Scorpio Tankers Cuts Dividend 92% – What Should Income Investors Do Now?

Scorpio Tankers STNG Dividend CutScorpio Tankers (STNG) shocked many income investors when the company announced a 92% cut to its dividend this morning.

After all, the company’s management team sounded confident about maintaining Scorpio Tankers’ dividend just a few months ago in November:

“If you run through our model, the company is fully able to pay its dividend and be in compliance of its loans.” – CEO Robert Bugbee

In the blink of an eye, however, Scorpio Tankers’ dividend yield plunged from 14% on Friday to just 1% at the end of Monday, wiping out substantial income for many yield-hungry investors.

While this type of company is highly inappropriate for conservative investors living off dividends in retirement, it’s worth studying to understand what makes some high yield stocks riskier than others.

Let’s review why Scorpio Tankers cut its dividend, how dividend investors could have known the company’s dividend was in danger ahead of time, and what could happen next for the stock.

Scorpio Tankers Does Not Enjoy a Healthy Business Model

Scorpio Tankers is the world’s largest ECO-spec (i.e. lower fuel cost) product tanker company.

The business has 78 product tankers on the water and an additional nine vessels under construction and due to be delivered in 2017 and 2018.

The company’s product tankers provide marine transportation of refined crude oil products (e.g. gasoline, diesel, jet fuel) to areas of demand all around the world.

Scorpio Tankers STNG Dividend Cut

Source: Scorpio Tankers Investor Presentation

Many ships transporting commodities and various hard goods have fallen on hard times in recent years. However, product tankers were holding up quite well.

The chart below compares the stock price performance of DryShips (DRYS), the blue line, with Scorpio Tankers, the red line, from the start of 2012 through the third quarter of 2015.

You can see that DryShips dropped more than 90%, while Scorpio Tankers nearly doubled. The divergence in performance began in mid-2014.

Scorpio Tankers STNG Dividend Cut

Source: Google Finance

“A glut of ships, combined with slowing growth in demand for commodities from China, has wreaked havoc on the [dry bulk] industry,” according to the Financial Times.

Why did Scorpio Tankers hold up so much better?

While many container ships were suffering, oil product tankers, such as Scorpio, were benefiting from the rise of U.S. shale oil supply and the plunge in global oil prices.

Lower oil prices made it more economical for companies to produce refined products, driving up transportation demand for product tankers.

The U.S. also emerged as a refined products powerhouse, quickly becoming the world’s largest product exporter.

Demand was outstripping ship supply during this time, helping Scorpio Tankers enjoy a surge in time charter equivalent per day rates (i.e. the average daily revenue performance of a vessel).

Scorpio Tankers’ average rate nearly doubled from $12,898 in 2011 to $23,162 in 2015!

With vessel revenue growing nicely, profits swelled thanks to the operating leverage in Scorpio Tankers’ business model.

Regardless of vessel revenue and transportation activity, the costs Scorpio Tankers incurs to operate its capital-intensive fleet is largely fixed.

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