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More scrubbers or more vessels? Maybe both

In spite of the ‘Dog Days’ of summer, second quarter earnings reports from listed companies are in season; unfortunately, they reveal the cooled down and generally chilled nature of investor attitudes regarding the sector.

Dry bulk was perhaps an exception in the late spring and into the summer months, with several of the listed companies registering healthy percentage gains in the quarter; increased iron ore moves contributed to investors’ buying mood.

Tankers, which saw nice seasonal tailwinds during the winter months, were basically treading water in late Q2 and into July, with the usual OPEC worries now compounded by ‘geopolitical’ uncertainties.

Product tankers were the exception.

For listed ‘names’, many priced below their theoretical breakup values, the modus operandi is far more complicated than the traditional ‘buy low, sell high’, in the face of uncertain prospects for each sector.

Besides buying ships, investments in scrubbers, which may yield premium hires (with lower fuel costs, the TCE is higher) is a big topic. Both investments in vessels, to position for the next wave, and/or investments in scrubbers, each require capital. Yet conventional capital (equity from outside investors, or traditional bank debt) is not readily available.

With a cyclical upturn on the minds of investors, Scorpio Bulk has made a big foray into leasing to fund vessel purchases – keeping capital free for scrubber purchases.

Read more: New study finds use of heavy fuel with scrubbers can help reduce GHG emissions

Eagle Bulk has gone in a different direction – with investors pushing back. Evercore ISI analyst Jon Chappell noted that Eagle Bulk has raised $114m of debt convertible into equity from institutional investors, as part of a package to finance the purchase of six ultramax bulkers, but cautioned, in a research report, that “Fleet Expansion Adds to Long-term Upside, but Not Without Near-term Dilution Concerns.” The “dilution” refers to additional shares that might be issued in the future.

In his note, Chappell explains that “…if fully converted at the $5.61 strike price, up 23% from the current price, the diluted share count would increase by nearly 30%.”

After the recent capital raise, Eagle Bulk’s price has backed down. Amit Mehrotra from Deutsche Bank stressed the importance of financial flexibility, telling his clients “…with the convertible note being unsecured, Eagle Bulk has the opportunity to tack on secured bank debt to its six acquired ultramax bulkers should an attractive acquisition opportunity emerge.”

Scrubbers figure into the likely course of the market in the view of Jefferies analyst Randy Giveans who looks for “…scrubber installations continue to limit fleet availability” on the dry side. In discussing Scorpio Bulk, Giveans points to the positive impacts of Scorpio Bulk’s investment in shares of sister company Scorpio Tankers, an owner of product tankers, with a heavily spot market exposure”, and comments, further, “…we believe Scorpio Bulk is well-positioned for further upside in spot rates, asset values, and scrubber premiums in both the dry bulk and product tanker sector in the coming quarters.”

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The product tanker sector continues to receive attention, after a late Q2 upswing. Deutsche Bank’s Mehrotra told investors: “Scorpio Tankers remains our preferred way to invest in the product tanker market given the company’s leverage, spot exposure and high quality fleet. After firming to multi-year highs over the last two months, the product tanker time charter market took a breather last week with term rates down 1% across the board… We continue to observe a significant premium for ‘eco’ and scrubber-fitted tankers on the time-charter market.”

Evercore’s Chappell also likes Scorpio Tankers, writing that: "We continue to believe that the underlying product tanker market is tightening, as witnessed through rising time-charter rates, and with IMO 2020 demand (and supply) tailwinds likely to begin to take shape in the coming months, we look for a triumphant return to profitability for Scorpio Tankers in 4Q19, with further acceleration likely next year.”