Scorpio Tankers has been on a year-long race against higher interest rates given the onerous level of debt — more than $3bn — that it carried into the start of 2022.
Fuelled by a rejuvenated product tanker market, Scorpio has used cash flow to buy back ships it had placed on costly lease financing, declaring purchase options on 24 of 110 vessels so far.
The result has been an effective tug-of-war in which the New York-listed owner has significantly cut debt even as its interest rates escalated. For that reason, it has counselled equity analysts to maintain their assumptions of a $17,500-per-day all-in break-even for the fleet despite lower debt.
But Scorpio may have a new tack in store that has little to do with the issue of rising interest.
The surging share price of the Emanuele Lauro-led owner could afford it the option of forcing a conversion of some $200m in convertible notes that are not due until May 2025.
Convertible notes are hybrid securities that act like a bond in paying coupon interest to holders, but can be converted to common shares at a specified “strike” price — sometimes at the discretion of holders and occasionally at the choice of the company.
Scorpio’s share price is up 300% on the year. It was trading around $52.50 this week, which is well over the $46 or so that finance sources say is the trigger price for it to force the notes to be redeemed for company stock.
Why is this significant? A conversion would instantly wipe $200m of debt from Scorpio’s books. At the same time, it would add $200m in share value or market capitalisation
With Scorpio already reporting results on a diluted basis because the converts are “in the money”, there is no negative impact to the additional shares and an estimated boost to NAV of $3 per share. Plus Scorpio eliminates the interest being paid on the notes, albeit not especially high at 3%.
Streetwise approached Scorpio management on the status of the convertible notes this week, but executives would not be drawn on the issue.
Scorpio president Robert Bugbee was willing, however, to discuss the company’s experience with rising interest costs and the efforts to counter them.
“As the year has progressed, it’s been a race between — on the one side — reducing debt which reduces overall interest payments, and on the other side interest rates that are going up,” Bugbee said.
“The majority of our debt is floating. The company is reducing debt quite quickly as interest rates are going up, which is why we haven’t changed our guidance for the analysts for a financial break-even rate of $17,500 per day despite the lower debt.”
Scorpio has been able to avoid the problem of rising Libor thus far by using cash off the balance sheet to exercise purchase options. Libor has gone from near zero to about 550 basis points currently.
But Scorpio has more work to do, and Bugbee acknowledged that it will need to take on some new debt with reduced margins to keep moving with the purchase options.
“So for now it’s cash, but in the future it’s likely we’ll take them down with a combination of debt and cash,” Bugbee said.
Lease financing can be relatively expensive with margins between 350 and 550 bps above Libor, where new conventional bank financing might be had at margins slightly below 200 bps.
If the revived tanker market follows in the footsteps of the once-raging container ship sector, Asian lessors also might be willing to recognise improved balanced sheets by renegotiating the high current margins.
“So it’s taking out the most expensive margins leases and taking total debt down, and then on the other side of the ledger earning higher interest on the increasing amount of our cash in the bank,” Bugbee said.
To be clear, Scorpio had a clear priority of reducing debt in any case as the new year dawned. It was objectively too high as had been noted by a number of equity analysts.
The prospect of rising interest rates merely intensified and perhaps accelerated the urgency, and the clean product rates market cooperated just in time to make it happen.
It’s a process, and it’s not over.
But for now, keep an eye on those convertible notes. They may be Scorpio’s next big thing.
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