BW LPG controls a massive fleet of 51 Very Large Gas Carriers (VLGC) fully delivered in addition to four LGCs. The company has a history that exceeds most of its peers in addition to a differentiating industrial approach to LPG shipping, which is highly benefitial in the current depressed part of the cycle, but limits the upside in a boom. Having already swallowed recent entrant Aurora LPG, BW LPG remains key consolidator in an industry currently trading far below steel values. We initiate coverage with a BUY recommendation and NOK 37 target price (+23%) ahead of improving fundamentals.
Strategy: The company reported ~30% timecharter and Contract of Affreightment (COA) coverage for 2017 as of end 2016. This exemplifies the industrial approach to operations, which ensures utilization above peers through the cycle and mitigates the current trough spot earnings, but also limits the upside as we saw in the 2014/15 super-cycle. In terms of asset strategy, the company aims at the simplistic approach of investing low and divesting high, which it has successfully proven over time: Most recent examples are the acquisition of Aurora LPG and the August/16 divestment of the 2001-built BW Borg reported at USD 40.5m (vs our current generic value of 29m).
Valuation: We calculate a NAV of NOK 50/sh (P/NAV 0.6), with one year forward NAV of NOK 63/sh assuming asset prices rise ~10%. Our target price of NOK 37/sh is based on a weighted average of current/future NAV and mid-cycle multiples in 2018/19E.
Market overview: Before the paradigm shift in 2014/15, LPG shipping on Very Large Gas Carriers (VLGC) had more industrial properties than today. The market was characterized by less spot activity, the Middle East as the main exporter and LPG prices primarily set to clear the market (supply driven). The US shale oil/gas boom, the collapse in oil prices and the massive expansion of US LPG export facilities have subsequently led to a market which is more spot cargo driven and dependent on the price differential between US and Asian energy prices being high enough for deep sea shipments of US LPG to make economically sense.
After enjoying super profits in 2014/15, VLGCs earnings collapsed under the weight of an extraordinary fleet growth from 164 vessels at the start of 2015 to 250 vessels today (CAGR of 19%), whereas demand has not kept up despite massive new US export capacity having de-bottlenecked the global trade. Lower global energy prices have also affected tonne-mile demand negatively, in concert with the expansion of the Panama Canal in mid-2016. Thus, we see two constraints that needs to be corrected before earnings once again can return to normalized levels and beyond: 1) The increase in global energy prices and 2) the reduction in the current tonnage oversupply.
The US rig count has risen 127% from the trough in mid-2016, representing increased present and future US shale oil and gas production. Hence, it is likely that excess LPG in the US will increase and prices will drop, increasing the LPG price differential vs the Far East, all else equal. However, the flip side of increased US production is lower global energy prices and thus lower LPG price differential. The optimal scenario would be high global energy prices and high shale production in the US, but this is not a base case scenario in our view. An increased LPG price differential is pivotal for making LPG shipments on VLGCs economical viable, with current theoretical TCE rates at USD -7k/d (vs USD 120k/d at the peak in mid-2014). Based on the current Brent crude oil futures curve, and assuming unchanged US LPG prices, we estimate VLGC rates below USD 10k/d until 2020E. However, elevating the futures curve by a mere USD 10/bbl to around USD 60/bbl enables theoretical VLGC rates around USD 40-50k/d. This shows how sensitive spot rates are to global energy prices. Overall, we forecast demand growth of 6% in 2017E, 8% in 2018E and 6% in 2019E (vs 6% average since 1999) based the new US export capacity coming online, a small increase in global energy prices and unchanged or falling US LPG prices.
In terms of supply growth, we are still seeing deliveries from the massive contracting during the 2014/15 super-cycle (current gross orderbook at 13% vs fleet). Given the lacklustre earnings and 17 vessels older than 30 years (6% of fleet), it would be natural to see significant scrapping at this point. However, we have only seen two vessels sent to the beaches over the past year, but we still believe scrapping to pick up going forward. Nevertheless, zero newbuildings have been contracted over the past year, thus laying the foundation for the next expansionary phase in the cycle. We forecast net supply growth of 12% in 2017E, 3% in 2018E and 1% in 2019E.
In sum, we expect utilization to trough at 73% in 2017E, recover to 77% in ’18E and rise to 81% in ‘19E. This equates to average VLGC spot rates of USD 13k/d in 2017E, USD 18k/d in ‘18E and USD 25k/d in ‘19E.