Overseas Shipholding Group (NYSE:OSG): Downgraded to Underweight at JP Morgan

JP Morgan is downgrading shares of Overseas Shipholding Group (NYSE:OSG) to Underweight from Neutral and lowering price target to $24 from $38:

We are downgrading OSG to Underweight (from Neutral) as the recent share-price strength has disconnected from the company’s deteriorating near-term earnings outlook resulting in an all-time high valuation for the shares. Specifically, based on our new tanker rate estimates for 2H09 and 2010 (detailed in our industry note published today), we now expect OSG to post losses for 3Q09, 4Q09, and full-year 2010, and the stock’s estimated 2010 EV/EBITDA multiple of 15.1 times represents an all-time high, the highest multiple in the peer group, and a 42% premium to the industry average. All told, after months of outperformance, we look for the shares to underperform the peer group through the earnings trough we forecast for 2010.

Lowering EPS estimates and now forecasting losses through 2010. We are lowering our tanker spot rate forecasts through 2010 and based on these new estimates, we now project that OSG will post a loss in 3Q09 and 4Q09 as well as in full-year 2010. OSG’s increasing spot-market exposure, particularly as time-charter and FFA hedges expire in 2010, exacerbates the magnitude of the EPS declines associated with our new rate forecasts, with OSG having close to the highest earnings leverage within the tanker peer group. We now estimate that OSG will post 3Q09, 4Q09, and 2010 per-share losses of $1.03 (versus our prior forecast of a $1.14 loss), $1.41 (versus a $0.01 profit), and $1.90 (versus a $0.43 profit), respectively.

Share-price strength far too early for a recovery trade. OSG shares have increased by 23% month-to-date (versus a 4% appreciation of the S&P 500), easily outperforming the tanker peer group and the next strongest stock (FRO). We believe much of the share-price strength can be attributed to a shift to commodity-focused stocks as the US$ weakens and oil prices increase. In addition, OSG’s heavy short interest likely exacerbates positive price moves. However, we think the optimism in the shares also likely reflecting a global economic recovery ignores the current oversupply situation in the tanker industry which is likely to materially lag a rebound in demand and the estimated pressure that this overcapacity is likely to have on earnings and cash flow through 2010.

Valuation unappealing; lowering price target. Based on our new 2010 forecasts, OSG is now trading at a 2010E EV/EBITDA of 15.3 times, which represents an industry-high multiple and a 42% premium to the peer group average. We are also lowering our December 2010 price target to $24 (from $38) to reflect our new 2010 rate and earnings forecasts.

Action: This is actually a sector call as JP Morgan is updating estimates on all of the Oil Tankers, but OSG stood out for me. There are some other rating changes as well:
- Tsakos Energy Navigation (NYSE:TNP) to Underweight form Neutral with tgt to $13 from $20
- Capital Product Partners (NASDAQ:CPLP) to Neutral from Overweight
- Knightsbridge Tankers (NASDAQ:VLCCF) to Overweight from Neutral with tgt up to $20 from $18
TNP is also quite strong call, but the other stocks are too thin for my taste.

There are some good reasons to like this call:
- EPS estimates cut way below the Street. In fact, for 4Q09 JP Morgan's EPS est goes from Street high to Street low
- Price target lowered way below current share price
- Overall bearishness of the call
- Stock price at the 52-week high

However, I don't know if this is enough. Charts like this do not break to the downside without a very good reason. This downgrade gives a good reason, but might not be enough..

So how to play this? In current market stocks like OSG and TNP fall only when there is strong selling pressure. When the volume fades, stocks tend to bounce quickly. So that's what I would be looking for - as long as the stocks are sold on good volume, I would like to be short. Once the volume dries up, I would cover. Not the best plan, but wouldn't want to get caught by a nasty squeeze.