Nordic American Tanker (NAT) is an all-Suezmax oil tanker company. It operates its Suezmax vessels in the spot market - i.e. prices for chartering NAT's oil tankers are changing every day. Prices for oil shipping are very volatile, thus NAT's revenue is highly unpredictable. NAT's return comes mainly from its dividends, and here we shall try to asses its capacity to continue its magnificent past performance.
Over the last decade, NAT had delivered no less than amazing returns with its fat dividends - about 17% annual average - mostly with little to no debt. NAT's returns were possible thanks to a very special capital work model, which is very different from the model of its debt ridden peers. This model allows a company to grow fast, utilize a very high payout ratio without fear of financial instability and reward investors with fat cash-flows.
|Year||Stock price at year end||Div. adjusted stock price||Yield from last year||Div yield**|
* Data as of market close, October 6th, 2010.
** Dividend for year divided by the previous year year-end price.
*** Does not include 2010 Q4 dividend.
But can this continue?
Let's inspect NAT's capital model:
NAT's policy is to distribute its entire operating cash-flow in one quarter as dividend in the following quarter. Since operating cash-flow does not take depreciation into account, its payout ratio is mostly above 100%.
NAT does not use debt to finance purchasing new vessels. Instead, it uses equity offerings. Money from newly issued stocks is used to purchase new vessels. Equity offering is a very strong instrument that mostly destroys value, but not always. NAT's management and its CEO, Herbjorn Hansson, are constantly arguing that the equity offerings are accretive - which means that the company's dividend capacity is growing after each offering, and that the offerings are not dilutive in nature.
This raises a few questions:
- How can one measure the dividend capacity of this company, given the constantly changing shipping rates? After all, dividends for different years are not comparable since shipping rates are very volatile in character. A lower dividend than the year before does not necessarily suggest a lower dividend capacity. We must think of a measurement that is indifferent to the shipping rates.
- How can one tell that those equity offerings are not dilutive in nature?
Well, fortunately, there are simple answers to these questions. Equity offerings do increase the number of stocks outstanding, effectively diluting current shareholders, unless the count of shares per vessel is decreasing.
A company with 100 shares and two vessels can produce less dividend than a company with 120 shares and 3 vessels, since for the latter, behind every vessel there are 40 shares while for the former, behind every vessel there are 50 shares. NAT strives (not always successfully) to purchase vessels in such a way that the increase in share count will still lead to a decrease in the shares / vessel ratio.
Another way of looking at it is to see how many vessels one shareholder holds. Let's take, for example, a shareholder that own 1000 shares, while the company has five vessels and 5,000 shares outstanding. Basically, this shareholder owns one vessel out of the company's five and will get one vessel's worth of dividends. If the management buys a new vessel for 2000 shares, the company will now have 7,000 shares for 6 vessels; now every vessel is worth 1167 shares and our shareholder was basically diluted, since he still holds only 1000 shares. He will now get less than one vessel worth of dividends. The case was opposite with less than 1000 shares, when 1000, the ratio of shares/vessel, is the tipping point between building value and destroying value.
If we take it one step further, the current ratio of shares per vessel, multiplied by the current share price in the open market, puts a cap on the price that NAT can pay for a new vessel without diluting its current shareholders, thus decreasing the company's dividend power.
|Number of shares |
per ship (thousands)
As you can see, the company does not really manage to lower the number of shares per vessel at a constant rate. Except for a sharp drop in 2004, the rate is almost unchanged, if not increasing slightly.
This suggests that the company is paying too much for new vessels, as it must issue more shares per each new vessel than the current share/vessel ratio.
Nevertheless, the model is good. Even if management fails to calculate the math correctly, the company can still deliver handsomely.
So, can this continue? Can NAT deliver such returns forever? The answer, unfortunately, is a big, emphatic 'NO'. The reason for such an emphatic 'no' is that shares are eternal, but vessels are not. Once you issue new shares, they will never go away, but vessels do get old and retire.
An average vessel life is 20 years, after which it is sold for scrap. During its adult life, it is mostly rented at lower prices and is more prone to malfunctions and problems, just like an old car. At this stage, the vessel is sold for metal parts (which counts only towards a very small fraction of its original cost). As old vessels are phased out, share count per vessel will increase rather than decrease, which will cause the dividend to slowly diminish. This is already happening; the oldest vessel NAT owns was manufactured in 1997, and is already almost 14 years old.
Let's take the first example and see what happens:
The company has 100 shares and two vessels. The current ratio is 50 shares per vessel. Every dollar one vessel makes is spread over 50 shares. Now it offers new shares to buy another vessel - let's assume the company follows the model rules and buy the new vessel in a lesser amount of shares, 20 per vessel. Now we have 120 shares per three vessels, 40 shares per vessel. Dividend power is increased. Every dollar one vessel makes is now spread over only 40 shares. Now, if one of the vessels dies of old age, the company will end up with 60 shares per vessel! Dividend capacity has decreased.
NAT may still have a few more years of grace, but the time when the share count will overpower the vessel count will eventually come, and the results for the shareholder might be devastating.
Disclosure: Writer does not hold any shares of NAT, long or short.