The tanker trade was a very popular thematic trade in Spring 2020 which led to immense trading volumes; one stock in particular: Nordic American Tankers (NAT) enjoyed an all-time record daily volume. This ‘tanker/contango’ or ‘floating storage trade’ lasted from March 2020 to May 2020 and developed due to a COVID-19 related collapse in global oil demand in early-2020 combined with an initial Saudi ‘Oil Price War’ initiated on 8 March. I flagged this trade on Value Investor’s Edge that weekend in March and I brought the thesis public on Seeking Alpha on Friday, 13 March.
Crude tanker stocks performed wonderfully from mid-March to end-April, but trading momentum fizzled as the enormous oil contango evaporated and OPEC+ did an exceptional job of holding to their unprecedented export cuts. Additionally, the global economy (with the notable exception of air travel and related jet fuel demand) opened up fairly rapidly, which helped oil markets balance. We therefore had a neat boom-and-bust trading cycle over the course of three months (March-May) followed by four months of residual ‘hangover’ from June-September.
Top Performance Variable? Dividend Policy
I’ve recently published a full-length post-mortem at Value Investor’s Edge, which I will be bringing public on Seeking Alpha shortly, but I’m sharing one of the findings here: the largest factor in determining both short-term trading returns during the cycle and medium-term returns March-September was dividend policy, specifically large variable or fixed payouts. There will be more to discuss later, but here is a chart breaking down the clear performance by ‘baskets’ of allocation:
The ‘Dividends’ allocation has produced a positive total return across the full cycle and also produced, by far, the largest average return in March & April across the trade window.
There will be more to discuss later, but a key finding for companies to takeaway is that dividend policies matter and the markets are rewarding the firms with large payouts at a disproportionate degree.
Clear Opportunity for Management to Excel
Many of the ‘biggest losers’ of the cycle are firms with otherwise decent market capitalization, good corporate governance, and excellent value propositions, but have otherwise either tiny or non-existent dividends.
There is obviously a balance, and leverage needs to be considered, but these ‘all-or-nothing’ deleveraging policies like we’ve seen at Diamond S (DSSI) and Teekay Tankers (TNK) or the anemic dividends like we’ve seen at International Seaways (INSW) or Scorpio Tankers (STNG) clearly aren’t helping. All four of these are good companies with enormous upside potential, but their dividend policies and over-focus on deleveraging have crushed the stocks this year.
How can management bridge the gap effectively?
We have clear examples of ‘the right process’ from DHT Holdings (DHT), Euronav (EURN), Frontline (FRO), and Nordic American Tankers (NAT). The solution is clear: offer a strong variable payout directly related to earnings and cash flow. Additional kudos to DHT and EURN who provide an exact formula for shareholders to follow (60% and 80% of EPS respectively). Even more kudos yet to EURN who has increased the return even further by allocating some of these funds to repurchasing units.
What about a small fixed component?
There is nothing wrong with a small fixed component and it can certainly help returns over time. International Seaways (INSW), Scorpio Tankers (STNG), and Tsakos Energy Navigation (TNP) have all taken this approach; however, shareholders want to be rewarded when times are strong. Therefore, I encourage firms to also consider some sort of variable payout policy. If leverage is much higher, then perhaps a lower EPS ratio is appropriate, but the facts speak for themselves: if you want your share price to improve, you need to be more generous on the payout!