Teekay Offshore Partners L.P. (NYSE:TOO) provides a variety of services to deep offshore oil producers including FPSO (Floating production, storage and offloading) vessels, shuttle tankers and towing. As compared to other popular shipping sectors such as dry bulk and container ships, TOO is in smaller niche markets with less competitors. An FPSO is typically built for a specific customer after a long term contract has already been signed. TOO is largely insulated from short term market fluctuations as compared to shipping peers like Star Bulk Carriers Corp. (NASDAQ:SBLK) or Scorpio Bulkers Inc. (NYSE:SALT) that typically lease vessels under short term contracts at spot market prices. Even so, TOO struggled when oil prices crashed. Fortunately, the company appears to have cleared many of the obstacles it faced. This article provides the top 12 reasons to consider the TOO-PB preferred issue.
What is TOO-PB?
TOO-PB is a par $25 cumulative preferred partnership unit with an 8.5% coupon. Distributions are paid quarterly and TOO-PB now yields 9.3% at a recent price of $22.91. It's a perpetual issue, which means that the company has no obligation to call it. TOO-PB may be called at par starting on 4/20/2020. See prospectus for additional details. TOO-PB and TOO-PA are similar cumulative preferred issues with equal seniority. TOO-PB has an average daily trading volume of approximately 22K shares. Limit orders and patience are recommended when trading.
Tax issues: No K-1 hassles!
Many income investors avoid owning partnership issues due to the hassles of dealing with K-1 tax forms. Fortunately this is not an issue for those holding the TOO common or preferred partnership units. TOO has elected to be treated as a corporation for tax purposes. This is detailed on the tax information section of the company's web site:
"The Partnership has elected to be treated as a C-Corporation for tax purposes (our investors receive the standard 1099 form and not a K-1 form).
Distributions we pay to U.S. unitholders will be treated as a dividend for U.S. federal income tax purposes to the extent the distributions come from earnings and profits ("E&P") and as a nondividend distribution or a return of capital ("ROC") to the extent the distributions exceed E&P."
1. The rally in TOO is positive for TOO-PB holders
TOO has been trading higher over the last 3 weeks. It bottomed at $4.70 on 3/27/2017 and closed today at $5.66 for a 20% gain. There are multiple catalysts for this resurgence. Oil prices have rallied (see #3). The Libro FPSO (see #9) was successfully completed) and the common stock dividend (see #12) was confirmed. This type of sharp rally in the common stock should be a wake up call for preferred stock holders. TOO is far more liquid and widely traded than the preferred issues. Common stocks often react more quickly to good news than preferred shares.
2. Long term contracts
The focus on long term contracts provides the stability that income investors crave. Long term contracts are essential in a niche sector where vessels are often custom built to support a specific customer project. For example, the Libro FPSO (see #8) was just deployed under a 12 year contract. A new 5 year North Sea Shuttle tanker contract (see #9) was recently signed. This type of long term contract gives TOO more earnings visibility than most shipping peers that operate on shorter spot market contracts.
3. Oil prices have moved higher
The May WTI oil contract bottomed at $47.01 on 3/22/2017 and has rallied moderately to hit $50.44 as of today. Due to long term contracts, TOO is somewhat insulated from short term moves in the price of oil. Energy production is capital intensive, but the marginal cost of producing oil from existing facilities is low. Unless there is an extremely severe drop in oil prices, TOO customers are not going to shut down their existing production. However oil prices do matter when new long term contracts are being signed or modified.
For example, the Arendel Spirit UMS contract with Petrobas (NYSE:PBR) could be modified as some unexpected maintenance issues are addressed. The recent firming of oil prices would be an important positive factor in that type of negotiation.
4. Adequate liquidity
Adequate liquidity is always an important consideration for preferred stockholders. While TOO still has some work to do in dealing with upcoming debt maturities, they have built up a nice liquidity cushion. As per the Q4 2016 earnings report:
"As of December 31, 2016, the Partnership had total liquidity of $260.7 million (comprised of $227.4 million in cash and cash equivalents and $33.3 million in undrawn credit facilities)".
5. Support from the parent company
Teekay Corporation (NYSE:TK) is the parent company of TOO as well as Teekay Tankers (NYSE:TNK) and Teekay LNG Partners, L.P. (NYSE:TGP). I recommend J Mintzmyer's excellent recent article for more background on TK. A strong parent company can be an important liquidity backstop. The TK 8.5% notes due 1/15/2020 (CUSIP 87900YAA1) are now trading at 98.75 with a 9.0% yield to maturity. Although I don't think TOO will require any additional support from TK (which faces some challenges of their own), this would likely be available as a last resort
6. Solid profitability expected in 2017 & 2018
Earnings and cash flow are ramping up as new projects come online. According to the company's Q4 2016 earnings presentation ( See page #7), $200 million in incremental cash flow will be added by 2018. Expectations of improving results are also reflected in analyst estimates. According to Yahoo Finance earnings estimates, all 3 analysts covering TOO expect it to be profitable in both 2017 and 2018. The average earnings estimate is $1.08 per share for 2017 and $1.33 per share for 2018.
7. 2018 preferred dividend DCF coverage of about 6.8X
Q4 2016 DCF (distributable cash flow) was reported as $21.6 million (See page #2 of the Q4 2016 earnings presentation). The DCF calculation is shown on page #15. DCF is expected to increase by $200 million ($50 million per quarter) for 2018. Preferred distributions are senior to common distributions. Note that DCF is calculated for TOO holders after paying $12.3 million per quarter in preferred stock distributions. 2018 quarterly DCF applicable to the preferred units should be approximately: $21.6 million + $50 million + $12.3 million = $83.9 million
Therefore 2018 DCF coverage of the preferred dividends should be approximately: $83.9 million / $12.3 million = 6.8X
8. The Pionero De Libro FPSO has been deployed
Converting a shuttle tanker to an FPSO (Floating production and storage vessel) is a non-trivial project. This labor intensive (19.9 million man hours) project took years and a $1 billion budget to complete. It is being deployed to a consortium of oil majors under a 12 year contract. The 4/7/2017 announcement was very significant. A recent article by Long Player highlighted the operational risks of delays to major TOO projects such as this one. As per the 4/4/2017 announcement:
"We are pleased to share that thanks to the efforts of everyone at the yard, as well as those working on shore, our lady safely set sail on March 28 from the Singapore yard for her resident Libra field in Brazil."
9. New North Sea shuttle tanker contract finalized
Teekay has demonstrated that they can obtain and successfully renew long term contracts with top tier oil companies even when market conditions are challenging. They are a leader in market niches such as towing platforms and shuttle tankers. A major new contract was finalized as disclosed in the Q4 2016 earnings report:
"In January 2017, the Partnership received a letter of award for a new, five-year shuttle tanker CoA, plus extension options, with a consortium of oil companies to service a development located in the U.K. Central North Sea. Subject to the finalization of the terms of the CoA, the CoA is expected to commence during the first quarter of 2018 and will be serviced by the Partnership's existing CoA shuttle tanker fleet."
10. The TOO 2019 bonds have traded higher
Preferred stock holders should always pay close attention to bond market trading. Preferred stocks tend to be traded by retail investors. Bond issues are often larger than preferred stocks and are traded primarily by large institutions and other professional investors. The Teekay Offshore 6% unsecured bonds maturing on 7/30/2019 (CUSIP 87901BAA0) are now trading at $91.25 with a 10.4% yield to maturity. The 2019 bonds have had a huge rally from the low 70's over the last year. This is a strong indication of improving credit quality.
11. Dilution is a good thing for preferred holders
Stock dilution may be painful for TOO holders, but is beneficial for TOO-PB holders. Teekay sold $31 million in common stock during 2016 through a continuous offering program that was registered in August 2016 enabling the sale of up to $100 million in common stock. These "at the market" sales can be made at any time to boost the company's liquidity.
12. The TOO dividend has been maintained
Management has demonstrated a lot of confidence by maintaining an 11 cent distribution on their common units. Preferred distributions are senior to the common distribution. The TOO-PB distribution must be paid before any distribution to TOO holders can be made. To conserve cash, TK and insiders are receiving their distributions in TOO stock. Distributions for the non-publicly traded Preferred C stock are also being paid in shares of TOO. These moves are detailed on page #47 of the SEC Form 20-F annual report filed on 4/12/2017.
What are the major risks?
Most TOO contracts are with financially strong oil majors with very low counter-party risk. However, there has been some concern regarding counter-party risk with PBR. Fortunately this risk has diminished. The PBR 4.375% unsecured bonds (CUSIP 71647NAF6) maturing on 5/20/2023 are now trading at $95.38 with a yield to maturity of only 5.3%. This suggests very moderate counter-party risk. Credit quality has improved dramatically since 6/1/2016 when the same bond issue traded at only $75.
TOO has a very experienced management team, but operational risk is always a concern. TOO leases some very expensive custom built vessels. Operational risk was highlighted by the recent suspension of leasing revenue (pending repairs) at the Arendal Spirit UMS. Oil prices are unpredictable. A severe decline in oil prices would hurt results as long term contracts come up for renewal. TOO has some near term debt maturities including $300 million of 6% notes due 7/30/2019. There are also 2 smaller bonds denominated in Norwegian Krone (the 2 bonds total approximately $309 million) maturing over the next couple of years. Near term debt maturities always provide some risk even though they appear to be very manageable TOO is well positioned to refinance these maturities given its current liquidity (see #4), improving earnings (see #6, #8 & #9) and access to capital (see #10, #11).
TOO-PB offers an attractive 9.3% yield with the potential for modest capital gains if it continues trading higher towards par. TOO-PB has had enough volatility over the past couple of years to make income investors sea sick, but the waters are now much more placid. The critical Libro FPSO project was completed and a shuttle tanker contract successfully signed. While there are still some remaining challenges, cash flow is ramping up and liquidity is improving. The TOO common as well as the bonds have rallied. The ship has sailed into calmer waters.
Note: My Panick Value Research Report is focused on high-yield preferred stocks, exchange traded debt issues and other undervalued high-yield opportunities. Members receive an advance look at all my articles as well as continued coverage. This TOO-PB article was announced to members on 4/7/2017 with TOO-PB trading at $22.30. Please read our outstanding subscriber reviews here.
Disclosure: I am/we are long TOO-PB, SALT, SBLK.
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.