The Stock

What to trade:  Buy Teekay Tankers (NYSE: TNK) < 13.50 with a stop @ 9.25.

Why Now: Teekay Tankers offers a dividend yield of nearly 11.5 percent, and its payout should grow as tanker rates recover into year-end. With conditions in the tanker market improving, the stock could double over the next six to nine months. Tanker rates usually hit a seasonal low in the third quarter and run up through the end of the year.

The Story

After attending a wedding in Horsham outside London, Elliott decided to book a EUR39 Easy Jet flight to the Netherlands to visit a friend. But Elliott had another reason for flying to the Continent: his monthly Stocks on the Run meeting with Yiannis.

Yiannis: Hello?

Elliott: Hey, it’s Elliott.

Yiannis: How’s London? I was there last week but missed you by two days.

Elliott: It was great to be back, even just for a few days. It was also nice to wear a suit without experiencing heat exhaustion. What are you up to this afternoon?

Yiannis: Only you would like the English weather. I’m still in Antwerp, man.

Elliott: The English weather is perfect for my constitution. I’m not a fan of the heat, and the sun just turns my skin red. Right now I’m in Leiden, visiting a friend. What do you say I catch a train, and we meet for lunch in Belgium? It’s been a while since we’ve broken bread together, and I have a hankering for some mussels.

Yiannis: I know just the place, In de Schaduw van de Kathedral [In the Shadow of the Cathedral].

Elliott: Where’s that? And don’t say in the shadow of the cathedral.

Yiannis: It’s in the center of Antwerp, just outside the cathedral in the Handschoenmarkt [Glove Market]. Tell the taxi to take you to the Groenplaats on the side of the cathedral, and you can walk 150 meters to the restaurant. I’ll make the reservation for 1:00 this afternoon.

Elliott: I’m headed out the door. See you in a couple hours.

After walking a mile and a half to the train station in Leiden, Elliott grabs a cappuccino and buys a ticket to Antwerp, Belgium. Two hours later he disembarks at station Antwerpen-Centraal and hails a cab to Groenplaats. Approaching the restaurant, he spots Yiannis seated outside with a bottle of wine and a Spa mineral water.

Yiannis: How was the ride?

Elliott: No problems. You have to love European rail–I got here in 45 minutes, with only three stops. And it’s nice to be in a country where I speak the language, though my French is a bit rusty.

Yiannis: Ah, but they speak Flemish in Antwerp!

Elliott: I can get away with French. Stop giving me a hard time!

Yiannis: True, too early in the meeting for that. Good to see you, man.

Elliott: That’s more like it. I see you’ve already ordered some wine, and I’m starving for some good food.

Yiannis: I thought you liked British food?

Elliott: England wasn’t the problem.  I had a lovely curry the first night, a solid roast beef and Yorkshire pudding on Sunday and veal and a bottle of Amaroni at the Carluccio’s in Covent Garden. The UK has a great food scene nowadays. But have you ever eaten Bitterballen?

Yiannis: Ah, Carluccio’s. I lunched at the one on St. Christopher’s Place. Didn’t see Bitterballen on the menu, though. Is that Dutch, or some barbarous English food I haven’t had the misfortune of tasting yet?

Elliott: Bitterballen is a classic Dutch dish. They look like fried meatballs, but they’re filled with a molten mix of beef stew and potato that has a greenish hue. The roof of my mouth is still recovering from that culinary minefield.

Leiden is beautiful, and the Dutch are great people. They need to work on their food, though; I’ve yet to have a good meal in the Netherlands, apart from sausage and cheese.

Yiannis: No wonder you were so eager to meet up in Antwerp. The food here is stellar.

Elliott: I can’t wait. Let’s talk business before we order. Did you get the email I sent you about Teekay Tankers (NYSE: TNK)? You ought to like that one; you Greeks are known for your oil tankers.

Yiannis: You know I own an oil tanker, right. I cruise the Aegean in it each summer.

Elliott: Haha.

Yiannis: I know, but one can dream. I like that TNK Tankers sports a dividend yield in excess of 11 percent, but is the payout safe? Tanker rates are a bit depressed. I know you’re not a yield zombie, but big yielders can easily turn into big losers if you pick the wrong one.

Elliott: You’ve done your homework. Tanker rates have languished in the spot market, but much of this weakness stems from normal seasonality. The peak seasons for tanker demand are the first and fourth quarters; tanker rates usually fall in the summer and are especially weak early in the third quarter.

And this year a number of vessels that Iran was using for floating oil storage returned to the spot market this summer. This near-term oversupply likewise weighed on rates.

Now is the perfect time to invest in a tanker company; rates usually pick up in the fourth quarter.

Yiannis: Fine, ‘tis the season for tanker rates. But I have some inside info. In 2004 when tanker markets were extremely strong, everyone in Athens was talking about how all the big “sheep owners” were exiting the business. These families have been in the tanker business for years and know when there are problems.

Elliott: Sheep owners? I was considering the rack of lamb, but I’ll guess you were referring to ship owners. Man, your accent has thickened since you left the states. Do I need to buy you a Speak and Spell for your return flight?

Yiannis: Very funny, man. My pronunciation is off, but I still have concerns about the oversupply of tankers.

Elliott: The Greek shepherds were right. In 2006-07 a number of new-build tankers threatened to swamp the market, and spot rates weakened measurably. The global recession took hold in 2008-09, sending spot rates for all tankers into a nosedive.

But the situation is improving rapidly. A few years ago, the International Maritime Organization (IMO) adopted rules mandating that all single-hull tankers be phased out by the end of 2010. Certain classes of single-hull vessels will be allowed to remain in service through 2015, provided that these ships pass a rigorous inspection.

IMO has allowed individual ports to ban exempted ships regardless of their inspection status; most of the world’s important ports have banned single hulls as of the end of 2010.

The bottom line: These tankers are all being scrapped and permanently removed from the global fleet. That’s an estimated 15 to 20 percent of the global fleet as of the beginning of this year, and the pace of scrapping has picked up noticeably since the end of 2009.

The waitress arrives and Elliott orders mussels with frites. Yiannis opts for the steak tartar.

Yiannis: I’ve heard about the new rules. Demand for scrap metal is strong; it’s not a bad time to demolish these older ships. I’ve also heard that some tankers are being converted into dry-bulk ships to carry coal and iron ore.

Elliott: Conversions are another key element of the supply story. Some ships were transformed into dry-bulk carriers few years ago because the market for these vessels was tight. Also, some ships have been converted into floating production storage and offloading (FPSO) vessels. FPSOs store oil produced from offshore fields and then load that crude onto smaller tankers to be transported to shore. Because global oil production from offshore fields is growing rapidly, FPSOs are in higher demand.

Then there’s the practice of slow steaming, or running tankers at less-than-maximum speeds.

Yiannis: Good, you’re still talking about tankers; slow steaming would ruin your mussels. I’m looking forward to your mussels as much as you are.

Elliott: Thanks for that astute observation, Yiannis. Anyway, slow steaming saves fuel and reduces the number of round-trip journeys the tanker can complete in a year. This further reduces the effective size of the global fleet.

Yiannis: I couldn’t resist, man. I’m on board with what you’re saying–and eating. Several of the Asian shipyards I cover in the Silk Road Investor noted that orders for new-build tankers were delayed or canceled when the credit crunch hit in 2008-09.

I agree that the supply situation is shaping up well for the next few years. What about demand? US oil inventories are bloated, and the global economic recovery is anemic.

Elliott: Demand for crude oil is bouncing back nicely from the 2007-09 recession, led by the emerging markets. According to the International Energy Agency (IEA) global oil demand will grow 1.8 million barrels per day in 2010 and 1.3 million barrels per day in 2011. Although US inventories are high, demand continues to recover. Gasoline demand is up roughly 2 percent from a year ago, and demand for diesel fuel is up 8 percent.

And oil prices don’t drive tanker rates; the amount of oil that needs to be shipped is the key.

OPEC members are cheating on their official quotas in a big way, cashing in on oil prices between $70 and $80 per barrel. I expect OPEC to raise its official production quotas at some point in 2011, which will increase shipping demand.

Yiannis: You’ve convinced me about the tanker industry’s near-term prospects. But why are you recommending Teekay Tankers instead of its much larger parent, Teekay Corp (NYSE: TK)?

Elliott: Teekay Corp established Teekay Tankers as a yield vehicle that pays out most of its earnings as dividends. The current quarterly payout is $0.34, a yield of roughly 11.5 percent at current prices.

If the tanker market improves, I can see Teekay Tankers paying $0.50 per quarter or $2 per year in dividends. With that payout, I’d expect the stock to trade well north of $20 per share, a double from current prices.

Yiannis: But is Teekay Tankers at a disadvantage because it has only 14 ships?

Elliott: That’s not cause for concern. For one, many of Teekay Tankers’ vessels are leased under long-term contracts at fixed rates, which provides stable cash flow.

Second, the vessels it has on the spot market are in the Teekay Pool; Teekay Corp leases these tankers as part of its fleet of more than 150 ships. You get the bargaining power of Teekay Corp when you buy Teekay Tankers.

Yiannis: I like it, let’s go with Teekay Tankers.

At this point, the table is littered with discarded mussel shells and the remnants of two large plates of frites. Yiannis orders a coffee, and Elliott selects a cognac from the menu. Elliott winces after his first sip.

Yiannis: What’s wrong with the cognac?

Elliott: Nothing, it’s lovely. My mouth stings from yesterday’s Bitterballen experience. This was a great meal.

Yiannis: Ha, serves you right for ordering cognac so early in the day. Are you staying in Antwerp tonight?

Elliott: No, I’m supposed to meet some friends in The Hague, and then I’m headed back to DC.  I’ll see you stateside later in the month.

Buy Teekay Tankers (NYSE: TNK) under 13.50 with a stop at 9.25.  

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