Teekay Offshore Partners: Be Prepared For Volatility

Summary

• The recent share price rally may have decreased equity costs. An agile management can and should take advantage of the latest rally to sell any needed equity.
• The stock will be volatile until the issues surrounding the loan of the Arendal Spirit are settled. Purchasing a put and a call may be a viable option.
• Other issues such as other debt due, cost overruns, and whatever else concerns the lenders might complicate the loan negotiations. So more equity might be demanded by lenders.
• Lender perception and industry reality could be very different. What was a viable loan in the past may not be a viable loan in the future.
• Lender fears may be heightened by the perceived delay of a cyclical recovery of parts of the company business.

Teekay Partners (NYSE:TOO) has been on a roller coaster ride. This ride appears to be very dangerous still, but there may be reasonable ways to take advantage of the stock price volatility. Plus the market rally may have thrown management a lifeline. If that is the case, management needs to take that lifeline and run quickly.

Source: Seeking Alpha Website, July 6, 2017, Market Close

In early May, the market reacted negatively to a contract cancellation. On May 18, 2017, management reported the cancellation of the Arendal Spirit UMS contract. As can be seen above the stock basically tanked and then has recovered some. That recovery has decreased the cost of capital materially. So if management needs to raise capital, then now may be the best time to do just that. Waiting for a clearer crystal ball could make capital raises prohibitively expensive. The common unit holders could be relatively wiped out in the process.

The contract cancellation started a six month period after which the lender can call the note. More concerning is other issues were under negotiation for extensions or renewals. There were some cost overruns. Multiple debt negotiations can exponentially complicate those negotiations. But the crux of the problem is shown below:

Source: Teekay Offshore Partners, Q1 2017 Earnings Report

The current amount of long term debt due is $621 million but there is far less cash shown above and the cash flow statement is not showing nearly enough cash flow to pay that debt coming due. The amount of debt coming due is fairly large for the company size. So the company will have to refinance a fair amount of debt. The partner distribution has a high cancellation probability. Refinancing a lot of debt was OK when business conditions were stronger. But now the cost overruns and the contract cancellation may be causing some lender concern. A large equity sale may be needed instead. The proceeds can be used to pay off the Arendal Spirit loan before it can be called and then the ship can be later used for its collateral value.

Joint ventures remain an option to raise cash also. But significantly, none have been announced. As the six month deadline approaches, a joint venture could become more challenging to negotiate.

For the investor a stock in this situation usually acts schizophrenic. Some days the market is really confident and other days pessimistic. So the relatively sizable decline shown in the stock price above followed by an fairly significant recovery is not that unusual. Usually though each recovery fizzles out at a progressively lower level as time goes on.

Previously management had stated they were working on a solution. Plus the parent company Teekay Corporation (TK) was working with the partnership to help with that solution. Furthermore, there would be some guidance as to the progress made, probably around the time of the second quarter report. But that leaves more than a month for the imagination of Mr. Market to run wild.

Volatility, may in fact increase until news of a solution has been disseminated. This is one of the few times that purchasing a put and a call to bet on volatility may be advised. If the stock itself is purchased, then stop-loss orders or the concurrent purchase of puts should be considered for volatility protection. But if action and adventure is for you, and if you have a strong stomach, then this stock should give you plenty of both.

The two preferred issued (TOO-PA and TOO-PB) have likewise rallied. But their yields are in high yield territory. This may be reflecting the current risk of the situation as the six month waiting period ticks down. If oil prices retreat, both the preferred and the common may follow.

As the six month deadline approaches, the market may become more subdued. The stock often trades in relation to oil pricing even though the contracts for the ships are fairly long term. Perception is 99% of the game and low oil and gas prices are perceived to be bad for the company.

But the real concern is what the lenders are using to evaluate loans that are coming due for renewal or extensions. Previous articles have detailed the partnerships exposure to strong areas, like the shuttle business as well as some not so strong areas. Cost overruns and a contract cancellation did not improve the negotiating position. Probably the biggest concern though is that the perceived recovery of the weaker parts of the business has been delayed. Even though cyclical recovery delays are common, that delay could give lenders the jitters, even if every loan has a contract before the loan can be negotiated in the first place.

Reality and lender perception are not the same. At times, they are very divergent. So what was a viable deal in the past may not be a viable deal going forward. Lenders may demand more collateral or more equity than in the past for the same type loan. That is the danger of renegotiating debt when some of the company divisions are posting weak results.

Lenders tend to suffer from group-think. So if enough persuasive lenders both inside and outside the group believe that these types of loans are not the best use of the lender's money, then this company could be in for quite a struggle.

Some compared the situation to Kinder Morgan (KMI), but Kinder Morgan had an investment grade rating. It was one of the stronger companies when lenders changed their terms. Even so, the lenders demanded more equity in each transaction. Plus the company raised additional money through sales and joint ventures to reach the new conformance requirements. Management acted to promptly bring the company back into conformance. In fact, management probably beat lender expectations. That is usually a key lending relationship tool.

Teekay does not appear to have changed much. If anything the company is more like Denbury Resources (DNR). That management has made a little progress. But as things have deteriorated, the material progress back toward conformance is just not there. Denbury management probably has less than half the activity of Kinder Morgan. Plus, Denbury management took a whole lot more time to do what little debt reduction has been accomplished.

Maybe the lenders did not demand many changes to refinance, change, or extend loans in the past. But that attitude can change at any time. Plus the closer a company gets to a financial crisis, the more likely its assets get revalued by the market. The worst result, bankruptcy, values assets very differently. The market knows that and reacts accordingly as a crisis escalates.

So the halfway point of the six-month period approaches. Management should have a plan in hand. Management should know if equity is likely to be needed. That equity could be opportunistically raised now after a rally. The current stock price is not great, but it may be the best that management can expect until the Arendal Spirit issues are resolved. In the meantime, shareholders need to be prepared for a lot of volatility.

Disclaimer: I am not a registered investment advisor and this article is not advice to buy or sell stock in any company. The investor needs to do his own independent investigation that includes reading the company governmental filings and press releases, as well as anything else relevant to determining if this company fits the investor's risk profile.

Analyst’s 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.