MLP Bottom Fishing 3: Capital Products Partners

| About: Capital Product (CPLP)

Summary

CPLP is a shipping partnership operating a variety of ships, but primarily crude oil and product tankers.

CPLP's performance is not directly tied to the price of crude oil, but CPLP unit seems to have been driven down in the general energy rout.

CPLP currently yields 31.2% and trades at roughly 3.5 times cash flow.

CPLP faces some challenges, but also should experience some positive developments in 2016.

At a current price of $3.06 per unit, CPLP is a bargain.

Capital Product Partners, L.P., (NASDAQ:CPLP) charters ships -- primarily crude and product tankers, and closed Thursday at $3.06 per unit. Based on its most recent dividend, annual dividends should be 95.4 cents for a yield of 31.2% at the current unit price. CPLP seems to have been taken out and shot with the rest of the MLP sector even though it is not dependent on the price of oil or gas for its economic performance. The weak oil market may even be somewhat of a plus for tanker owners as low prices stimulate additional demand and that demand requires more transportation resources. And in the United States market, lower prices really mean that domestic production is going to be replaced with imported oil leading to more demand for tanker transportation.

Financials - CPLP has recently reported its full year 2015 results. Earnings were $55.4 million or 38 cents per unit so that the price earnings ratio is currently 8.0. Depreciation was $62.7 million and I calculated EBITDA at $138.1 million. Year-end cash was $90.2 million and debt was $568 million. Net debt was just 3.5 times EBITDA, which is a very attractive leverage level. CPLP's debt covenants (a big issue in the MLP sector) are structured based on the value of the ships secured by the debt and CPLP is in very good shape in terms of covenant compliance. Cash flow was $118.1 million so that (based on a total unit count of 135 million units of all kinds) the units are selling for roughly 3.5 times cash flow. On the other hand, for shipping companies, depreciation is not merely an accounting fiction -- the vessels do actually depreciate over time. Thus, to compare the cash flow of a shipping company with the cash flow of a normal company can be deceptive. Still the current low price of the stock suggests that CPLP could reduce distributions and still maintain an attractive yield while setting aside substantial funds to finance the replacement of aging vessels. As noted, CPLP has been aggressive in its distributions and one concern may be the need to establish a reserve to replace vessels as they age. On the other hand, distributions could be reduced by two-thirds and still leave a double-digit yield at this unit price level. If this were done, an enormous reserve fund could be built up to replace vessels. If it is not done, buyers at the current price level will get all of their money back in a little more than 3 years.

Stress Test - One concern about CPLP has been that it is leasing five vessels to Hyundai Merchant Marine (HMM) and HMM is having financial difficulties. I have examined CPLP's financials and made some stress test calculations. Even if charter rates on all five of these vessels were reduced by 30%, CPLP's earnings and cash flow would remain strong. I calculate that CPLP would lose $15.6 million in annual revenue and, while this would negatively impact the bottom line, cash flow would still support a 75 cent per year distribution so that yield would still be well over 20 per cent.

It is important to note that CPLP also has some offsetting positive developments as discussed in CPLP's most recent conference call. A new ship (the "Magdalena") was delivered in February and it is chartered at an attractive rate. In addition, two container ships, which had been idle have now been chartered. I do not anticipate a distribution reduction although the current pricing of the units at a yield of over 30% clearly reflects the market's anticipation of a distribution cut.

No K-1 - Unlike many MLPs, CPLP has elected to be taxed as a "C" corporation so that no K-1s are issued and the tax complexities often associated with MLPs can be avoided.

Risks - I generally have not been a big fan of this sector. Charter and spot rates can vary enormously over time due to excess capacity and a glutted market can produce disastrously low revenue. CPLP currently avoids this problem with long-term charters, but there is always a risk that financial distress on the part of customers can lead to renegotiations or demands for lower rates in bankruptcy proceedings.

We have been in a phase in which oil has been put into storage at a rapid rate and this may mean that we are headed into a period in which the volume shipped may decline. In addition, the container and bulk markets have been weak and CPLP does have significant exposure to the container market. On balance, however, at this price CPLP is a bargain. It should crank out attractive distributions and very likely return half of its current price in less than 2 years in the form of those distributions.

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.