DHT Maritime (DHT) owns nine double-hull tankers consisting of 3 very large crude carriers (VLCCs), 2 Suezmax, and 4 Aframax tankers. All nine tankers are chartered out under long-term contracts to Overseas Shipholding group (OSG). These two companies have a solid history together as DHT was spun out from OSG in October 2005. Of the nine vessels, seven are chartered until the end of 2010 to early 2012 while the remaining two are chartered until 2014 to 2018. These long term charters allow DHT to completely avoid the sometimes volatile spot market but also include profit sharing agreements with OSG that allow DHT to participate in the upside should spot rates be higher than the chartered base rate.
DHT has been crushed with the rest of the shipping group and now trades at a compelling valuation and offers a total return opportunity as the dividend is yielding roughly 20%. DHT has long term charters and is completely contracted out through the end of 2010 so they are entirely insulated from any downward swing in spot rates. Furthermore DHT has profit sharing agreements that allow them to capture 33-40% of the upside from higher spot prices. DHT looks attractive even under my worst case analysis which assumes that DHT earns only their already contracted baseline rate. DHT has no pending purchases, options, or funding requirements. Longer term rates for double hull tankers should hold up as the industry phases out single hull tankers by 2010. In addition, tanker rates should also benefit from investors using tankers as storage as to arbitrage the extreme contango present in the oil futures curve.
- Attractive valuation, predictable free cash flows
DHT has sold off with the rest of the peer group even though they have the unique characteristic of effectively having a “put” or floor on their free cash flows through their long-term charters with base rates. My model below assumes DHT earns only the baseline rate in Q3 & Q4 2008, FY 2009, and FY 2010. Should tanker spot rates maintaining their current levels, it will result in additional upside for DHT not accounted for in this model. Given the current baseline contracts, DHT is yielding 20% FCF and has a 20% sustainable dividend yield. In the below model I went through vessel by vessel and modeled out the baseline cash flows that are already contracted out to OSG. As a side note OSG is the former parent of DHT and is in pretty good shape, they have a $1B market cap, $340m in cash, and $1.6B in revenue.
Forecast using Baseline Charter Rates / Actual Results
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DHT’s vessel expenses per day have steadily declined over the past eight quarters. My analysis assumes vessel expenses going forward will be equal to average cost for the past eight quarters, this equates to a +23% increase in vessel expenses versus Q2 2008 which I think gives us some margin of safety ($.0073 avg vs. $.0059 Q2 2008).
Using the above assumptions, I valued the cash flows going out until the end of 2010 (which is only 2.5 years and assumes no terminal value) which are 100% under contract, and the value of the vessels net of liabilities and arrived at $7 per share. The important thing to remember is that these cash flows are “worst case” ( I hate to say that in this environment) in other words they do not include any upside from spot rates being above the baseline rates that are fully chartered. Furthermore only 2 of the 9 ships run off contract at the end of 2010 so the actual contracted free cash flows will be higher than what I have used through 2010.
- Opportunity for an asymmetrical pay-off
What I find really attractive about DHT is the opportunity for an asymmetrical payoff with the baseline contracts and profit sharing opportunities, if tanker rates go down we are protected through the base rates however DHT will participate in any upside from higher rates. The below chart shows the baseline charter rates versus the spot rates, please note that DHT reported initial rates for Q4 which is ~50% complete. As long as the spot rates are above the charter rates (which they are nearly +100% above currently) DHT will continue to earn profit sharing revenue which is icing on the cake given that DHT represents a compelling investment based solely on the baseline rates. The area above the baseline rate to the actual rate is the FCF that we have essentially bought a free option on. Note that what I refer to as the “spot rate” is also known as the “time charter equivalent” or TCE.
- High dividend yield (20%) provides total return, dividend secured by ample FCF
DHT raised their dividend to $1.20 per share in Q3 which equates to roughly a 20% yield at the current stock price. The dividend should be stable going forward as DHT has ample coverage even under my baseline charter rate assumptions. The average dividend yield for DHT since 2005 is 11.45%. A 12% yield would imply a price of $10. On the Q3 earnings call, I asked for confirmation that the baseline charter rates alone could support the new $.30 dividend and the CEO affirmed this. Also, I urged them not to purchase any vessels without first lining up similar long term deals with baseline rates and profit sharing opportunities and the CEO seemed to agree with this approach. The new dividend allows investors to extract even more value out of DHT’s long term contracts and ultimately should send the stock higher.
- Balance sheet solid, no funding needs or purchase obligations
DHT has arguably the best balance sheet in the shipping space. They have zero vessels on order and zero options. They prepaid $75m in debt in Q3 that was due at the end of the year and were still able to increase their cash balance by $8m in the Q. DHT does not have any additional debt expire until Q1 2011. Management is very conservative and I think it is unlikely they will attempt to expand their fleet in the near term.
- Industry trends favorable for double hull tankers
Tanker rates should remain firm as the new build order book is being squeezed by the credit crisis. According to Merrill Lynch 30% of the order book has already been delayed or canceled. Furthermore ~18% of the world’s current tanker fleet are single hull which are to be eliminated by 2010 due to the International Maritime Organization’s regulations. This regulation should continue to support values for double hull vessels and keep rates firm as it removes 18% of capacity.
Tanker rates should also continue to benefit from the extreme contango seen in the oil futures curve. Recently, the average Feb-Jun contango had gone out to $7.08, which is an incredible 43% and is the widest the contango has ever gone. In other words for those who can borrow the money and can find the storage, taking delivery of Jan'09 WTI and storing it and re-tendering into Jan'10 will earn the investor +43%, less the cost of borrowing. In a recent interview Mr. Jens Martin Jensens, the managing director of Frontline (FRO) which is the world's largest operator of VLCCs, told The Financial Times that there were at least 25 VLCCs on the high seas being used solely as "floating storage." With storage capacity scarce, tanker rates should benefit on the margin from traders looking to arbitrage this opportunity.
- OSG runs into trouble and has to renegotiate or cancel charter contracts. Given the relative stability of tanker rates, health of OSG, and past relationship (OSG was parent company) I do not think the charter contracts are in danger.
- Management tries to expand the fleet and executes value destroying vessel acquisitions or creates funding needs. Given their track record I trust management will remain conservative.
Disclosure: Long DHT