Big Dividend Cut Coming Within 2 Weeks For Nordic American Tankers
Summary
- Nordic American Tankers operates a fleet of 33 Suezmax crude tanker vessels, of which 30 are currently operating (3 on order).
- NAT operates 95%+ of its fleet on the spot market and has a variable dividend policy based on the quarterly cash flows from the spot market.
- NAT's long history of high dividends gave it a premium valuation of more than 2x the Net Asset Value of its ships, while peers trade around or even below NAV.
- I believe Q2 and Q3 will both show large dividend cuts and predict NAT will lose its premium valuation status.
Last week, Nordic American Tankers (NYSE:NYSE:NAT) issued a press release reaffirming the company's high priority for dividends. The full text reads (emphasis mine):
"Nordic American Tankers Limited (NAT) – Dividend distribution for 2Q 2017. Dividend is a high priority for NAT.
Hamilton, Bermuda, July 7, 2017
The dividend for 2Q 2017 will be announced at the end of July; reflecting the distribution for the 80th consecutive quarter since the autumn of 1997. As reported in our message to the market of May 29, rates in 2Q 2017 were lower than in 1Q 2017, but well above our cash breakeven. In 1Q 2017, dividend was $0.20 per NAT share.
Typically, the NAT dividend will vary with the level of the tanker market. We send this message to reflect the strong NAT priority on dividend.
We are pleased with the position of NAT – financially, commercially and strategically."
I believe that this message is a warning for investors that a dividend cut for Q2 is impending. The text specifically highlights that Q2 2017 Suezmax spot rates were lower in Q1 2017 and that the level of dividend is variable with the level of the tanker market (rates).
NAT has many retail investors who like the company for the long track record of big dividends, which resulted in a very high premium valuation over peers. The Q1 2017 dividend was $0.20 per share, which translates into a current dividend yield of about 13%. The long track record of high dividends and large historical yield results in NAT being near the top of many stock screener tools. This article serves as a warning that NAT's long history of rich dividends is about to end.
Analysts seem to agree and take a very bearish stance on NAT. At a recent major shipping conference, 4 out of 11 analysts chose NAT as their top short pick for the next year. A 5th one picked another name because he did not want to give the same answer as four of his colleagues already did. No other firm got more than one mention.
Dividend History
As the press release highlighted above, NAT has a very impressive and long dividend history.
The last 10 dividend payments by NAT have been:
Q1 2017 $0.20
Q4 2016 $0.26
Q3 2016 $0.25
Q2 2016 $0.43
Q1 2016 $0.43
Q4 2015 $0.38
Q3 2015 $0.40
Q2 2015 $0.38
Q1 2015 $0.22
This clearly shows that the dividend is highly variable with quarterly results. Of note is that the $0.20 dividend payout was based on an average daily charter rate of $22.700 - in Q1 2017.
Suezmax spot rates in 2017
In their weekly market overview report, CRweber shows the developments of the average Suezmax day rates.
The vertical axis shows the average daily Suezmax spot rates in thousands and the horizontal bar the months. The greyed out area reflects the 2016 rates and the orange the 2017 figures.
The first observation is that the current rates have been well below the 2016 levels all year. Another clear development is that the trend is going down. A final observation is that CRweber reports an average July day rate of only $7.7k/day so far, well below NAT's reported $11.5k cash flow breakeven. As July, August and September are normally the worst months of the year, the near-term outlook is negative.
NAT reported an average day rate of $22.7k/day for Q1 2017, which seems high looking at the graph. The reason for this is that there is a delay between a booking of an earnings fix and when these day rates are actually materialised in practice. For example, booking a 40-day voyage on December 1st at $30k/day, probably means loading in the 3rd week of December and almost all of the revenue days of this trip will fall into Q1.
NAT's Q2 earnings set to plunge
The Q2 average day rate for NAT will therefore be a mix between the rates in the March, April, May and June. From the picture above, I set the target for NAT around $15k/day.
In Q1, NAT reported -$0.03 EPS, but had a -$0.02 1-time adjustment in that figure. Without the adjustment, NAT reported -$0.01 EPS. Cash flows were stronger because ship depreciation is a non-cash expense. According to Yahoo Finance, the current average earnings estimate for Q2 is -$0.06 EPS. This number is hugely outdated and is overdue for a negative adjustment.
A quick back-of-the-envelope estimate, assuming all other costs remain stable for NAT and it has 29 vessels operating spot (one operates a fixed contract) shows:
- Q1 2017: 22.7k
- Q2 2017 assumption: 15k/day
- Number of Q2 days: 91
- Number of shares per Q1 report: 101.969.666
(15.000-22.700)*91*29/101969666 = -0.20
This simple calculation shows that the Q2 earnings of NAT should be roughly $0.20 lower than the Q1 result of -$0.01, so roughly -$0.21 EPS. It is very clear that the current NAT earnings estimate is much too high.
Recent debt covenant breach limits NAT's ability to keep paying high dividends
In the 2016 20-F filing (annual report), NAT reported a debt covenant default (page F-21).
"As of December 31, 2016, the Company was in default with one of its debt covenants; (V) required security ratio of vessel value clause. A waiver was obtained lowering the required ratio to a level where the Company is in compliance. This waiver is effective until May 31, 2018. Under the terms of the waiver obtained, we are unable to draw further on the Credit Facility, our margin is increased by 2.0% for the period of the waiver and we cannot distribute dividends exceeding 85% of our "Adjusted Net Operating Earnings" with respect to the first quarter of 2017, and 75% of Adjusted Net Operating Earnings as from the second quarter 2017 until we are in compliance with the terms of the original Credit Facility. The Adjusted Net Operating Earnings figure is income from vessel operations before depreciation, any impairment losses, non-cash administrative charges and net financing costs."
This covenant limits the dividend payment to 75% of the adjusted net operating earnings. In Q1, the reported adjusted net operating earnings were $30.5M. The same back-of-the-envelope calculation shows:
(15.000-22.700)*91*29= -$20.3M
Therefore, if NAT reports a $15k/day result this quarter, this will lead to roughly $20M lower earnings and only about $10.5M adjusted net operating earnings, which is 0.103 per share. The covenant limits the payout to 75%, which would imply a maximum payout of only $0.077, a massive reduction from the $0.20 payout in Q1 and by far the lowest dividend in a long time.
Q3 outlook is far worse than Q2, Dividend at risk of being cut to zero
The average Suezmax spot rate for Q3 will be some blend of the rates in the June, July, August and September period. So far, the average spot rates of June and the first half of July is roughly $8.5k/day. I expect the company to have at least 25% of the total available Q3 spot days booked around that average by now. This compares very poorly to the $11.5k/day that NAT claims is its cash flow breakeven.
Q3 is the seasonal low of the year. Almost every single year, the rates are the lowest in July-September. History tells us not to expect rates to materially improve over the next two months. 2015 is actually the only year in recent history were rates in Q3 were almost stable compared to the rest of the year; in all other years, Q3 was by far the worst.
Since a period of extremely heavy Suezmax new build deliveries started in May 2017, I expect 2017 to show a very bad Q3 again. The same CRweber weekly report shows that for the remaining 5.5 months of 2017, there are 28 more new builds expected, which translates into a 5.7% fleet growth in just this very short time frame. Even if the scrapping of Suezmax tankers picks up to the 12 they expect (which would be a massive acceleration of scrapping activity; only 4 Suezmaxes has been reported sold for scrap during 2017 so far), the net fleet growth will still be 3.3% in just 5.5 months.
I think this outlook for the big fleet growth is especially troubling for NAT as it has as much as 10 pre-2000 build Suezmax tankers. As the company owns a large portion of the world's oldest Suezmax fleet, NAT has many tankers at risk of getting pushed to the scrap yard by the fierce competition of new and more efficient tankers. There are only 55 Suezmax tankers from 1999 or older in the global fleet so NAT owns many of them. Many of the (by CRweber) assumed scraps (gray bars in the picture above) are NAT's vessels.
Last year, Suezmax spot even hit negative rates for a couple of days in September, and that was in a much stronger rate year than 2017 is so far. If we get the same dynamics again the next weeks, it is likely that the least efficient (oldest) ships in the global fleet will start to show some off hire/idle time, further pressuring NAT's Q3 average Suezmax rate.
With the current Suezmax spot rates well below NAT's cash breakeven, NAT likely having booked around 25% already around $8.5k/day (versus $11.5k cash breakeven), the very heavy influx of new vessels, and the historical precedent of weak July-September rates, I think odds are very high that NAT will show a cash burning Q3 quarterly result.
Yahoo Finance shows a current average Wall street earnings estimate for Q3 is -$0.14 for NAT. This is, again, very outdated and much too high. Same back-of-the-envelope calculation:
- Q1 2017: 22.7k
- Q3 2017 assumption: 9k/day
- Number of Q2 days: 92
- Number of shares per Q1 report: 101.969.666
(9.000-22.700)*92*29/101969666 = -0.358
For Q1, NAT reported an adjusted EPS of -$0.01, so the rough calculation above shows Q3 earnings currently look to be around -$0.37. These analysts have some heavy model updating to do.
Either no dividend in Q3 or major dilution
It should be very clear that the debt covenant restriction of 75% of adjusted net operating earnings would result in a dividend of zero in case of negative operating earnings. NAT should deal with this covenant by getting a waiver or else it's set to lose its status as "distribution for the 80th consecutive quarter since the autumn of 1997" which it always markets very proudly. Like Seeking Alpha contributor James Catlin recently speculated, history tells us that another equity offering is likely as that will bring NAT back out of the covenant breach territory and removes the covenant restriction on paying dividends. In that case, NAT can keep the dividend payout streak alive (like it did in the bad 2013-2014 years) due to the cash generated from issuing shares.
Shorts outstanding and trading suggestions
The simple calculations I did above are hardly rocket science. I have also reported that analysts are very negative on NAT. The company trades at a very big premium over current tangible book value, recently assessed below $3 here, while many peers trade at or below the tangible book. It should therefore not be a big surprise that many shorts have emerged.
In the 30 June filing, the short percentage outstanding was 17.9% with a staggering 21 days to cover. My broker also charges very high lending rates (currently about 30%/year) for NAT. Similarly, put options on NAT are both illiquid and very expensive. This is simply a bit of a crowded (and obvious) short.
I am personally short NAT both with put options and a relatively small number of shares. However, in heavily shorted companies like NAT, there is always risk of a short squeeze. I therefore think it is best to not short this stock if you are an inexperienced trader and always keep exposures relatively small.
Despite the fact that put options on NAT are very expensive, I still think they are a reasonable investment. If you are interested in buying put options in NAT, I would make sure that these options expire after the Q3 dividend announcement and the Q3 figures, so November 2017 or later.
If you are currently long the stock, I suggest selling the position. It is fine to be bullish on tankers, but many peers are simply much cheaper. Euronav (NYSE:EURN), for example, would be a good pick, as it actually trades below current tangible book value (while NAT trades over 2x tangible book), has a much more modern fleet and has a stronger balance sheet compared to NAT. I simply cannot think of a single rational fundamental argument why anyone would prefer NAT to a company like EURN right now, if you can, please share your thoughts in the comments.
If you own shares of NAT and disagree completely with this article, you should still take advantage of the fact that so many investors are betting that the stock will fall, which results in very negatively skewed options with very large put premiums. For example, consider the January 2018 $9 put that last traded at $3.7 when NAT traded at $6.40. (This put gives the holder the right to sell NAT at $9 per share through Jan 19, 2018). You could sell your NAT shares but maintain your long exposure by selling one of these puts for every 100 shares you just sold. You would essentially be selling NAT at $6.40 and simultaneously buying back exposure to NAT at a price of $5.3 ($9 - $3.7). The negatives of this trade are that you will not receive the dividend payments from NAT (but those are set to drop in a big way anyway) and you miss out potential above $9 in case some unexpected big short squeeze happens. If this isn't clear, please ask questions in the comments. I personally don't recommend this strategy at all, but if believed NAT was going up rather than down from here, then I surely feel that the risk-reward outlook of this trade is much more favourable than being outright long.
Conclusion
There is no single doubt in my mind that NAT will cut its dividends for Q2 by at least 50% and again in Q3. The question that remains is to what levels. This article serves as a warning for investors that might not be aware of recent Suezmax day rate movements, the Suezmax order book and the effects that it will have on NAT's ability to pay large dividends.
NAT trades at a heavy premium over peers, presumably because of its long history of paying very high dividends. As NAT will soon be forced to massively cut dividends, both in Q2 and again in Q3, I believe that it will also lose the premium valuation status.
This article was written by
Analyst’s Disclosure: I am/we are short NAT. 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.
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