Is The Uncertainty In Capital Product Partners' Distribution Model Justified?

| About: Capital Product (CPLP)

Summary

Capital Product Partners (CPLP) is, in theory, well positioned due to attractive charters providing cash flow visibility.

However the quality of certain long-term containership charters is now questioned.

HMM has chartered in 5 vessels from CPLP all expiring in April 2025, with an average daily rate of $29,350.

HMM is facing financial difficulties and is likely to attempt to renegotiate with ship owners to reduce above the market charters.

Some reports have suggested HMM will seek 20-30% reduction in charters.

The intention of this article is not to cause panic but to inform investors about the evolution of the distribution coverage ratio assuming Hyundai Merchant Marine (HMM) requests a 25% reduction in payments. Even so, the pro-forma coverage is still slightly above 1, taking into account the cash flow of new the containership to be delivered in Q1 2016, the recent re-chartering of the 2 containerships, which are currently without employment (even though we don't know the rates) as well as re-chartering of tankers opening in 2016.

Since our last article dated 22 January 2016, it become known to the public that HMM is seeking to restructure charter contracts of its chartered-in fleet e.g. see Hellenic Shipping News, Tradewinds

Arguably, this is worrying news for CPLP investors. After all,HMM is the charterer of 5 of the 10 containerships CPLP currently owns, including the new containership expected to be delivered in Q1 2016. If CPLP had a distribution coverage of 1.5+ we would not be so concerned, however the current coverage ratio is tight and there is little margin of safety in case of a charterer defaulting, especially on 5 vessels. Information on the financial situation of HMM is available on the investor relations section of their website.

Capital Product Partners (NASDAQ:CPLP) is, in theory, well positioned to weather the general market and MLP storm, which has resulted to depressed unit prices and extremely high yields (exceeding 20%). As such, CPLP and virtually all marine MLPs are blocked from issuing units to raise equity due to the prohibitive cost of capital. As a response, many MLPs have reduced or suspended their distributions. For example Teekay LNG Partners (NYSE:TGP) and Teekay Offshore Partners (NYSE:TOO) lowered their distribution substantially to fund previously committed CAPEX requirements. Navios Maritime Partners (NYSE:NMM) completely eliminated the distribution to pursue distressed acquisitions in the dry bulk space.

CPLP benefits from the strong tanker market, as evidenced by recent re-chartering activity at higher rates. Also CPLP has no committed growth CAPEX, besides the new containership to be delivered in Q1 2016, which is fully funded. CPLP has the ability to wait until the storm is over (as there are no further CAPEX commitments), whilst comfortably maintaining the current distribution per unit for the foreseeable future.

Old Expectations

Due to the above reasoning, we wrote an article on Seeking Alpha dated 22 January 2016, outlining the steps for CPLP to strengthen its distribution coverage without issuing new units until the MLP space recovers. Our findings suggested that the distribution coverage ratio would increase from 1 (as of Q3 2015) to 1.3, assuming the current quarterly cash distribution of $0.2385 per unit.

The increase would be attributable to the following factors 1) delivery of the new containership in Q1 2016, 2) a $25m unit repurchase program at an average unit price of $3.5, 3) finding employment for the 2 containerships currently without employment at $8,500/day and 4) re-chartering tankers opening in 2016 at current 1-year period rates.

What has Changed? HMM

What has changed since last time we published the above? The answer is 1) nothing and 2) a lot. This has to do with Hyundai Merchant Marine (HMM).

Nothing in the sense that it was evident and well known that HMM had financial difficulties for quite some time. We were aware of the debt maturities coming due this year. However, most of us, including ourselves, assumed things would work out. No need to go into more detail. Perhaps we were naïve or too optimistic.

On the other hand, a lot has changed in the sense that now everyone is aware of the HMM situation due to recent articles published on prominent shipping websites such as Tradewinds, due to NMM's recent conference call, etc. Things might eventually work out. After all, HMM is Korea's largest carrier playing an important role in the country's and region's logistics.

CPLP has 5 vessels chartered out to HMM, all expiring in April 2025, with an average daily rate of $29,350. Apparently, HMM will attempt to renegotiate charter cuts of between 20% and 30% in order to secure fresh investment from creditors.

Lets assume that HMM requests a cut of 25%. The 5 vessels chartered out to HMM produce $146,750 in total per day ($29,350 x 5 vessels). A 25% cut equates to around $37,000 per day in lost revenue across the 5 vessels, which will be "replenished" by the new containership charter coming on board in Q1 2016 at $39,250 (less the associated OPEX etc). In addition, CPLP recently managed to charter out the 2 containerships, which are currently without contract.

Revised Expectations

Our revised expectation regarding the distribution coverage evolution changes as follows, always assuming the current quarterly cash distribution of $0.2385 per unit:

  • 1.1 - currently
  • 1.2 - after delivery of the new containership in Q1 2016
  • 1.25 - after finding employment for the 2 containership vessels at $8,500 per day
  • 1.3 - after re-chartering tankers opening in 2016 at current 1-year period rates
  • 1.05 - after taking into account a 25% charter cut from HMM

Even if HMM cuts charters by 25%, the coverage is still above 1. Compared to our previous article, we have assumed that CPLP will not proceed with a unit repurchase program any time soon and will adopt a "wait-and-see approach". The rationale is as follows.

Unit Buybacks are Not Very Likely

The very high distribution yield will not go away anytime soon, due to concerns about China and global GDP growth. Management has made it clear there will be no buybacks until the new containership has been delivered in Q1 2016 and the 2 containerships without employment are chartered out (this has already been achieved but the rates have not been disclosed). Also, Management has hinted that a cash balance of approximately $50m is the "minimum" for a company the size of CPLP. This means that following the new containership expected to be delivered this quarter, pro forma cash will be around $50m.

Lets assume that Management gets convinced to pursue a buyback program due to the very high yield, funded by a portion of the pro-forma cash on the balance sheet. The problem now is that the HMM drama has entered into the equation, and this will cause delays in the buyback decision as Management will closely monitor how the situation unfolds. The HMM story will take time, which means prolonged uncertainty. In the meantime, CPLP will blocked from raising equity as the yield will most probably remain above 20%.

Unless the general MLP space recovers, the only way for the unit price to start going up is for Management to be proactive and make a clear statement via a clear guidance road map and/or buyback program.

However, if the high yield situation goes on for another year or so, we are afraid that Management will not fight the irrational market via buybacks to improve the distribution coverage, as CPLP cannot go much below the $50m cash balance.

Also, Management will want to preserve cash in case the HMM story unfolds in a negative way. In short, CPLP will not be able to grow and will be "stuck". One could argue that CPLP does not need to grow for a couple of years but we are not sure how the sponsor and Management will view this.

Unless CPLP leverages up (takes on more debt to fund growth) or the sponsor steps in (e.g. to invest in a preferred offering with 8% yield or so), we are really concerned about the distribution going forward.

Summary

In principle, we were optimistic about a buyback program but the HMM situation most probably has changed Management's thought process i.e. the decision will be delayed. Also, even if HMM forces CPLP to agree to a 25% charter cut, it does not mean that HMM will not return for more cuts. Even if HMM gets a breather from lenders, shipowners, etc it will still be financially weak unless the market picks up substantially.

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.