With the continued recovery in dry bulk rates from the nadir of Q1 2016, there has been some speculation on Seeking Alpha regarding Navios Maritime Partners L.P. (NYSE:NMM) reinstating a distribution on its common units. In assessing the probability of such a reinstatement, the following should be considered closely:
- Due to the nature of its asset mix of dry bulk vessels and containerships and the related time charters, any investment in NMM during the next two years is really a bet on the credit worthiness of Hyundai Merchant Marine, the counterparty on five containership time charters.
- The flurry of asset transactions and financings at year end 2016 and during the first quarter indicate that the NMM was under significant liquidity pressure as it struggled to meet the covenant requirements of its outstanding debt.
- NMM arguably sold its best asset, the MSC Christina, to generate funds to repay two debt facilities. The loss of the associated time charter will have a negative impact on 2017 revenues and gross margin.
- NMM will have time charters rolling off during 2018 that currently contribute significant revenue and gross margin. Dry Bulks rates will need to increase during 2017 and 2018 to offset these decreases.
- Four of NMM's 23 dry bulk vessels will likely need to be sold or scrapped due to age and/or impending dry dock and ballast water remediation requirements during the next 18 months.
- NMM entered into a purchase agreement for purchase of $23 million of Navios Europe I Notes owned by NM. The purchase of the Pay-in-Kind ("PIK") Notes offers no discernible benefit to NMM and highlights future NM self-dealing risk.
On the positive side, the dry bulk market rates bottomed in February 2016 and recovered throughout the remainder of the year. After the usual seasonal weakness during January and February 2017, dry bulk rates have rebounded strongly and are approaching the 2016 highs already. The increases in rates should help NMM offset some of the revenue and margin losses from the roll off of various time charters. Two notes of caution about the dry bulk rate rebound:
- Scrapping has declined precipitously on a year over year basis due to the rate rebounds. This will result in greater fleet growth than forecast at the start of the year and could put a ceiling on rate increases.
- Second hand vessel values have increased as buying interest, such as Golden Ocean Group's (GOLG) recent acquisition, has increased. If second hand values increase too much, it could trigger newbuild orders, a potential negative for the nascent recovery.
This is a lot of ground to cover so this article will focus on the risks associated with the containerships and review the recent purchase and sale of various dry bulk vessels by NMM. The remaining issues will be discussed in future articles.
NMM has a containership portfolio of seven vessels. The following table lists the vessels, the time charter counterparty, and the time charter expiration date.
In brief, the containership sector has suffered from the same feverish overbuilding that afflicted the dry bulk sector. Rates have collapsed to levels that approximate operating expense levels even though containership scrapping has occurred at a furious level with ships as young as 10 years being sacrificed to the blow torch. Despite the scrapping, 2017 will be another year with a heavy schedule of newbuild deliveries and this will continue to weigh on rates. Diana Containerships recently announced a time charter for a 6541 TEU vessel for 13 months at a rate of $10,750. Compare that to the renegotiated rate of $24,095 on the Hyundai time charters and the $34,266 time charters on YM Utmost and YM Unity (Yang Ming of Taiwan) from the table above. Additional anecdotal information is provided in this IHS Markit article. Most relevant to NMM is its comments on 8,000 TEU vessels.
"8,500 teu class vessels, which qualify for a number of east-west trades as well as for north/south trades, have seen spot availability slashed as well. Numerous vessels were fixed for trades either within Asia or connecting Asia with the US East Coast, East Coast of South America or the Middle East. Thus rate levels moved up from low USD8,000s for nearly USD9,000 per day for flexible medium periods. NYK Line apparently had to pay USD12,500 per day on the 8,400 teu ER Tianan to cover an urgent requirement in Northeast Asia that points to further upward potential for charter earnings in this sector."
The opening of the third locks in the Panama Canal that allows very large containerships of 10,000 to 14,000 TEU capacity to traverse the canal has dramatically reduced the value of 6,800 to 8,400 TEU vessels. Bad news for Navios Maritime and Hyundai Merchant Marine, which is losing money every day on the vessels it has on time charter.
Both Yang Ming of Taiwan and Hyundai Merchant Marine of South Korea were rescued by their respective governments with capital injections that kept them from floundering under the weight of uneconomic time charters like these. As noted in the table above, the two YM time charters expire during 2018. It is highly probably that rates on these two vessels will drop $15,000 to $20,000/day upon expiration of these time charters, barring a significant rate recovery. Please note that the expiration dates are the midpoint of the three month expiration range. Therefore the August 2018 expiration is much more likely to occur at the end of June and the October 2017 expiration date is much more likely to occur at the end of August. To provide a sense of the impact of potential rate declines, one vessel suffering a rate decline of $20,000 would result in a revenue and gross margin decline of $7+ million/annum.
Yang Ming will likely be able to honor the remaining term of its time charters with NMM since the two charters have 15 and 17 months remaining to the earliest termination date. If the containership rates do not recover meaningfully by the end of 2018, however, it is important to question whether the South Korean government will continue to shoulder the burden of Hyundai's over the market time charters without additional concessions from vessel owners. The South Korean government may force the negotiation of additional rate cuts from vessel owners in return for additional capital contributions. Given that five NMM vessels are chartered to Hyundai, this represents a significant credit risk. NMM already reduced the time charter rates to from $30,500 to $24,400 as of July 18th 2016 (which will reduce revenue and gross margin $6.1 million when comparing 2017 with 2016). The impact of the Hyundai and YM time charters on the loan to value covenant calculation will be discussed in a later article.
Despite being purchased in January 2015, NMM was forced to sell the MSC Christina in a transaction that closed January 2017. Per the press release that announced the acquisition, the Christina was a 13,100 TEU containership with a 12 year time charter for a whopping $60,275/day. At the date of sale in 2017, there were approximately 10 years left on the charter and this made the Christina the most valuable vessel in NMM's fleet. Per the acquisition press release, the Christina was estimated to contribute $18.4 million per annum, or approximately 15% of NMM's Adjusted EBITDA for the full year 2016. Loss of this revenue and margin during 2017 will be a big hit when added to the $6+ million year over year decline in revenue and margin from the Hyundai containerships time charter renegotiations.
NMM sold the Christina because the counterparty credit risk on the other containerships made them unmarketable at a reasonable price. It was the only asset sale that would provide NMM with sufficient proceeds to pay down debt and avoid failing a covenant test. Note that in the 20-F for the year-ended December 31st, 2015, NMM stated in Footnote 10 "Borrowings" on page F-23:
"As of December 31, 2015, Navios Partners was in compliance with the financial covenants of all of its credit facilities."
For the 20-F for December 31st, 2016, NMM changed the disclosure of Footnote 11 "Borrowings" on page F-26 to read (I bolded the language change):
"As of December 31, 2016, Navios Partners was in compliance with the financial covenants and/or the prepayment and/or the cure provisions as applicable in each of its credit facilities."
It is apparent that NMM failed either the Loan-to-Value (.8x) or Fixed Charge Coverage Test (2x) covenants. NMM sold the Christina for $125 million and used approximately $100 million of the proceeds to pay down bank debt. By selling the Christina and using the proceeds to pay down debt, NMM was able to cure the breach. I will explore this more in a subsequent article.
NMM purchased the Beaufiks, a 2004 Capesize vessel, for $15.3 million and the vessel was delivered in January 2017. In light of the sale of the Christina and the age of the Beaufiks, this would initially seem to be an odd transaction. NMM was able to use $13.5 million of cash held in escrow as security for outstanding debt, however, to fund most of the purchase. It was better to use this cash on an asset that would provide a better return in an improving dry bulk market than the .25 - .5% that would be earned by cash in an escrow account.
Finally, NMM sold the Apollon, a 17 year old Ultramax dry bulker, for $4.8 million. Subsequent to the 15 year Special Survey, vessels must go into dry dock every 2.5 years for a hull inspection. This increases the cost of maintenance for the vessel. In addition, the ballast water remediation protocol goes into effect September of 2017. Given the tightness of capital (prior to NMM executing an offering of common units that closed March 20th), the Company chose to sell the vessel rather than incur the $2 - $3 million costs of Drydocking and retrofitting the vessel to meet the ballast water protocol. Between proceeds and avoided capital costs and expenses, the sale represented a $7 -$8 million positive swing in cash.
The sale of the Apollon was a sensible decision but it also begs the question of what NMM will do with three Panamax vessels, Felicity, Libra II, and Gemini S, that are 20, 22, and 23 years old respectively and are facing the same Special Survey, Dry Dock, and Ballast Water Remediation issues. My surmise is that NMM will sell all three during the next 12 months due to the limited remaining life to recover the costs of any money spent on the vessels. This will shrink the dry bulk fleet from 23 to 19 vessels (factoring in the Beaufiks and Apollon) and has an impact on future potential earnings. The need to replace these vessels was likely a governing factor in the recent common unit offering.
This is Part I of a series of articles that will look at NMM and its ability to reinstate a common unit distribution. Although I am optimistic about the dry bulk market recovery, that is not the primary variable that will determine NMM's near-term ability to make a distribution to unitholders. At this point, based just on the points discussed above, I would be cautious.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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.