Octave Specialty Group Inc (OSG) 2004 Q3 法說會逐字稿

Good morning and welcome to the Overseas Shipholding Group third quarter 2004 earnings conference call. At this time, all participants have been placed on a listen-only mode, and the floor will be open for questions following the presentation. It is now my pleasure to introduce Robert Cowen, Senior VP and Chief Operating Officer. Sir, the floor is yours.

Thank you and good morning. This conference call may contain forward-looking statements regarding the Company's prospects, including the outlook for tanker markets, changing oil trading patterns, prospects for certain strategic alliances, anticipated levels of new building and scrapping, and the forecast of world economic activity and world oil demand. Factors, risks and uncertainties that could cause actual results to differ from expectations reflected in these forward-looking statements, are described in the Company's annual report on Form 10-K.

With that out of the way, I’d like to introduce OSG's CEO and President, Morten Arntzen. Morten?

Good morning. I will quickly go through the results, talk a little bit about the Job Creation Act, talk a little bit about the fourth quarter and then some of the highlights we had in the last quarter.

As you’ve seen, for the third quarter we reported net income of $68.5 million. This was a 388 percent increase from the third quarter last year. EBITDA rose to 145 million from 57 million in the same period last year. For the first nine months we reported record earnings of 190 million, compared with 100 million the year before. And EBITDA rose from 250 million to 415 million.

I think this reflects, obviously, a very strong tanker market and our decision to maintain a high degree of exposure in the spot market, a position we have maintained and continue to maintain, and also our decision to expand our participation in time chartered and tonnage, a practice which we also continued in the fourth quarter.

In addition to the terrific tanker market we enjoy right now, OSG also had a tremendous legislative victory in the third quarter – well actually the fourth quarter. On October 22nd, President Bush signed into law the Job Creation Act, which as many of you know was the very large corporate tax bill that both Houses of Congress passed. This will place OSG’s international tanker fleet on a level playing field with its offshore competitors for the first time since 1986.

In the past, since 1986, when we have analyzed foreign vessel acquisitions, we have had to burden our calculations with a 35 percent tax rate. That will no longer be the case. It's a major step forward in creating economic conditions for US companies to invest in the international shipping business.

Let’s try to put this into perspective. The new tax law will effectively restore the pre-1987 tax treatment of foreign shipping income and will permit indefinite deferral on foreign shipping income. Prior to 1987, we did not set aside taxes for our foreign shipping income, as we operated on the assumption that we would reinvest all the earnings in our foreign fleet. That is the policy we will now practice going forward.

So had the deferral on foreign shipping income contained in the Act been effective for 2004, our provision for federal income taxes of $95 million for the first nine-months would have been eliminated. Or put a different way, rather than reporting nine-month earnings of 190 million, we would be reporting nine-month earnings of 285 million. Or for the quarter, instead of reporting 68 million, we would be reporting 100 million. This is a very material change for OSG, and now we will no longer be burdened in our competition with the other public foreign tanker companies.

In addition to that, because of the Act, the Company expects to reverse approximately $70 million of net deferred tax liabilities and take them in income in the fourth quarter of 2004. All in all this is something we have been actively supporting. We think it’s a great victory for US shipping and great victory for OSG going forward.

Let me go through some of the highlights in this quarter and some we’ve talked about before. In July, the joint venture with Euronav, we took delivery of the 442,000 double hull V+s. These unique vessels, which were built for a 40-year life and can transport 3.2 million barrels of oil, have now been operating within the TI umbrella, Tankers International umbrella. And so far the results from these ships are better than what we expected and we’re very satisfied with that acquisition.

Another big move during the quarter – we established a strategic business unit headquartered in Newcastle, to pursue opportunities in LNG transportation. This unit will be headed by Angus Campbell, who is currently a senior executive in our Newcastle operation center. And why Newcastle? Because initially you need to build up your technical expertise in order to pursue this market. Our foreign flag technical base in Newcastle is our center of excellence there. It is the natural place from which to do it. In addition, there is perhaps a better ability to recruit the people you need in the UK than there is today on the East Coast of the US.

I know some may have questions, can we talk about any specific contracts we’re involved in? And the answer will be we can’t. LNG contracts that you compete for have punitive confidentiality agreements. But all I can say is we are pursuing opportunities and we intend to build this into a world class segment, the same thing we’ve done with our Aframax and VLCC business.

In August, I think somebody else reported, we sold the Olympia, our oldest and only remaining single-build VLCC. And in August we agreed to sell the Dundee, a 1993 built double-sided VLCC. And we’ll take a gain of about 13.6 million in the fourth quarter. That sale closed two days ago. And then in October we agreed to sell the Diane, a 1987, 17-year-old, double-sided product tanker (ph) and we will recognize a gain of about $5.4 million in the first quarter of 2005, when that is sold.

And the last piece of information on the fleet. In September – in fact it was on September 14th, the Company along with another full partner who took a 25 percent stake, chartered an Aframax tanker for one year. This was the tenth vessel that the Company has participated in the chartering on over the last year.

And so if you look at what we’ve done in the course of a year, we have sold three of our oldest vessels, our oldest product tanker and our two oldest VLCCs and we’ve chartered and participated in 10. And if you add up the math in the disclosure, second (ph) we took in four new double-hull Aframax and VLCCs to replace that. So net-net, our fleet has expanded.

On the finance side, if you look at the fixed charges through the first nine-months of 58 million, EBITDA $415 million, we have 7.1 coverage of fixed charges, which is an extremely strong number. And we ended July with liquidity of 1.1 billion. That includes cash, tax adjusted CCF funds and undrawn long-term fixed commitments.

Let me switch and talk a little bit about the fourth quarter and it will be more discussion of what’s going on in the market. If you look at the spot market in the month of October, and keep in mind that for October you’re fixing those ships in late August-September, we think the spot market will probably average mid-70s for VLCC. I’m talking about VLCC, because I think they’re a good proxy for the entire tank (ph) markets.

For November, spot rates have averaged north of $100,000 and been trending up the entire period. Now most of November is covered for the big ULCC operators and that’s the levels we’re seeing out there. What we’re seeing fixed for December so far is north of $120,000 a day and again, it has been trending up pretty much day in/day out. There’s an occasional one or two world scale (ph) points drop, but basically it has been trending up. So that our expectation is that for the entire VLCC spot market, the fourth quarter, this will be the best quarter in the industry’s history since 1973. A very good quarter.

And then do we see this continuing into 2005? This is an incredible market. Keep in mind that this fourth quarter you’re seeing now, there have been virtually no scrapping of older VLCCs, because anybody who has a ship is hanging onto it as long as they can. By April 5th of next year, a number of ships, a few VLCCs – I think it’s about 10 or 11, a larger number of Aframaxes will have to leave the fleet. They will not be able to trade. So that net-net there will not be much growth in the market.

In addition, we continue to see strong demand for tankers throughout that. And diversely (ph) this quarter and last quarter were great markets, yet there were no big events in the world. There were no strikes in Venezuela, no strikes in the North Sea, no strikes in Nigeria. It was basically a calm market. Iraq was producing at a high level – relatively high level. But no incidents out there. No incidents, no scrapping, yet we had a very strong market. Seasonally the winter months tend to be the better months, so our expectation is this market would continue. And so we look forward to a very strong quarter and a very strong first quarter of 2005.

I think with that, we’ll open the floor to questions. So Lynn, if you would do that?

Thank you. The floor is now open for questions. (OPERATOR INSTRUCTIONS.)

Hey, Lynn? Can I interrupt? There’s one thing I forgot to say. It's a small correction we had in our release. And I apologize for interrupting you on that. But for the listeners, if you go to page 7 on the release, on Appendix 1, in the per share data, there is an error in there. We will send out a brief release. It's not material, but I wanted to just flag it for people. It is the per share number for the three-months ended September 30th. It says 1.41. It should be $1.50 and the gain on security transactions should be 3 cents, not 12 cents. It's an error in our favor. It's a mistake. I apologize for it. It's not material. We will send out a correction later today. Sorry Lynn.

That’s okay. (OPERATOR INSTRUCTIONS.) John Chappell, JP Morgan.

Good morning, guys. First of all, that little change is very material. That makes apples to apples earnings $1.50, which beats consensus, rather than just missing. So, hopefully that gets reflected in the market later on.

A couple of questions for you. First, a couple of your competitors in the past week, when they announced earnings had given us a little bit of visibility on the fourth quarter by saying what percentage of their fleet they had booked and at a rounded rate, to just give us a little bit of help as we start to look at the fourth quarter. Do you have those figures?

I think I gave you pretty good feel for – we’re certainly going to do better than the average spot market rate for the market in any month. And what I gave you was where’s the overall market. October is pretty much done for us. November is about two-thirds done. And December is – that’s probably about 25 percent done at this stage. The only thing I’d say there is anything that we’re right now going to be locking in, in November or December is going to be a better rate than anything I’ve talked about so far, because that’s where the market is. So if you took the whole quarter we’re around 57 percent fixed in, north of 80 and about 43 percent uncovered.

All right, that’s helpful. The one issue where I missed on my third quarter number was the VLCC rates. And the reported number was like 61,000 versus the average you put in the press release is 72,000. Were there any issues? Were you repositioning vessels to kind of get them ready for the fourth quarter spike that you anticipated? Any other outstanding issues that might have brought the actual reported rate below (indiscernible) Clarson’s (ph) average?

The Clarson’s average is just a theoretical average and the numbers that you’re seeing – what we have given to you is the actual. There was a little bit of repositioning, but not very much. But I wouldn’t take – Clarson’ is not that accurate an indication.

And then just one last thing for miles. We talked about the tax bill and the benefit there and you said you can eliminate the full $95 million in taxes from the first nine-months of this year. But you still have to pay some taxes on what’s pretty minimal US slag Jones Act business. For modeling purposes, do we just throw a couple percent in there for ’05?

I think we’re still studying that. But we want to be very clear on that. Right now we’re not seeing – basically where the business is currently configured, prior to any investments we would make, you don’t need to do that. In the event that we made some acquisitions in the US flag side, which is certainly possible, because we’re looking at things, then you should do that. But as currently configured, there is no need to do that.

So no cash taxes.

Correct. We are effectively now and ineffectively, we will be on the same ground as Front Line, Genmar, all the other non-tax paying foreign incorporated shipping companies.

Okay, that’s great.

We think it’s great also.

Natasha Boyden, Sidoti & Company.

Hi gentlemen. I just have a quick follow-up question, since Jonathon’s answered most of my questions. You do have a lot of cash. Are you planning to just use most of that or all of it for acquisitions? Is that your primary focus? Do you have any intention of doing anything with a dividend?

I think – the dividend is something we look at, at every board meeting. We look at it in light of commitments we have for charter and tonnage, for new buildings, for acquisitions. We have still been looking at some LNG investments. If those were to materialize that would require some cash. It's no secret that we’ve been very actively looking at the military security program building product tankers here in the US. If that materializes and those submissions are happening this month I believe, we are looking at a number of programs there. If those don’t materialize, clearly the board will take that into account. But right now, in this environment, we see some interesting opportunities out there.

Okay, great. And then I just wanted to follow-up on your point about supply going to the market in 2005. If I remember correctly, you were talking about the market in general. I’ve been looking at the Aframax vessels and it looks like in that particular class of vessels there are an awful lot of vessels coming on line. I’m just wondering, it appears to be more than any other class. Is that something that you’re concerned about?

It's something that we have to be concerned about and it’s obviously something that we follow extremely closely, since the Aframax fleet is one of the two largest segments that we have. The number of vessels coming in, some of those vessels, as you’re going to see, are going to be trading in the clean trades, although we predominantly operate our pool in the dirty trades. Also, you’re going to see under the Marpa (ph) regulations in the ’05 days, you’re going to start seeing a number of vessels are going to be required to leave the fleet, because they’re not going to be able to trade internationally. So it is an issue for us. It's certainly a concern that we have, but it’s one that we think is certainly manageable.

Okay, so the people you said – the owners that have not done any voluntary scrapping and they’ve been holding on for dear life with these rates, are they – as you’re going to bang up against those dates in ’05 aren’t going to be forced to do it?

They will be forced out of the market and the Aframax has a much larger number of ships. We can give you that follow-up if you want the exact number that goes out before then.

John Carsomas (ph), Smith Barney.

Hi guys. On the VLCC segment what was your realized day rate for the quarter, how many days did you book?

We don’t break that out. Keep in mind we have a 49.9 ownership in four ships. We don’t break that out separately. We put that in with our VLCCs. What I would say about the use is that if you want to do it for modeling purposes, they have a 3.2 million-barrel carrying capacity, compared to 2 million for our Vs and that so far they have been earning their carrying capacity. So if you took a V rate and grossed it up by the carrying capacity, you’d be approximating what those are earning.

Okay, so they’re still earning ship (ph) premium over VLCCs?

Yes.

Okay. And also, did you buyback any debt during the quarter?

No. We’ve been asked that, I think in particular on our 20-year debt. The 20-year unsecured bond we did earlier this year at 7.5 percent, we like carrying that in our liability structure. And we have no plans today to buy any of it back. Could we revisit that in a year or two? Sure. But right now there are no plans to do that and we didn’t do that.

(OPERATOR INSTRUCTIONS.) Justine Fisher, Goldman Sachs.

Good morning. I just have a few questions. First of all, could you tell us what CapEx was for the quarter?

What CapEx was for the quarter? You asked this question last time. We never look at it that way. Well the biggest expenditure we had in the third quarter was I think $123 million went out for our participation in the V+s. Peter, are you on for dry docking expenditures in the third? I just don't have it at my fingertips.

No, I’m sorry, I don't have it at my fingertip either, Morten.

We will get that number for you and I apologize.

Okay, that’s fine. And then of the 70 million that you’ll realize to income of the tax benefit in the fourth quarter, is any of that cash?

No.

No. Okay. And then I know that I guess it was last week or maybe the week before, there were some publications talking about how OSG had potentially been bidding for Stelmar or had been in discussions with Stelmar. I know that you stated you were looking to expand in the Jones Act product carrier market potentially or the crude market even for the Jones Act. But are you still looking at international product carriers as well?

Yes, we are.

Okay. And then is there – and I know you--.

Just a clarification. The initial military program that we’re competing for is one where the military will provide subsidies of $50 million per ship to build vessels in a US yard, but they will trade in the international tanker market. The initial ones. After that, we have an interest in Jones Act product tankers also. But the initial ones will trade internationally.

Okay. So if they give 50 million a ship, what would the total purchase price be? As far as I’ve heard, a Jones Act vessel is around maybe 130 to 150, depending on the size?

Well, if that’s the case, they won’t get built. I think the way to look at it is for this program to go forward, with this subsidy, you have to get down to below the price of what the foreign flag vessel will cost you. Because even with the subsidies you get for operating the vessels, you’ll still have a shortfall compared to a foreign flag tanker. So the yard will have to get a net price that’s cheaper than you can build in Korea or Japan or China. And at that level, then the program would happen. If it doesn’t, there’s no economic incentive for anybody to do the program. The yards are going to have to work hard.

Okay. And then the last question I have, I know that you said it was your strategy to continue operating most of the vessels on the spot market, but is there any point at which you would consider at least putting some of your Aframax on time charter, if not the VLCCs. I know it’s hard to clarify whether there’s an exact rate or just a market trend.

We have a couple of our efforts (ph) that are on short-term time charters. But we have deliberately kept (indiscernible) exposure. If you look forward based on the order book – and the Aframax order book is relatively high, but in fact the net additions to the fleet will be greater in 2004 than you project in 2005 (inaudible). In the VLCC segment it’s an extremely tight market. It's an extremely tight market. So at this stage we’re going to continue to maintain a pretty high spot exposure.

I think – what factors will we take into account as the tanker market expands and you start being able to lock in cover at rates that are near or above what we’re budgeting, then we’ll think about it. But right now, we’re pretty comfortable with the fundamentals. And keep in mind, we keep a very strong balance sheet, lots of liquidity, so that we can tolerate more spot exposure than others. So we’re doing this we think in a prudent risk effective manner also. But we like the outlook. I’ve said that every quarter.

Thomas DeBello (ph), Turner Investments.

Hi, I just wanted to make sure I understand this tax situation. You reported $1.50 for the third quarter, so if that law had been in effect, you would have reported significantly more than $2 a share, is that correct?

Rather than reporting $68 million, we would have reported $100 million of net income. What’s that per share? With 39.3 it’s--.

It's over $2, I’d imagine. I didn’t do the calculation.

$2.54.

Okay, so that means that the $1.75 estimate that is for the fourth quarter for your Company, if that is correct, just even if you meet estimates, that actual number is going to have to move up significantly?

Keep in mind that the tax law doesn’t take effect until January 1, 2005. The fourth quarter we will pay more taxes. But from January 1, 2005, it’s level playing field.

Senille Jaguani (ph), Carlson Capital.

Hi gentlemen. Good morning and congratulations. My question is also regarding your balance sheet. You guys have more cash per share than any of your peers and you’ve addressed that before. And now with this tax change, it’s effectively a 50 percent jump in your cash earnings. Have you guys considered possibly raising the dividend or any other ways to return some of the cash to the shareholders? I know you guys have plans on the acquisition front, but is that something that you guys have addressed internally as well?

We discuss the dividend every quarter. The Company has paid a dividend since 1973, through high markets, low markets, tight cash periods and excess of cash periods. So we will continue to do that. When we look at some of the things we’re looking at or competing for today on the LNG side for example, they involve large amounts of money.

Let’s just talk a little bit about the LNG. The one thing you want to be able to do on the LNG is be able to have the financial flexibility to pursue the most attractive financing options out there. You can only do that if you have the ability to underwrite that kind of position yourself. So you know you can finance it, so you have the time to optimize it. As opposed to being in a position where you have to accept a financing alternatives, because the amounts are so large.

We like that position. We see some interesting opportunities on the US flag side and the US flag, because of the nature of US ship building, involve very large amounts of money. And we want to have the flexibility to pursue those.

Well, the other thing is that obviously with so much firepower remaining on the balance sheet, the accretion from whatever you guys end up doing with the cash, what sort of timing should we look at for that bump up in earnings? Because, clearly sitting idle on the balance sheet doesn’t really help much and I know you guys are actively looking. But what kind of timeframe are you guys working with?

I don't think we fixed a timeframe, but clearly, starting January 2005, let’s just say that 2005 was the same as 2004, for example – just as an example, that means that we’re going to have – we will not have to pay out 35 percent of earnings in tax. That will build up in our balance sheet. At some point, if we think that the opportunities have lower probability or that we can finance them without any contribution from OSG, I think the board will look more carefully at that.

I think the board has gotten the feedback on these calls that people asking about it. But very clearly, until we see good opportunities to employ the money, we’re going to continue to keep it. If we don’t, then a dividend will become a more compelling option.

(OPERATOR INSTRUCTIONS.) Natasha Boyden, Sidoti & Company.

Hi there. I just wanted to go back to your comment that the tax legislation won’t kick in until the first quarter 2005. So for the fourth quarter should we still be using a regular tax rate?

Yes, you should.

At this time there appears to be no further questions.

Natasha? Am I still on?

You are still on. Natasha’s out of queue now.

Oh, she’s out of queue. I just wanted her to understand that yes, you should, but you should also be factoring in the $70 million non-cash benefit that we put in there, just for modeling purposes.

We have a question coming from Jillian Dolman (ph), of Dolman Rose Weiss.

It's actually Simon Rose, from Dolman Rose Weiss. Hi guys. Congratulations on a good quarter. My question, basically the way we’re looking at it, you could potentially be trading at something less than five times next year’s potential earnings. At what point do you guy your own stock back?

We’d like to look at it another way. The tanker segment as a whole still enjoys ridiculously low multiples, particularly EBITDA multiples. When we look at it we’ve had now – the industry has generated five straight good years of very high EBITDA margins and earnings. And I think that if you look at the consensus, 2005 should continue. How long can the industry continue to punish the tanker segment for the bad years of the late ‘70s and ‘80s? We’re hoping that we’ll get a higher multiple entitlement. I will say that every conference I go to. But when you see what cash flow this industry is generating, we deserve it.

Right, but in terms of buying your own stock back, are there better opportunities to put cash to work than your own stock?

I think the one thing that makes us different from some of the other public companies, is we do have the US flag opportunities. And the US flag is – we are, in terms of cash and size, we’re basically bigger than the rest of the industry, which gives us the opportunity to compete in a market which our foreign incorporated competitors can’t. And that gives us access to opportunities they don’t.

That’s the one – LNG opportunity, are there a number of players in that segment? Yes. But this is a segment that mom and pop shops and smaller owners allover the world can participate, the way they can the dry bulk markets? The answer is no. So we have the size, the capital and the technical skills to go after that segment. So we’d like to have – you need a large capital base and resources to do that. So, we want to be positioned to take advantage of those if we can find attractive opportunities.

So you’re saying that there are more attractive opportunities in Jones Act business and LNG than buying your own stock back at these levels?

Today I’d say absolutely, yes. Absolutely, yes.

So we should look for wildly accretive transactions in the near-term?

I would never use – I’m a sober ex-banker, so I never use terms like wildly. Disciplined growth is the way we describe what we do and I’ll stick with that phrase.

Thank you. There appear to be no further questions at this time.

Thank you very much.

Thank you. This does conclude today’s teleconference. You may disconnect your lines at this time and have a wonderful day.