Evolution Of Capital Product Partners' Distribution Coverage Ratio

| About: Capital Product (CPLP)

Summary

Capital Product Partners is now yielding more than 25% due to the intensified general market sell-off.

Nothing has changed since December 2015 in terms of fleet employment and the prospects of re-chartering tankers opening in 2016, based on current 1-year period rates.

The only negative is the 2 containerships continue to be without employment, however, the distribution coverage is still above 1.

There is also 1 new containership schedule to be delivered in Q1 2016 with a 5-year charter attached, which will improve the distribution coverage meaningfully to more than 1.1.

After taking delivery of the above-mentioned vessel, we estimate CPLP to have c. $50m in cash remaining, which can go towards unit repurchases and improve the coverage ratio further.

The stock market is in sell off-mode due to low commodity prices, concerns about China/global GDP growth and uncertainty regarding the path of interest rates, among other things.

Capital Product Partners (NASDAQ:CPLP) is still a healthy MLP with several catalysts for upside to increase distribution coverage. Nothing has changed since December 2015 besides the unit price falling by more than 30% YTD, along with the broader market.

Some investors were concerned that CPLP will re-evaluate its distribution policy. These fears were gone after the market closed on 20th January 2016 and CPLP declared a quarterly cash distribution of $0.2385 per unit, in line with expectations. The day after the announcement, the unit price was up almost 20% at $4.48 in early trading (as expected) and then started declining after 11 am to close flat at $3.75 (not expected). As a result, at $3.75, the distribution yield is 25.5%.

The Fundamentals

CPLP has a diversified fleet of 34 vessels (24 tankers, 9 containers and 1 dry bulk vessel). 79% of the fleet is fixed for 2016.

CPLP has a strong balance sheet with net debt to capitalization of 30.5% as of Q3 2015 (cash of c. $90m and long-term debt of
c. $575m including the current portion).

Two vessels are currently without employment, the 8,266 TEU containership Agememnon and the 7,943 TEU containership Archimidis. Despite this, the distribution coverage is still above 1. Eventually these vessels will find employment. Even if they are chartered out at $8,500 per day, it's a step in the right direction in terms of distribution coverage.

In terms of fleet growth, there is 1 containership scheduled to be delivered in Q1 2016 with a 5-year charter attached. The vessel is fully funded and will lift the distribution coverage to more than 1.1.

There are several tankers opening in 2016, which will most probably be re-chartered at higher rates based on current 1-year period rates ($18,750 for MRs, $24,750 for LR1s, $29,500 for LR2s, $29,500 for Aframaxes, $38,000 for Suezmaxes, $52,500 for VLCCs).

In addition, CPLP benefits from a diverse customer base of high-quality charterers (Shell, Cargill, BP, Total, Repsol, etc), which reduces charterer default risk.

Accretive Moves

We encourage CPLP to take advantage of its low unit price of c. $3.75, which is offering a 25%+ distribution yield, by implementing a $25m unit repurchase program.

CPLP has enough resources to fund a meaningful buyback program. After taking delivery of the new containership in Q1 2016, CPLP will have around $50m in cash on the balance sheet, a part of which can go towards unit repurchases.

A $25m buyback program at today's unit prices of around $3.75 will save at least $6m in annual distribution payments, and will improve the distribution coverage by 10 basis points.

As an extreme measure, CPLP can even sell the two containership vessels currently generating no income, and use the proceeds to fund further buybacks or buy vessels with long-term charters attached, therefore improving the coverage further.

Evolution of The Distribution Coverage Ratio

The distribution coverage will evolve as follows, assuming the current quarterly cash distribution of $0.2385 per unit:

· c. 1.0 - currently

· c. 1.1 - after delivery of the new containership in Q1 2016

· c. 1.2 - after a $25m unit repurchase program at today's unit price (c. $3.5)

· c. 1.25 - after finding employment for the 2 containership vessels at $8,500 per day

· c. 1.3 - after re-chartering tankers opening in 2016 at current 1-year period rates

Summary

There are valid concerns about newbuilding activity in the tanker sector. However, CPLP has the ability to make accretive moves now to improve distribution coverage and mitigate the impact of a deteriorating tanker market in the future.

We believe that there is no need for CPLP to reduce the current distribution as buybacks and/or vessel acquisitions can be funded from cash on the balance sheet.

Disclosure: I am/we are long CPLP.

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.