A 10% Yield On Qualified Dividends, With Strong Coverage, Record Earnings, And No K-1

Summary

• The yield is 10.54%, with strong 1.26X coverage.
• Q4 '17 earnings hit records for revenue and adjusted EBITDA.
• It issues a 1099 at tax time - no K-1.
• It's only 3% above its 52-week low.

Looking for a high-yield investment without the hassle of a K-1?

KNOT Offshore Partners LP (NYSE:KNOP) is one of a few LPs that has elected to be treated as a C-Corp, and issues 1099s to unitholders at tax time. Thus, we are spared the complexities of a K-1.

Profile:

KNOT Offshore Partners LP owns and operates shuttle tankers under long-term charters in the North Sea and Brazil. The company provides crude oil loading, transportation, and storage services under time charters and bareboat charters. KNOT Offshore Partners GP LLC serves as the general partner of the company, and Knutsen NYK Offshore Tankers AS is its sponsor. The company was founded in 2013 and is headquartered in Aberdeen, UK. (Source: KNOP site)

Shuttle tankers are a niche industry - these specialized tankers comprise only around 1% of the world's conventional tanker fleet, and are a vital key solution for oil companies looking to monetize their product. Since many ports don't have the infrastructure to accommodate large tankers, producers charter shuttle tankers to get their oil into port. They also are used for transporting deep-sea oil to port. These are specialized vessels that take 2.5-3 years to build, which will cause a vessel shortage in this industry.

Distributions:

KNOP pays its distributions in the usual Feb-May-Aug-Nov. cycle for LPs, but there's a big difference at tax time: Unlike most LPs, it has elected to be treated as a C-Corporation for tax purposes, so investors receive the standard 1099 form and not a K-1 form.

Our High Dividend Stocks By Sector Tables track KNOP's price and current distribution yield (in the Services section).

Management has held the quarterly distribution steady, at $.52, since October 2015 - it's ~39% above its targeted minimum distribution of $.375.

Historically, KNOP has had good coverage, and 2017 was no exception. It averaged 1.26 distribution coverage over the past four quarters:

When asked about future distribution hikes on the Q4 earnings call, the CEO said that they will be concentrating instead on strong distribution coverage:

(Source: KNOP site)

Options:

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Earnings:

KNOP has had strong growth in Q2 -Q4 '17, with revenue, EBITDA, and DCF all rising significantly, as new dropdown vessels were added to the fleet.

It had record revenues and EBITDA in Q2, Q3 and Q4 '17, thanks to new assets being dropped down from sponsor Knutsen:

(Source: Q4 earnings call - KNOP site)

Revenue grew 28%, EBITDA rose 21%, and DCF grew at a lesser rate, up 9%, in 2017. Distribution/unit growth was flat, and coverage was steady, even with 15.55% unit growth.

"On November 9, 2017, the Partnership sold 3,000,000 common units in a public offering. In connection with the offering, the General Partner contributed a total of $1.2 million in order to maintain its 1.85% general partner interest in the Partnership. The total net proceeds from the offering and the contribution were $66.0 million. The net proceeds were used to acquire the shuttle tanker Brasil Knutsen and repay amounts drawn under the revolving credit facility." (Source: KNOP site)

Risks:

Management said on the earnings call that it won't be issuing earnings guidance for 2018. There will be several special survey drydockings scheduled to take place in 2018, which will impact earnings somewhat.

It also noted the impact of rising interest rates on its earnings, but it sees its coverage as rising in 2018 and 2019:

Recontracting - KNOP has three vessels with charters expiring in 2018 - the Windsor Knutsen and the Hilda Knutsen at the end of Q3, and the Toril Knutsen at the end of Q4 '17.

When asked about the Windsor on the earnings call, (the Windsor has been chartered by Shell (RDS.B) since October 2015), management said,

"Shell has eight vessels in Brazil, and is expanding quite rapidly. They need more shuttle tankers, not less. The Windsor is an older ship, but it's well-specked, and the charter rate is cheaper than a new ship would be."

The CEO also commented on the refinancing of the Hilda and Toril vessels, and on how long it would take a competitor to replace them with a newbuild vessel:

As of December 31, 2017, KNOP's 15 vessel fleet had an average remaining fixed contract duration of 4.2 years. In addition, the charterers of the Partnership's time charter vessels have options to extend their charters by an additional 4.6 years on average.

(Source: KNOP site)

New Developments:

KNOP only had the earnings from its newest vessel, the Brasil Knutsen, for half a month in December 2017 - (the dates are incorrect in the table below).

Q1 '18 earnings should be very strong, with Brasil Knutsen contributing for a full quarter and the Anna Knutsen contributing for ~1 month.

Management's strategy seems to be one of building up a strong coverage factor in Q1 '18, which will help KNOP maintain a higher trailing coverage ratio through 2018, even though the various drydockings will impact coverage in Q2-4 '18.

(Source: KNOP site)

Tailwinds:

Management commented upon the current market for shuttle charters on the Q4 earnings call, noting that the long newbuild times are heating up the market. The chart below shows a looming shortage of ~ 49 vessels through 2022.

"Fearnley's sees a significant demand for shuttle tankers going forward."

"The market is very, very tight. We've had no problems tendering lately."

(Source: KNOP site)

Management highlighted on the Q4 earnings slides that Brazil's Petrobras (PBR) has reemerged from the corruption scandals, with 17 projects due to start by 2022, which will need multiple shuttle tankers.

In 2017, there were eight Continental Shelf plans for development and operation, involving offshore loading, which were approved in Norway, which also will create demand for shuttle tankers:

(Source: KNOP site)

Performance:

With all of this mostly positive news, you'd think Mr. Market would have hopped onboard KNOP, but, instead, he has chosen to stay on land, focusing on the 2018 drydockings and recontracting instead.

KNOP is only ~3% above its 52-week low.

Analysts' Price Targets:

KNOP's price underperformance has put it far below analysts' consensus price target.

KNOP is currently 18.6% below analysts' average price target of $23.40, and 26.71% below the $25.00 highest price target.

Valuations:

Although KNOP isn't an LNG tanker company, we've added it this LNG shipping company valuations table to compare it to other tanker companies we cover in our articles, such GasLog Partners LP, (GLOP), Golar LNG Partners LP (GMLP), Dynagas LNG Partners LP (DLNG), and Hoegh LNG Partners LP (HMLP).

The table also includes Teekay Offshore Partners LP (TOO), which is KNOP's closest competitor. Like many of the Teekay group's companies, TOO has had serious issues - TOO once again slashed its distribution in 2017, down to just $.01/quarter.

KNOP has the highest distribution coverage, the lowest price/book, and the lowest price/DCF in this group.

Financials:

Like most LPs, KNOP's debt load rises and falls with new acquisitions - management uses a combo of debt, private preferred units, and common unit issuance to help fund its growth. All of the new 2017 acquisitions pushed up KNOP's debt leverage vs. 2016 levels.

Management addressed this on the earnings call:

(Source: KNOP site)

KNOP's ROA, ROE, and operating margin ratios are all higher than average for this group. Its debt/equity leverage is lower than average, but its net debt/EBITDA leverage is higher.

Debt and Liquidity:

As of December 31, 2017, the Partnership had $81.1 million in available liquidity, which consisted of cash and cash equivalents of $46.1 million and $35.0 million of capacity under its revolving credit facilities. The revolving credit facilities mature in June and August 2019. The Partnership's total interest-bearing debt outstanding as of December 31, 2017, was $1,033.3 million ($1,026.6 million net of debt issuance cost). The average margin paid on the Partnership's outstanding debt during the quarter ended December 31, 2017, was approximately 2.3% over LIBOR.

Management made a refinancing deal in January 2018:

"On January 30, 2018, the Partnership's subsidiary, KNOT Shuttle Tankers 15 AS, which owns the vessel Torill Knutsen, closed a new $100 million senior secured term loan facility (the "New Torill Facility") with a consortium of banks, in which The Bank of Tokyo-Mitsubishi UFJ acted as agent. The New Torill Facility is repayable in 24 consecutive quarterly installments with a balloon payment of $60.0 million due at maturity. The New Torill Facility bears interest at a rate per annum equal to LIBOR plus a margin of 2.1%. The facility will mature in 2024 and is guaranteed by the Partnership. The New Torill Facility refinanced a $73.1 million loan facility associated with the Torill Knutsen that bore interest at a rate of LIBOR plus 2.5% and was due to be paid in full in November 2018."

"With the Torill refinancing in early 2018, (the partnership has), no significant balloon repayments until 2019."

(Source: KNOP site)

Summary:

We continue to rate KNOP a long-term BUY, based upon its leading position in a niche industry, its current low valuation, its attractive, well-covered yield, and its access to financing. Yes, Q2-Q4 '18 may be a rocky ride, with drydockings hitting earnings, but there will continue to be an ongoing need for shuttle tankers, and, moreover, there will be a shortage of these specialized vessels in the future.

All tables furnished by DoubleDividendStocks.com, unless otherwise noted.

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Disclaimer: This article was written for informational purposes only, and is not intended as personal investment advice. Please practice due diligence before investing in any investment vehicle mentioned in this article.

Analyst’s Disclosure: I am/we are long KNOP, GLOP, DLNG, GMLP. 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.

Long certain preferred units, vs. common units.