 per day, with a mark-to-market value of approximately $60 million. When we have conviction on the market, These in-charters give us the ability to quickly and materially increase our operating leverage beyond what we get from our own fleet, and that dynamic is currently playing out. Turning to slide six, we look at changing crude tanker trade patterns over the past 12 months and how they have benefited midsize tankers over other asset classes. Russia's invasion of Ukraine in February 2022 has led to a substantial redrawing of global oil trade routes. Short-haul movements of crude oil from Russia to Europe declined during the course of 2022, culminating in the total ban of Russian seaborne crude exports to the EU from December 5th. Most of the crude oil which Russia was previously exporting short-haul to Europe is now moving long-haul, primarily to India and China, which has benefited the mid-sized sectors given that the main Russian load ports in the Baltic, the Black Sea, and at Kosmino in the Far East are all inaccessible to BLCCs. This led to a 39% increase in mid-sized tanker ton-mile demand from Russian crude oil exports during the year, stretching the fleet and increasing tanker fleet utilization. While TK Tankers is not participating in the movement of Russian cargoes, the transfer of ships into the so-called shadow fleet effectively removes them from mainstream trades and reduces effective vessel supply. In addition, Europe has been replacing Russian barrels with imports from further afield, including the U.S. Gulf, Latin America, West Africa, and the Middle East. Ninety percent of the crude oil which Europe imported during 2022 was on Afromax and Suezmax tankers, and the lengthening of voyages resulted in a 12 percent increase to midsize tanker ton-mile demand. The net result of these changes is that global Afro-max demand increased by 12.6 percent last year, while Suez max demand increased by 10.7 percent, far higher than demand growth in other tanker asset classes. We think that these trade pattern changes are durable, representing a step change in demand rather than a short-term spike. and that midsize crude tanker trade routes will continue to be stretched in 2023, which will help support strong spot tanker rates in the midsize segment. Turning to slide seven, we look at the outlook for oil demand. The IEA expects global oil demand to grow by 2 million barrels per day this year, taking oil demand above pre-COVID levels for the first time. Almost half of this growth is expected to come from China, with demand accelerating from the second quarter onwards as the country opens up after three years of strict COVID-19 lockdowns. This will help offset slightly weaker demand growth in the OECD nations due to economic headwinds as a result of high inflation and rising interest rates. Another key element of oil demand growth in 2023 will be the continued resurgence of international air travel. The IEA estimates that jet fuel demand will grow by around 1.1 million barrels per day this year to 7.2 million barrels per day, bringing demand back to pre-COVID levels. This will provide a boost to crude oil demand as refiners look to increase throughput in order to keep the market well supplied. If global demand recovers, the world will need more oil. This will partially be met by higher non-OPEC production which is projected to grow by 1.8 million barrels per day this year, led by the United States, Brazil, Norway, and Guyana. With the majority of all demand growth expected to come from Asia, this should lead to an increase in long-haul movements from west to east during the year, which should be positive for crude tanker ton mile demand. The OPEC Plus Group has pledged to keep its current supply cuts in place through the end of the year, However, by the second half of the year, the projected call on OPEC Plus rises to about a million barrels per day above current production levels, suggesting that an increase in production could be merited. Finally, Russia recently announced that it will cut crude oil production by half a million barrels per day during March. We believe that this cut is likely due to a reduction in refinery throughput. lowering refinery product exports, while crude oil exports are anticipated to remain at current levels. Turning to slide eight, we look at the positive tanker supply and demand fundamentals over the next two to three years, which we believe point toward the potential for sustained tanker market strength. As of February 2023, the Global Tanker Order Book, when measured as a percentage of the existing fleet, has fallen to a record low of less than 4%. This is reflected in the tanker delivery schedule, as shown by the chart on the left, with a historically low number of tankers scheduled to deliver over the next two to three years. The pace of new vessel ordering remains very low, with just 8 million deadweight tons of new tanker orders placed in 2022, which was the lowest since the mid-1990s. The beginning of 2023 has seen a slight uptick in activity with around 8 to 10 LR2 orders being placed in recent weeks. However, there is little scope to meaningfully add to the 2025 order book as shipyards are largely full through the second half of 2025 due to the record amount of container ship and LNG carrier orders placed over the past two years. We project that the global tanker fleet will grow by around 1.5% this year, with virtually no growth in 2024. In comparison, tanker ton-mile growth is set to remain at very healthy levels over the same timeframe due to projected firm levels of oil demand growth, particularly from China, and the continued stretching of the mid-sized tanker fleet due to changing trade patterns. As such, we believe that the tanker market has potential to remain very firm over the medium term. I will now turn the call over to Stuart to cover the financial slide.

Thanks, Kevin. Turning to slide nine, we highlight the company's high operating leverage and what that means for T&K's capacity to generate cash flow and create shareholder value in a strong tanker market. Throughout 2022, our focus has been on strengthening our financial position and creating equity value for T&K shareholders. Generating $318 million of free cash flow in 2022 enabled us to reduce our net debt by 41% to $345 million, bringing our net debt to cap down to 24% at the end of 2022. Importantly, this cash flow increased T&K's equity value, thereby creating value for our shareholders. We have 51 vessels, or 96% of our fleet, trading in a very strong spot market that is supported by solid fundamentals. positioning T&K to continue generating significant free cash flow. As can be seen in the chart, our fleet-wide free cash flow breakeven level, including dry docking and other capital expenditures, is approximately $15,000 per day. For every $5,000 per day increase in spot rates above this level, the company is expected to generate approximately $90 million, or $2.60 per share, in annual free cash flow. While this is not a projection of future rates, to illustrate this point, if fourth quarter spot rates were to be sustained throughout 2023, we would expect to generate approximately $20 per share of free cash flow for an annualized free cash flow yield of over 50% based on our closing share price yesterday. It is important to also consider the role of our in-charter portfolio, which is having a material impact on our earnings beyond that of our own fleet. Historically, we have taken advantage of opportunities to increase our exposure to promising spot markets by expanding our in-charter portfolio. For example, when we last significantly increased our in-charters in anticipation of a strong spot market in 2015, our 11 in-charter tankers generated $44 million of incremental free cash flow in just one year. There's a similar dynamic playing out now where our in-chartered vessels generated $20 million of incremental free cash flow in the fourth quarter alone. And our current eight tanker in-charter portfolio has a mark-to-market value of approximately $60 million.

I will now turn the call back to Kevin to conclude. Thanks, Stuart.

In summary, the spot market for midsize tankers has remained exceptionally strong. and the combination of structural shifts in the global crude flows, a record low order book that is essentially capped through the medium term, and multiple drivers of demand growth are conditions supportive of a strong market for some time, even in the face of potential macroeconomic headwinds. The positive ton-mile impact related to Europe's ban on Russian crude imports are durable and have accrued disproportionately to midsize tankers. and rates for both Afromaxes and Suezmaxes have outperformed all other vessel classes in recent months. In line with our stated priority, our 2022 focus has been on balance sheet strength, and the sharp improvement in the spot market in the second half of the year enabled us to significantly strengthen our balance sheet. Moving into 2023, our operating leverage puts TNK in a position to continue generating a great deal of free cash flow in a strong tanker market. While continuing to build financial capacity, the company will need for future fleet reinvestment. The additional cash generation allows for a broader range of options to be considered in our capital allocation planning for the year. As with all our decisions, we will continue to be guided by discipline and the goal of creating long-term shareholder value. With that operator, we're now available to take questions.

Thank you. If you'd like to ask a question, please signal by pressing star 1 on your telephone keypad. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Once again, press star 1 to ask a question. We'll pause for just a moment to allow everyone an opportunity to signal for questions. And we'll go first to John Chappell with Evercore ISI.

Thank you. Good morning. Or good afternoon. Stuart, I want to start with the debt side of things. A couple announcements here, and I just want some clarification, so bear with me. It's a multi-parter, but hopefully pretty simple. These nine sale and leasebacks is at the end of them. Then the $350,000 that you're hoping to draw on this new facility in the second quarter, obviously significantly more than the $164,000. Are you using that to pay your existing, you know, non-sale and leaseback facilities? And then the final part of that is what's the savings, you know, from the $350,000 that you're drawing down in the second quarter to what you would be used to pay down, you know, with those proceeds?

Yeah, thanks, John. Good afternoon.

So, yeah, there's a few moving parts here, so let me try and kind of walk through it. So, first of all, as you mentioned, we have given notice to exercise non-sale leaseback purchase options. We'll be repurchasing those in March with cash on hand. Related to that, however, we are putting in place a new 350Million dollar debt facility that that revolver will ultimately finance 19 vessels. So, in addition to the 9 vessels that we've already given notice on, we'll be giving notice on another 10 vessels this quarter. Four of those late in the year, but the rest of them by the end of Q2 and joining that sale leaseback facility. So, 14 vessels will be, pardon me, 15 vessels will be done in Q2, four vessels in Q4, all of them going into that $350 million facility. At the end of that, we'll only have eight sale leasebacks remaining. So, and in terms of the savings, it really depends on the spot market, how much cash we generate. The two areas of savings from making this change one is we're at a lower cost of borrowing and the second one is it allows for more efficient cash management by being able to have a revolver which we can kind of use dynamically so overall we're we're expecting about eight million in savings on a run rate basis per year but that really will depend on on how much cash we generate okay that helps I was looking for the spread on the current rate versus the new one and I figured it would be much lower in this environment when this balance sheet is

Kevin, your last point on capital allocation, things are happening really quickly here. The fourth quarter was amazing. The first quarter, even better. If I just look at this chart you put on on slide nine and not even having to extrapolate beyond whatever, 40 days from now, that first quarter to date average rate, free cash flow equivalent for a quarter, your net debt at 345 would be cut by more than half. just by March 31st. What's the timing on the potential shift in this capital allocation? I mean, I know this is something we've asked in the past. I know it's something we've been talking about for years now. The heavy lifting on the balance sheet is done. You're in a phenomenal position. Your operating leverage is incredibly strong, but you do kind of stand out as one of the very few tanker companies that haven't started the capital return machine. And arguably, you're in the best position to do it out of any of them. So what can we think about the timing and the magnitude here?

Yeah, sure, John. It's a good question.

Talk about 2022 first. As you said, things have moved very quickly. And the Q4 was a fantastic quarter. It's certainly better than our initial expectations going into it. So that really allowed us to close off what we'd been saying all last year, which was our focus and our channeling of our cash generation would go to paying down debt and strengthening the balance sheet. So we're really pleased with the way we've been able to close off our 2022 plan. We now need to look at 2023. And we started the year off extremely well, even better on the Afromax than Q4. the debt is coming down very quickly. And, you know, we do recognize that in this position with this level of cash generation and with a forward view that, you know, the market should remain strong, maybe perhaps not at these levels, but certainly strong throughout the year, you know, that does afford us optionality other than just looking at balance sheet strength. So as we, you know, sit down with our board, We will be talking about 2023 and what we do with the cash. Part of that discussion will be around, you know, the third leg or the third phase that I think Stuart has spoken about on a previous call last year about building that financial capacity to be able to do some significant fleet renewal when the opportunity arises. But I think we also can talk about other options. So that is certainly something that we plan to do.

Okay. Just out of curiosity, then I'll move on. When is the next board meeting? Our next board meeting is in March. Okay. Great. Well, thanks for the time, Kevin. Thanks, Stuart. Thank you, John.

We'll go next to Ken Hexter with Bank of America.

Hey Stuart, hey Kevin. Hi, this is Nathan Dalian for Kent. Just wanted to get a bit more color on how the team is seeing the macro environment as well as the spot market here. We noticed that there were some simultaneous charter in and charter outs over the fourth quarter, earning a very decent spread. Would you mind maybe talking a little bit about the availability of these opportunities and what, your view is on like future charter out opportunities.

Thanks. Yeah. Hi, Nathan.

I think we covered a lot of ground in our prepared remarks and our presentation just about the macro environment. I think one of the things that is really missed in in articles and general view on the tanker market. There's a view on the clean space and there's a few on the crude space, but it's a lot more nuanced than that. And we're trying to highlight that within the crude space, the real beneficiaries of the macro developments that we've seen in 2022 and what we expect to continue in 2023 is that the midsize Afromax and Suezmax are the real beneficiaries of of the ton mile growth. And that is why we feel that the durability of those fundamentals are there. And this isn't, you know, the spikes that we're seeing aren't seasonal or aren't, you know, short-term sanctions sort of related. They're far more durable than that, which is what's giving us a bit more confidence as we look forward. In terms of our in and out charter, it's one of those tools in our toolkit that we have used very well in the past. As we gain confidence in the market's ability to generate income, we're willing to go out and take positions on vessels with owners that we have good relationships with that are maybe looking for a bit more security as rates move up. And we can take those vessels and trade them within our program and make a very healthy margin. Obviously, as the spot market creeps up, the time charter market also starts to creep up in tandem. And as we look at managing the risk reward, if you will, we do look at hedging some of the positions that we take in. So, for example, we took in a ship early this year at about $30,000 a day and automatically flipped it out at $48,000 a day. So we're locking in a spread over the first year, which pays down the asset and gives us a cheap vessel going into the second year with an option to extend it for a third year. So that's kind of how we look at how we play the in and out charter in a market like this. But it's certainly something that we've done in the past to good use. And as Stuart mentioned in the finance slide, our mark-to-market on these charters, if the market stays strong, could add another $60 million to our war chest.

Got it. That's helpful. And just as a follow-up, there were some brief mentions of about the emergence of an illicit fleet following the December 5th price cap on Russia's seaborne exports. Could you maybe talk a little bit about the magnitude of that and how it's affecting the capacity and scrapping from your purview?

Thanks.

The illicit fleet, as you call it, generally I think we tend to call it the shadow fleet. It's vessels that are owned by one-off companies in various parts around the world, the Middle East, China, for example. And they trade Russian oil or they carry Russian oil from exports out of Russian ports into mainly China and India. In terms of scale and size, I know on the Afromax, there's roughly about 150 vessels. Afromaxes that are in that trade that the tracking services have listed. I think on the Suezmaxes, it's about 70. If I remember, maybe Christian has a more accurate number, but it's a significant size of fleet that is servicing that trade. The good thing is that those ships are being pulled out of the regular trades that companies like TK Tankers are willing to participate in, and that's why you're seeing the spikes that we're getting than we had in the fourth quarter, and we're enjoying now in the first quarter as well.

Great. Thanks, Kevin, and congrats again on a great quarter. Thanks, Nathan.

We'll go next to Omar Nocta with Jefferies.

Thank you. Hi, Kevin. Hi, Stuart. I wanted to just follow up on John's line of questions. Obviously, you know, things have been, you know, much stronger than anticipated and they're happening very quickly. You are on pace to get into a, I would say, a net cash position here in a not so distant future, which really does kind of cap the, or at least closes the book on your years long, I would say, efforts to, you know, reduce debt. And from your comments, you know, it sounds like here in 23, you're preparing to shift capital allocation. You're going to be sitting with your board potentially as soon as March, as John asked. I guess, you know, maybe you, Kevin, and sort of as management, am I reading correctly that your preference in terms of shifting that capital allocation is towards renewing the fleet versus paying out dividends?

No, I wouldn't categorize that at all.

I think we have to be realistic. TK, like any chip-owning company, has assets with finite lives. And as we generate income, we have to be prudent about reserving some of our earnings to invest in renewing our fleet and renewing our business. But we're fully aware that a capital allocation strategy or plan which we do talk to our board about every meeting, can include other options. And as we continue to generate the levels of cash flow that we've seen in the fourth quarter and here so far in the first quarter, it does give us the options to look at other avenues. And we are fully aware that we have shareholders that do like capital return. And there's various forms of doing that. So it allows for a very healthy, open, robust discussion with the board about what the best approach is. But we're not fixed that all of it has to go in one direction or another. It's setting everything on the table. And as we look at the forward view of our market, and as that market develops and changes, is looking at how we think best to deploy that capital for the benefit of shareholders over the long term.

Yeah, thanks for that, Kevin. That's fair and clear. Can we sort of expect maybe a broad sort of action plan coming out of, say, this March meeting? I don't know if we're thinking too much of this upcoming board meeting, but generally speaking, should we be thinking here in the next couple of months maybe that TK Tankers will be announcing a new plan of action?

No, I think what you can expect is that, you know, the management will be having, as we do, have robust conversations with our board at all of our meetings. And, you know, don't read into, you know, a March board meeting coming up. The decisions when they're made will communicate them, as we did last year when, you know, we spoke to the market and we were I think quite clear that we were channeling our cash generation towards debt repayment. If that changes, we will communicate it once that decision is made, but I don't want to preempt the conversation or the discussion with the board or what decision they and us together land on.

Yeah, no, I completely understand that. Okay, and then maybe just as a, you know, Thinking about, say, fleet renewal, because it is important, as you highlight, have you given it some thought as to how does that fleet renewal look for you going forward? Obviously, the balance sheet is just about in tip-top shape, as it can be. How do you think about fleet renewal from here? What's the avenue of going younger, as you think about that?

I think, you know, as always, it's going to be a combination of different elements, whether it's going into the second-hand market and doing, you know, a series of transactions or whether it's placing new build orders or, as we've done in the past, where we do unblock transactions on a larger scale. You know, it could be all of those. It could be one of those transactions. it really comes down to the opportunities that develop over time and our expectations for the returns of any given investment opportunity. So we keep a very open mind. We're agnostic to how we go about it, but it really, at the end of the day, has to provide good returns and a good investment so that we can drive value for shareholders.

Got it. Yeah, and thanks, Kevin. And one final one, then I'll turn it over. You did mention in your opening comments just the separate topic, you know, the AfroMax LR2s are now blended together as you report the average rates. And I just want to make sure that I know in the past you've focused a lot of the LR2s on the dirty trade. Is that basically how it is going forward? Effectively now the LR2s you have are trading in the crude market currently and going forward?

Well, we have nine owned LR2s.

On past calls, I think the fleet that was traded or the LR2s that were trading in the clean market, we'd increased it to three. That is subsequently dropped as the clean LR2 market dropped off and crude stayed high. We converted a couple of ships into the crude side, so we're down to one pure clean LR2 at the moment. You know, I think I've described this before. We really look at the LR2 as a fungible asset and we trade it on a voyage by voyage basis. So there is some of our LR2s that are currently dirty that we're keeping an eye on for potentially cleaning up as the LR2s start to spike again here. But in terms of,

the fleet we don't separate the two units out we trade it as one fleet and that's why we've changed the way we report it i see okay so that natural relationship will continue to exist um okay well great thanks for answering my questions and and congrats on the record quarter um guys thank you thanks omar appreciate it and at this time there are no further questions i'll turn the call back to management

Thank you for calling in and we look forward to speaking to you in the future.