Tanker prices hit record highs, but sustainability in question

Source: Drewry Maritime Research

With the recent spike in charter rates, the second-hand price to EBITDA ratio has contracted from its 2022 highs. Considering the current ratio, one may think that these high second-hand prices are justified. But the question remains, is this the right time to invest in second-hand tankers?

Equity IRR and project IRR analysis – Investment in a five-year-old VLCC

We have analysed and evaluated the attractiveness of investment in second-hand tonnage, considering a five-year-old VLCC changing hands at USD 113 million. We aim to compare shipowners’ potential returns on investment in these ships against their cost of capital. To estimate potential returns, we used equity IRR and project IRR and then compared potential returns with the cost of equity and the weighted average cost of capital (WACC). Our cost of equity (COE) and weighted average cost of capital (WACC) pertain to a US-based investor having a credit rating of AAA. 

Investment in five-year-old VLCC does not seem lucrative

We have arrived at projected IRR and Equity IRR, taking our long-term forecasts of charter rates, and second-hand price (five-year-old) of $113 million. 

Based on our calculation, we believe a five-year-old vessel in the period market for 20 years should offer a project IRR of 7.2% and an equity IRR of 9%, using 70% debt/equity in our base case. We found that the Equity IRR of 9% is lower than the cost of equity of 9.7%. Additionally, the project IRR of 7.2% is lower than the WACC of 8.3%. While the difference between IRR and cost of capital looks narrow, if asset prices improve, IRR will further reduce, making the investment even less attractive. 

In a bull case, the equity IRR of 10.5% is higher than the cost of equity of 9.7%, suggesting rising freight rate environment favours shipowners. Project IRR is lower than WACC even under the bull case. In the bear case, both equity IRR and project IRR are lower than the required rate of return.  

Using NPV analysis, we have arrived at an equity NPV of negative USD 2.9mn and a project NPV of negative USD 8.8mn, suggesting that investment in a five-year-old VLCC at current prices does not look lucrative.

Source: Drewry Maritime Financial Research

Key assumptions

We have calculated equity IRR and project IRR (levered IRR) using Drewry’s time charter forecast for the next five years and the mean reversion model for the charter rates beyond five years. We have assumed off-hire days, intermediate and special survey costs based on our understanding of the market and the remaining useful life of the vessel to be 20 years. Our cost of equity and WACC are representative of a US-based investor with low business risk, the highest credit rating and assumes financing at prevailing market rates. We have calculated equity IRR and project IRR under three scenarios- Bull, Base and Bear. These scenarios are based on our time charter rates forecast for the next five years for each of these scenarios and charter rates obtained by the mean reversion model thereafter.