Source: Company's website
Capital Products L.P. is another company primarily involved in energy infrastructure, which has become ridiculously cheap in recent months. CPLP charters its 35 ships under long term leases. Its fleet consists of 4 suezmax crude oil tankers, 20 product tankers, 10 container vessels and 1 bulk carrier. Seven of the leases are bareboat; the rest are term leases with provision for the reimbursement of operating expenses. Thus, CPLP's business could be viewed as similar to that of real estate investment trusts (REITs), which provide build to suit single tenant properties under long term leases. In both cases, a property or ship is provided to a single user under a long term lease and the owner finances the property paying interest and generating net cash flow from the lease proceeds. It should be noted that many of these REITs trade at price to funds from operations (FFO) ratios of more than 15 to 1. FFO is comparable to cash flow and CPLP is trading for only 3 times cash flow.
CPLP closed yesterday at $2.96 a share. It now pays a 30 cents a share distribution and thus yields 10.1% at its current price. It should be noted that, although CPLP has "LP" in its name, its tax situation is essentially the same as most corporations and unit holders will not receive K-1s but will receive the vastly simpler 1099s instead so that some of the complex tax issues that arise with master limited partnerships will not be a factor here.
CPLP's leases are long term (the fleet average is more than 6 years) so that its revenue stream is relatively stable. Based on its most recent annual report and its latest quarterly numbers, CPLP produces cash flow for unit holders of roughly $132 million per year. As noted below, CPLP's capital structure includes Class B preferred units and the annual payout to these units costs roughly $11 million. Thus, more than $121 million is available to common unit holders. With a common unit count of 120.4 million, CPLP is generating cash flow of roughly $1 per unit. This means that buyers of CPLP at this price level are paying only 3 times cash flow. In a world in which 10-year treasury bonds are trading for roughly 60 times annual interest payments and stocks are approaching a price earnings ratio of 20 to 1, CPLP's low market valuation is truly remarkable.
Leverage - CPLP has total debt of $602.4 million and balance sheet cash of $57.8 million for a net debt total of $544.6 million. I have calculated EBITDA at $151 million; thus, the net debt/EBITDA ratio is a reasonable 3.6. CPLP has a fair amount of debt maturing between now and the end of 2018; it has disclosed that this amount of debt totals $175.7 million. Because it is now very difficult to raise equity capital on favorable terms and because the debt market in this space has become skittish, CPLP has elected to cut its dividend from a much higher level to the current level so that it can, if necessary, repay this maturing debt from cash flow. It should generate roughly $85 million per year for this purpose (in addition to the existing balance sheet cash). If this scenario plays out, CPLP will emerge with much less debt and will be in a strong position to increase its dividend to a much higher percentage of cash flow.
Capital Structure - CPLP has a typical LP capital structure. It has Class B preferred shares which are entitled to receive annual distributions of 85.5 cents before any distributions are paid to common unit holders. Some Class B preferred unit holders have converted to common (at times when the common units were paying higher distributions than the preferred) and the cost of the annual distribution to the remaining roughly 13 million preferred units is a bit more than $11 million. Capital Marine is the sponsor and manager of CPLP and it is entitled to incentive distribution rights (IDR's) but these become significant only when distributions to common unit holders exceed $1 per year. As a buyer at this level, I am very happy to share distributions with the manager when I start receiving a yield of more than 30% on my original cost.
Risk Factors - The biggest risk factor seems to be CPLP's 5 charters with Hyundai Merchant Marine (HMM). HMM seems to be in financial trouble and there have been rumors that it may go into bankruptcy and/or seek a renegotiation of its charter rates. The 5 charters generate fees of $53.6 million a year. Even making the ridiculously pessimistic assumptions that HMM walks away from its charters, that CPLP is unable to recharter any of the 5 vessels at lower rates, that CPLP is unable to sell any of the vessels, and the CPLP is unable to recover any damages due to the cancellation, the loss of $53.6 million would still leave CPLP with common unit holder cash flow of some $66 million or 55 cents a share -- more than enough to cover the dividend and still producing a price cash flow ratio of less than 6 to 1. Making a more reasonable assumption of renegotiation or rechartering at a discount of 20%, cash flow would be reduced by only $10.7 million leaving the dividend very secure and still providing a flow of capital to repay maturing debt. In the long term, there is a risk of a general lowering of rates as charters expire. On the other hand, world oil trade is very likely to increase as lower prices stimulate additional demand and, in the United States, as lower domestic production is replaced by imports. The container ship market is driven more by total world trade volume and is somewhat at risk but 24 of CPLP's 35 ships are crude or product tankers.
Management Alignment - One thing I like about CPLP is the fact that management is reasonably well aligned with common unit holders. Capital Marine already owns 13.7% of the common units. In response to the low price CPLP has been trading for, Capital Marine has recently adopted a unit repurchase program under which it may purchase up to 5 million additional units. Based on the latest filings, these unit purchases are now underway. The IDR structure is very favorable for unit holders buying at current depressed prices. Capital Marine gets meaningful IDRs only when distributions exceed $1 per unit per year and, as noted above, I would hardly begrudge the manager a share of distributions when my yield on original cost exceeds 30%.
Bottom Line - I am a buyer of CPLP and have been adding to my position on dips. I am very encouraged by Capital Marine's unit repurchase program. CPLP may well raise its dividend to 75 cent level within the next three years and, if that happens, the stock could triple in value.
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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.