This Company is Just Beginning (Another) Huge Bull Run

Friday, April 9, 2010 - 12:37pm

by Tom Hutchinson

The financial crisis interrupted an unmistakable trend.

Worldwide demand for oil, which had been sharply on the rise in the past decade as a result of ever-increasing demand in China and India, plummeted in the past year.

While worldwide oil consumption rose from 64.8 million barrels a day in 1980 to more than 85.0 million barrels a day in 2007, demand shrunk by about 1.4 million barrels a day in 2009.

But demand is once again on the rise as economies throughout the world recover. OPEC, the oil cartel, estimates oil demand will increase by 900,000 barrels a day in 2010. This uptick in demand will be driven by China, which is expected to grow by about +9% this year. That's far better than overall worldwide economic growth, which forecasters predict will be +3.4% in 2010, a strong rise from a -0.9% contraction last year.

Rising demand for oil benefits companies that transport oil. As the flow of oil increases, so does demand for shipping and, with it, the rates shippers can charge. Low demand for crude pushed oil shippers to seven-year lows in 2009, but things are beginning to look up.

Overseas Shipholding Group (NYSE: OSG) is the second-largest publicly traded tanker company in the world. The New York-based shipping group owns and operates a diverse fleet of 129 vessels that primarily ship crude oil and petroleum products all over the world for oil companies. In the fourth quarter of 2009, about 50% of revenue was attributable to crude shipments; 22% was from the petroleum product segment and 28% came from the U.S. flag fleet.

What makes OSG particularly attractive at this point is that it has a significant exposure to spot rates, the daily shipping rates at time of charter, which vary significantly. OSG estimates that 75% of its revenue-earning days in 2010 will be exposed to the spot market. While spot-rate exposure has been disadvantageous in recent quarters, it should be a big plus going forward.

According to Chief Executive Morten Arntzen, 2009 was one of the most difficult tanker markets of the past 20 years. The company earned $70.2 million in the period, or $2.61 per share, way down from $317.7 million or $10.65 per share, in 2008. The company cited the worldwide economic slowdown, OPEC production cuts and a +6% increase in the worldwide fleet, which all had the effect of reducing the amount of oil shipped and lowering spot rates for shipping in 2009.

Average rates earned by the company’s international crude oil tankers fell -50% in 2009 to $26,307 per day from $52,344 in 2008. International product-carriers declined -21%, to $17,976 per day, from $22,803 a day the year before. Revenue days, that is, when ships are operating and producing revenue, decreased year-over-year by 1,810 days fleetwide, or -4.6%.

Things have been turning around fast.

As world economies continue to recover and oil demand increases, shipping rates have moved higher. In the fourth quarter, average charter rates earned for OSG's tankers were $37,620, a rate that trounces average 2009 rates of $26,307. Spot rates for VLCCs -- shorthand for "very large crude carriers" -- averaged $25,000 in fourth-quarter '09 but are expected to reach $55,000 in 2010, according to investment group Jefferies & Co. The firm sees rates at $60,000 in 2011.

OSG has paid quarterly dividends of $0.438 per share since mid-2008. Annual payments of $1.75 translate to a solid 4.1% yield. Earnings of $2.61 per share even in a rotten year nicely covered the current dividend with a payout ratio of 67%.

Shipping rates are on the rise. A worldwide recovery makes it likely that rates will be significantly higher in 2010. Longer term, worldwide oil demand should continue to increase. OSG appears to be facing long and short term tailwinds and the stock is still a long way from its high of $90 in 2007. OSG appears timely and is a great way to play the recovery and rising oil demand.

Tom Hutchinson does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.