Capital Product Partners: Raise Capital or Cut Dividend?

Includes: CPLP, CRU, TNP
by: J. Bruun

Capital Product Partners, L.P. (NASDAQ:CPLP) is one of the tanker companies trading with the highest premium to its book value adjusted to market prices. It does so because of its very high dividend. It also appears to be well managed and enjoy some level of strong sponsor support. As far as I can tell CPLP will have to cut its dividend in 2011 unless there is a significant change in the product tanker market or else it will come close to breaching its loan covenants.

Valuation model

As discussed in other articles on SA here and here I am of the opinion that the tanker industry is one of perfect competition and relatively low barriers of entry.

I therefore focus on book value by taking net liquid assets + market value of the vessels from third party brokers + market value of long term charter party agreements being the difference between the agreed rate - the current market rate * duration discounted with 5% (because of the strong counter parties) to get the net present value.

This is in many ways a Net Asset Value (NAV) calculation.

The 16 companies I follow on average trade at a premium to adjusted book value of 2-3%. For CPLP I believe it to be 34%. The variable that best explains why certain companies trade at a premium to their book value or discount is the size of the dividend. Second is the level of debt.

CPLP has a trailing dividend yield of 9.5%, which indeed appears very attractive.

Current dividend paying capacity

To see whether this premium is likely to continue I have had a look at the 2009 annual report.

This is what it says about loan covenants on page F-21:

"On June 30, 2009, the Partnership reached an agreement with its lenders to amend certain covenants in the credit facilities. It was agreed to increase the fleet loan-to-value covenant to 80% from 72.5% in both of its credit facilities. It was also agreed that a number of CPP vessels currently on long term period charter with certain of our top rated charterers will be valued on the basis of their current estimated fair value plus the value of their remaining charter instead of charter free. In exchange, the interest margin for both of the CPP credit facilities was increased to 1.35% - 1.45% over LIBOR subject to the level of the asset covenants. These amendments were effective immediately and are valid until June 2012. All other terms in both of the Partnership’s facilities remain unchanged."

So in short: loan / (market value of ships + fair value of long term charters) < 0.8.

So where are we now?

From the 2010 annual account:

Long term debt: 474

From my estimations:

Market value of ships: 587

Fair value of charters: 60

-> 474 / (587+60) = 0.73

So there is still room.

How does 2011 look?

To maintain a dividend yield of 9.5% CPLP will have to pay 34 M. Using current forward prices for TC rates for 2011 for estimating free cash flow it will be 40 MUSD.

This leaves us with the market value of the ships and long term TC agreements. If the market doesn't change then ageing the fleet by one year reduces its value by 20 M.

The market value of the charters will be reduced by 14.

End 2011 then looks like this: 474 / (567 + 46) = 0.77.

It is still ok but tight. Too tight I would think. I haven't seen the actual loan agreements so I'm not sure exactly how the covenants work. Uncertainty exists around how the derivative liability from the IR hedge and cash on the books is treated.

This only gets worse once we look into 2012.

So what happens now?

Unless the market turns for the better, I think CPLP will either cut the dividend or raise additional capital. If I were part of management I would do the latter. It makes sense for a company to raise capital if it can sell shares at a premium. The problem with this is that as long as you continue to pay out too high dividends you have to raise an ever increasing amount of capital to support your existing capital base.

I think there are much better opportunities out there than this to invest in the tanker market. I would suggest Tsakos Energy Navigation Ltd. (TNP) or Crude Carriers Corp. (CRU). Or First Ship Lease Trust listed in Singapore ((SES: D8DU.SI)) [this is however a mix of bulk, tank and container] at a13% dividend yield.

Disclosure: I am short CPLP.

Additional disclosure: and long CRU