- VLCCF recent distribution increase to $0.20 from $0.175 is not a singular, opportunistic gesture based on Q1 2014 settlement income.
- VLCCF expansion to 39 ships by end of 2016 creates compelling case for rapidly-ascending distributions.
- We foresee VLCCF paying out $0.89, $1.64, $2.40 and $2.60 annually in years 2014, 2015, 2016 and 2017, respectively.
- We foresee distribution growth providing for 100% upside potential in stock price by 2016-2017.
On May 8, 2014, Knightsbridge Tankers, Ltd. (VLCCF) reported its first quarter 2014 earnings. The market responded favorably to the shipper's financial results and the stock rallied roughly 8% to close at $12.92. In addition to significantly improved revenues, VLCCF declared a $0.20 distribution - a 14% increase compared to the $0.175 distribution VLCCF has paid out over the past seven quarters.
Over the short term, investors must be cognizant that VLCCF received a $9.7 million settlement during the first quarter and included that figure as part of its net income. This is not an insignificant amount - it is the equivalent of roughly $0.32 per share based on the 30.5 million shares used in calculating the shipper's first quarter earnings. This suggests that VLCCF earned only $0.03 outside of the settlement income, which could be classified as an extraordinary item.
Some VLCCF investors have suggested this $0.025 quarterly distribution increase is an opportunistic bonus distribution based on the settlement and is not indicative of VLCCF's future prospects of paying higher distributions. However, given management's historically conservative financial practices when it has come to paying, reducing and eliminating distributions, this increase is representative of VLCCF's objectives to increase distributions to unit holders.
First, some facts:
- VLCCF has paid distributions in 60 of the last 65 quarters.
The shipping industry, which is volatile by nature due to the daily changes of spot market rates, really came under fire in 2008 and has continued to showcase wild swings. While it appears some stability has returned to the marketplace, many shippers have continued to put a moratorium on dividend and distribution payments. That is, quite a few of the surviving shippers that once paid out generous quarterly distributions have not authorized any payments in over five years. VLCCF management has reduced the dividend and eliminated it on occasion but, considering how the business works, they have been a steady payer.
- VLCCF will be paying the increased distribution on an additional 18.6 million shares.
The quarterly earnings were calculated using roughly 30.5 million shares outstanding. However, today, VLCCF has 49.1 million shares outstanding and at the closing of the recently announced deals to build the fleet to 39 ships, VLCCF will end up with 111.1 million shares. VLCCF will be paying out the $0.20 distribution on all 49.1 million shares.
- The $9.7 million settlement is not an extraneous windfall.
This may be somewhat up for debate, but the $9.7 million partial settlement did not just come out of thin air. A couple of years ago, some of VLCCF's contract customers bailed on the contracts or became insolvent. VLCCF was forced to take possession of the ships and lose out on the remaining revenue of the contract. Ultimately, VLCCF sold off some of the repossessed ships and took impairment charges. This $9.7 million was at one point earned by VLCCF and subsequently written off. Granted, it is better to have the cash in the pocket today but when you are recapturing previously written off revenues and value that you once had, it is not as extraordinary as it appears to be.
- VLCCF financial performance and balance sheet are strong. Little mention has been given to critical financial items that are playing a large role in VLCCF's success. Comparing Q1 2014 to Q1 2013, VLCCF operating revenues (outside of the partial settlement) are up 61% ($10.4 million vs. $6.5 million), interest expense was reduced by $275,000 and most importantly, VLCCF's TCE (time charter equivalent) earnings rose by 41% to $25,200 per day versus $17,900 per day.
VLCCF's ability to pay distributions 60 of the past 65 quarters is a showcase to the board's and management's conservative, shareholder-focused philosophy. That is, VLCCF has not been inclined to richly pay out shareholders for short-term benefit if tougher times are ahead. It would be a major shift of focus to pay out an extra $0.025 on an additional 18.6 million shares just because "it was there right now." In terms of the settlement, at one point, the owners earned those funds and just now, thanks to VLCCF's persistence, have been able to recoup some of the dollars. I must admit, when I have run my numbers in the past, I did not factor in receiving a dime from any of these potential settlements. While I am not quite ready to bake in other possible settlements VLCCF may receive in the future, I would not be surprised to see a few more settlement dollars trickle in during 2014 and 2015.
So, if management is raising the dividend and paying out an extra $3.7 million to new owners that did not even hold a share or contribute a shilling to VLCCF's operating performance in Q1 2014, there must be a reason. We decided to take matters into our own hands and try to forecast the future distribution potential for VLCCF based on recent developments. Certainly, the general consensus is that VLCCF is positioning itself to benefit from the "expected" dry bulk shipping recovery, but what does that exactly mean?
We conducted an analysis on expected operating income and funds available to distribute based on:
- Breakeven rate of $15,000 per day
We calculated that to be roughly $13,500 per day today - $15,000 is VLCCF management's published goal rate. We believe the breakeven rate will increase to this $15,000 level over time due to rising fuel costs and higher administrative expense associated with managing 39 ships versus 5.
- Various TCE earnings scenarios
For Q1 2014, TCE rate was $25,000 per day. From 2000-2012, average TCE rate ranged from $39,000-$50,000. We believe VLCCF will never get a "peak" TCE rate as it prefers long-term contracts, allowing customers to lock-in an agreeable price (not too high, not too low). VLCCF may operate some ships in the spot market from time-to-time (they are doing so with 2 now) but the spot rate is anticipated to be volatile for the foreseeable future.
- Quarterly onboarding schedule of new ships.
Fleet is expected to grow from 5 ships today to 39 by the end of 2016.
- Quarterly share counts and issuances.
VLCCF has published its share issuance schedule going forward. We have also considered incremental stock issuances to management and directors.
- VLCCF historical use of long-term debt and equity financing liquidity to make funds available to shareholders at distribution time.
VLCCF has already secured financing for 11 of its newbuildings at $30 million each. We believe that if TCE rates increase, VLCCF will use less of this extra debt liquidity to pay unit holders and instead will opt to more quickly reduce debt.
Our calculations are below and suggest that $0.80-$0.98 per share distributions are likely for 2014, up from $0.70 in 2013. In 2015, we project the dividend to be $1.57-$1.68; in 2016, $2.41-$2.68; and in 2017, $2.58-$2.70. The critical factors contributing to improving the dividend will be:
- TCE earnings based on BDI pricing.
- Speed of delivery of newbuildings and placement into contracts or spot market engagements.
That is, the faster VLCCF can get the ships on the water, the sooner higher returns can be realized. If deliveries or securing contracts get delayed, this will be a short-term drag on VLCCF's ability to produce cash returns for its holders.
- No additional ship purchases.
Additional acquisitions of vessels are not out of the question, but we believe VLCCF may be content with its current order book of ships. VLCCF is now 70% owned by Frontline 2012, Ltd. VLCCF used stock as currency to acquire many of the new ships and now not much more is left in the hopper from a dilutive standpoint. Current Capesize purchase prices for new builds are close to historical lows but are appreciating. VLCCF is unlikely to pay big premiums for new ships if prices increase. Example: although doubling the fleet size could nearly double from a mathematical distribution, the purchase of an additional 40 vessels at average historical market prices would carry a price tag north of $2B and VLCCF would be hard pressed to secure financing/liquidity against the additional ships at the same terms it has received today.
Based on historical average yields for VLCCF, our target prices for VLCCF are:
- 2015: $15.70-$18.60
- 2016: $22.40-$26.80
- 2017: $28.70-$30.00
In conclusion, we believe that management's increase of the quarterly distribution to $0.20 per unit has been well thought out and is not an opportunistic increase based on just paying out extra cash due to an extraordinary cash settlement.
A critical risk for VLCCF, apart from delays in delivery, is a stagnant or deflating TCE, and would negatively impact the stock price. If management was wrong in expecting a full stabilization and growth of the dry bulk market and there is another collapse, VLCCF can likely weather the storm due to its strong financial position, but it will make the recent Frontline 2012, Ltd. arrangements very hard to stomach from an ownership standpoint.
2014 FULL YEAR
2015 FULL YEAR
2016 FULL YEAR
2017 FULL YEAR
Disclosure: I am long VLCCF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.