10.5% Sustainable, Qualified Dividend Yield Play With Growth (That's Not A Misprint)
- The LNG industry is booming and HMLP is a less risky way to play it.
- The company has unique, long-term charter cash flows locked in place.
- Incredibly, HMLP gets qualified dividend treatment.
Hoegh LNG Partners LP (NYSE:HMLP) is an MLP headquartered in Bermuda that owns and charters out FSRU ships as well as two LNG carriers. HMLP trades on the NYSE, has a $550-million market cap, and in the last year has averaged 75,000 shares per day trading volume. Foreign MLPs (there aren't many) can choose how they want to be treated for U.S. tax purposes. HMLP elects to be treated as a corporation for U.S. tax purposes. This is crucial because investors do not have to deal with a K-1 for tax purposes, and it's captured on a 1099 like any regular stock in the U.S.
Even better, HMLP's dividend gets qualified dividend status. Its 10%-plus dividend yield makes it very attractive in taxable accounts. HMLP also has an 8.75% preferred stock issue that gets qualified dividend status as per Form 20-F. I can attest to that fact as Interactive Brokers gave me qualified dividend status on my 2017 1099.
The U.S. natural gas industry has boomed in terms of quantities produced in the last 10 years. This has worked out very well for users of natural gas, less so for those depending on the price of natural gas to earn profits in its production. Because production has been so strong, exports of natural gas in the form of liquefied natural gas (LNG) has also taken off in recent years. Cheniere Energy (LNG) has converted its operations in Louisiana (Sabine Pass LNG) from receiving LNG from foreign producers to instead taking in U.S. produced natural gas and converting it to LNG to be exported abroad. A second LNG export operation has just started at Dominion Energy's (D) Cove Point plant on the East Coast. Other large natural gas producers around the world are setting up like the U.S. to export natural gas via LNG ships. This industry is rapidly following in the footsteps of the oil tanker industry.
Natural gas tanker rates are following similar paths to oil tankers in terms of supply/demand. Fortunately, growth in the natural gas sector is huge simply because it's newer. In the last few years, it appeared that the supply of LNG tankers was greater than demand because construction of ports to allow exports and imports of LNG is a many-year process and was lagging. Recently, with so many new ports coming online, demand for LNG tankers has improved and rates are climbing. There are several LNG tanker MLPs, including Dynagas (DLNG), GasLog (GLOP), Golar LNG Partners (GMLP), and Golar LNG (GLNG). Some of these also own a few FSRU vs. straight tankers, but HMLP seems to be the only one focused mostly on FSRU.
What are FSRU ships? They are floating storage regasification units. Simply put, there are floating factories where LNG brought in by tanker can be converted back into natural gas and then pumped into an existing natural gas infrastructure. They exist for the most part to allow third-world/poor credit countries the ability to participate in buying cheap LNG without the need to spend billions building port facilities to enable this process. They also get used in places in the world where geography makes building a port facility too close to existing towns (due to the fear of explosions) not acceptable, and FSRU parked offshore can do same thing with less risk. In case you were wondering, HMLP is the only true pure play in FSRU on Earth.
I first started out investing in these LNG companies over a year ago, as they offered significant yield in a booming business with great growth potential. But one of the odd things I noted was extreme volatility in price movements (in both directions), which made no sense. Next I discovered that, unlike oil tanker rates with plenty of public data available to show you trends, LNG tanker rates were at the other extreme with zero publicly available info, beyond reading quarterly reports. And those were mostly a review of where rates were the previous 90 days as well as, of course, a bullish outlook for the future. I soured on sector because I realized to get long the space was to just guess at where LNG tanker rates were going. While many LNG ships go out on multiyear charters, ships also come off charters and, if spot rates fall, ships might go back out at lower rates and the share price falls.
Then I discovered HMLP, with its emphasis on FSRU. I discovered that unlike tanker charters, FSRU ships go out on 10- to 15-year charters (the average charter length of the current HMLP FSRU fleet is 11.5 years). This allows the company to lock in extremely long-term profits. In the world of MLP, this is nirvana. I realized I didn't have to worry about where FSRU charter rates are headed because, for most part, they are way beyond my horizon of worrying. Even better was the fact that HMLP is usually able to place a vessel on charter before taking delivery of a new build. Furthermore, looking at how HMLP had grown its fleet over time and the additional profits each new vessel adds to the operation, there were very strong prospects for additional dividend growth down the road (ultimate dividend investing nirvana).
Now, let's flip over to traditional U.S. MLPs. This sector has been crushed in the last six to 12 months for reasons that are unclear, as well as changes in the tax code and fears of Fed rate hikes/rising rates harming income plays. Despite all this, the usual relationships exist. Downstream energy plays with oil and gas price risk tend to trade at the highest yields due to perceived price risks, while at the other end of the spectrum pipeline companies trade at the lowest yields. That's because the pipes last for decades and they collect a fee for just moving the oil and gas. If downstream MLPs are trading at 8-10% style yields, good pipeline plays are, let's say, 4-6% yields.
Now, let's look at HMLP with 11-year charters in its fleet. That's a very predictable cash flow locked in for a long time. I would suggest it should trade closer to a pipeline yield, yet the typical LNG tanker yield is currently over 10% and so is HMLP!
Why so cheap? The answer is complex, but it's a mix of the following:
- MLPs simply trade like death and have since oil prices crashed from $90 to $40 in 2014-15. Despite a rebound back to $60-plus recently, traditional U.S. MLPs are mostly trading near lifetime lows. This negative bias has likely infected even LNG shipping MLPs, despite a near-zero correlation to what moves traditional MLPs. Just recently, FERC did some tweaking to MLP tax laws that sent the entire sector into a new tailspin. LNG shipping MLPs are completely unaffected by this, but for many traditional MLP investors it's just another reason to give up on the space. If things stay this bad, I expect you will see MLP convert to corporations or liquidate or take other actions to escape the sector ills.
- Away from MLPs, the entire shipping sector (oil tankers, drybulkers, and container ships) has been in a near depression for the last 10 years. This is mostly a function of excess supply and the need by countries such as China and South Korea to keep building ships, despite excess supply, to keep thousands employed.
- Combine 1 and 2 together and you have a lot of reasons to really avoid MLP shipping companies. Then add in the fact that LNG tanker supply got ahead of LNG port infrastructure last year and you saw LNG tanker rates weaken (not a lot, but some). As this news leaked out it scared the heck out of longs who were already suspect of all MLPs or anything to do with big ships. I managed to exit positions in GLOP, GLOG and GMLP with modest profits. As I studied HMLP I realized it was a completely different animal, and I entered it and have never looked back. Although I confess my price basis is underwater, though close to breakeven with dividends.
- On March 13, a big yet unidentified large holder filed to sell 1.5 million shares of HMLP. A few days later, the FERC news on tax change came out. The combined effect sent HMLP from almost $20 in January to $15.50 by late March. With large selling now finished, the price has recovered to $16.50. With its $0.43 dividend, that equates to a 10.40% yield (qualified dividend).
Now, let's look internally at HMLP. You trade MLPs on an EBITDA basis/growth and the ability to grow dividends on a sustained basis. HMLP's one-year dividend growth is flat, its two-year dividend growth is 4%-plus, and its three-year dividend growth is around 8%-plus.
2017 vs. 2016 growth of revenue and EBITDA at HMLP was very impressive. Revenue was up 58% YoY and EBITDA was up 22%. In particular, Q4 was a blowout with an all-time high record EBITDA of $33.7 million, up 31% YoY. This has many predicting a coming dividend increase (nothing big, probably a penny or so, or 4% growth). Bloomberg's Street consensus for 2018 shows HMLP EBITDA growth of 22% on 6% revenue growth.
Let's step away and take a 30,000-foot view of HMLP. It has locked in cash flows today for over a decade. It has easy opportunities to add more FSRU either outright or by buying out partnerships where it's 50% owner (as happened last year). It pays out an enormous 10-11% yield due to weakness of virtually everything in shipping and MLPs dragging on it. And you get qualified dividend status on that yield, which for high-income folks equates to an about 8-9% after-tax yield at the 15% tax rate.
Compare this to fully taxable junk bonds at 5%-plus or HYG at 4 7/8% yield. Compare that to typical state muni CEFs with 4-5% yields. Both sectors get hurt with each additional Fed rate hike coming and yield curve at 10-year flats. The only thing even remotely comparable are some of the mortgage REITs and downstream MLPs with big commodity risk. The former is fully taxable and the latter has loads of commodity and rates risk.
I rarely step out and bang pots and pans when something looks this cheap. The last time was when San Juan Basin Royalty Trust (SJT) was in the high $5s and Mesa Royalty Trust (MTR) was in the $8-9 area, as I discussed in a previous article. I believe that given HMLP's locked in cash flows on the current fleet, its ability to add more FSRU, and its qualified dividend status that it truly warrants a $20-22 price target going out 18 months. By the way, Stifel, Barclays (BCS), Seaport Global, and Fearnley Securities all have a $22 target going out 12 months with a Buy rating (Morgan Stanley says "buy" with a $20 target and DNB Markets has a buy rating with a $23 target).
The worst-case scenario, in my opinion, is that the price goes sideways from here due to weak equity markets and you live with a 10%-11% dividend yield. HMLP is a 3% position for me.
This article was written by
Analyst’s Disclosure: I am/we are long HMLP WITH A 3% POSITION. 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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