3 High-Yield Plays For 2018: Q1 2018 Updates

Summary

• At the start of 2018, we shared a trio of attractive high-yield names, all of which also offered significant capital return upside.
• Three months later, we’ve returned to chart the progress of these names. Total returns have slightly lagged the S&P 500 even as prospects have clearly improved.
• These names markedly outperformed high-yield comps, and I expect the remainder of 2018 to be quite successful.
• Read below for our updates on three of our favorite high-yield plays, with payouts ranging from 9.9% to 10.5%.
• For more in-depth research in this sector, please consider a membership to Value Investor's Edge.

Income Overview

2017 was a brutal year for many higher-yield opportunities, especially those tied to energy and shipping, and Q1-18 continued this trend, to the extreme! When we first introduced this trio, they ranged from 9.2 to 10.0% yields. Although prospects have improved for two of these firms, the yields have expanded, now sitting at a 9.9% to 10.5% range.

These risk profiles and forward growth prospects are far stronger than headline yield would suggest. All three firms have strong payout coverage, long-term charter backlog, reasonable leverage, and payouts have room to grow. In addition, all of these firms are registered as corporations and offer 1099 forms as opposed to the more complex K-1 for pass-through income. This means these firms can be held in 401K and IRA accounts without hassle, or US investors can hold in taxable accounts and take advantage of the lower ‘qualified dividend’ tax rates.

These three firms, sorted by yield:

• KNOT Offshore Partners (KNOP): 10.5% Yield
• Capital Product Partners (CPLP): 10.4% Yield
• Hoegh LNG Partners (HMLP): 9.9% Yield

The following report includes an overview of each firm, updated for Q1-18. I’ve kept the overviews brief to maximize exposure to newer information. I recommend reviewing our original report for more background.

Slow Start to 2018...

The below chart shows the YTD returns of this trio versus the S&P 500 total return. Thus far, these names have underperformed by around 3% when dividends are factored in.

Chart Credit: Yahoo Finance

We’ve been playing in a very tough sector, with more meltdowns than we can possibly chart in one graph. Here are some of the bigger ones, and we’ve also charted the Alerian MLP (NYSEARCA:AMLP) index for a broad indication of how the sector has performed. The AMLP is off by 15%. Even blue chip Enterprise Product Partners (NYSE:EPD) has dropped by over 8%, so although we’re certainly not happy with the return from our ‘trio,’ we’ve handily outperformed yield comps while taking substantially less risk.

Chart Credit: Yahoo Finance

The rest of this report will focus on current prospects. I am long each of these three firms and I expect we’ll eventually see very strong performance over the remainder of 2018.

KNOT Offshore: 10.5% Yield, Growing Coverage

KNOT Offshore Partners is an MLP-style firm with general partner 'KNOT,' which is a 50/50 joint-venture between Japan's NYK line and Knutsen OAS. KNOP is wholly focused on the shuttle tanker sector, with a current fleet of 16 vessels.

Contrary to what the unit pricing suggests, the company has been executing on all cylinders. Although their equity offering last fall was controversial, they utilized a raise at $21.90 to fund three dropdowns. This was a highly accretive move and yet equity now sits at $19.75. Silly.

KNOP reported a distribution coverage of 1.19x for Q4-17, but this was inclusive of an extended drydock and didn’t include meaningful contribution from the “Brasil Knutsen.” Q1-18 coverage will be higher, and the “Anna Knutsen” dropdown, concluded in March 2018, will ensure even stronger results in Q2-18. I expect forward coverage of 1.5-1.6x. KNOP is trading at a DCF yield of around 16%. I’m a very happy buyer.

Production is set to soar in KNOP’s two primary operating areas, as illustrated in their latest presentation.

Source: KNOP Q4-17 Presentation, Slide 10

The shuttle tanker industry is an effective duopoly between Knutsen and Teekay Offshore (NYSE:TOO). This is a highly selective field and assets are held to strict 20-year lifespans (15 years on the top fields). KNOP’s fleet is very young, with an average age of 4 years, whereas competitors have many older vessels. KNOP only has a single vessel, which is more than 7 years old, and they won’t need to focus on fleet renewal for a long stretch.

KNOP has close to 33.5M units outstanding, for a market capitalization of around $660M. They also have nearly $100M of privately-held convertible preferred units ($24/unit conversion).

Capital Product Partners: 10.4% Yield, Rising Payouts?

Capital Product Partners LP is a shipping holding company specializing in vessels with medium and long-term charter contracts, primarily in the product tanker and container sectors, but also with some limited exposure to Suezmax crude tankers. Unlike the majority of its peers, which trade nearly all of their vessels on volatile spot markets, CPLP has the majority of its vessels on medium to long-term time charters, which gives it much greater revenue visibility. This allows them to appeal to more income-focused investors versus direct rate speculators.

CPLP produced strong Q4-17 results, but they kept their distribution flat, which disappointed a few investors, who apparently didn’t think a 10% yield was strong enough. They added two dropdowns, paid for from cash on hand and the sale of a spot-trading vessel. Most importantly, their interest rate payments are scheduled to keep declining due to their conservative financing structure while their organic DCF will likely remain steady during 2018, bolstered by recent dropdowns.

Skeptics have focused on the challenging Suezmax tanker rolls, and they’re right to be concerned; however, they also have two containerships up for renewal with current rates of just $8,147/day.

Source: CPLP Annual Report (20-F, page 67)

The current rates, should you ask? $22,500/day, a 176% improvement! It’s possible they rolled the charters at lower rates, but even still, we’re looking at significant gains here. A roll to a decent $18k/day would add nearly 6 cents to annual DCF.

Source: Harper Petersen Container Index ("Harpex")

Unlike nearly every other MLP in the business, CPLP actually conservatively overstates their capital reserve, which means their reported unit coverage of 1.4x is actually even higher, I estimate closer to 1.8x.

Folks have bemoaned the ‘poor performance’ of CPLP, but they’re missing the forest for the trees as the underlying product markets have been very tough. Here’s a shot of how comps in this industry have performed since mid-2016, when we invested in CPLP. In the meantime, CPLP has provided nearly 15% in distributions, outperforming the strongest comp, Ardmore (NYSE:ASC), by 35%.

Chart Credit: Yahoo Finance

Despite this substantial outperformance, CPLP is a coiled spring, ready to explode upwards when product rates eventually recover. CPLP currently trades at $3.07 with approximately 130M common units outstanding, for a current market capitalization of just under $400M. CPLP also has nearly 13M convertible preferred shares (privately held), with a conversion at $9/sh and a 9.5% yield ($0.214/qtr). CPLP common units currently offer a quarterly distribution of $0.08, for a current yield of 10.4%. I estimate their normalized DCF yield around 18%.

Hoegh LNG Partners: 9.9% Yield, Parent in Transition

Hoegh LNG Partners LP (HMLP) is a limited partnership with Oslo-traded general partner Hoegh LNG Holdings Ltd. (OTC:HOLHF). Hoegh is an LNG floating storage and regasification ("FSRU") pure play, which focuses on assets with long-term contract backlog. HMLP has a viable growth pipeline through the purchase of drop-down assets from the parent company or by increasing ownership stakes in its current fleet.

HMLP controls a fleet of five FSRUs, but has total economic interests in 4.0 (2x are held via 50% economic stakes). General partner Hoegh Holdings owns 46% of HMLP and is aligned to eventually increase payouts due to their incentive distribution rights (“IDR”).

HMLP reported fairly routine results in February, but they are planning to raise payouts, potentially within a couple weeks:

Source: HMLP Q4-17 Earnings Release

Although HMLP’s core operations are fine, unlike KNOP and CPLP, which have fallen for seemingly no reason, Hoegh’s weakness is partially explained by the weak performance of their parent company, which has been unable to secure employment on three of its FSRU newbuilds and has seen its stock plummet over the past year. Shares currently sit around $5.47 (below chart is in Euros), compared to nearly $12.00 last year.

Source: Google Finance Quote

Despite this weak performance, the insider family has been heavily buying, and Tradewinds also reports an upgrade from Carnegie, a major Swedish investment bank.

Source: Tradewinds, "Hoegh News"

I believe the jitters on HMLP are partially justified, but I believe the majority of the risks are contained at the parent level, and it seems clear that the insider family is a major believer in the long-term story.

HMLP has 33.1M units outstanding for a current market capitalization of just under $580M. HMLP's current yield is 9.9%, but this could potentially increase within just a couple weeks.

Conclusion

This report provides updates on a trio of opportunities for income-focused investors. These bargains are available due to continuing selloffs in the higher-yield segments combined with a general misunderstanding of most of these firms. There’s risk in any investment, and we covered several key focus areas in our initial report, but the yields vastly outshine the challenges.

Finally, these are tax friendly opportunities due to the 1099 structure, and lack of significant international taxation. I am personally long all three of these names in our alternative income portfolio. I expect great returns over the coming years.

Analyst’s Disclosure: I am/we are long CPLP, KNOP, HMLP. 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.

Comments

[Triple F Fred]

J, as an old saying in the south..."beats a poke in the eye with a sharp stick"

[Biological]

JM -- there' some troubles in the LNG, particularly DLNG and GMLP. I sold GMLP at 19.25 early am on day of earnings announcement and bought back in at 16 some 36 hours later -- annoyed that I missed the intraday low was in the 14's! I do think we are OK for a few more quarters of divs at GMLP at present rates.

Have added to CPLP at 3.08 recently -- that looks safe. Have HMLP although I have been lightening up (on a rather large position); now at 3% of portfolio. I am bit worried about the parent, Egypt..., etc.

[J Mintzmyer]

As mentioned above, the Egypt risk is a parent-risk, where insiders have been heavily buying. FSRU got rushed and crowded and as Joeri mentioned there’s about 2 years of overhang. Good news is that I think folks aren’t moving into the sector anymore, so we should see a rebalance soon.

DLNG simply has unsustainable payout levels. GMLP also a lot of transitional issues. We warned about both of them quite clearly.

[Biological]

Agreed. I have GMLP at 16, recent, and still have GMLPP (I will trade GMLP and keep the latter). Otherwise, I own HMLP, KNOP, CPLP and NMM. I have CMRE-E, GLOP-B, TGP-B and TOO-B.

FSRUs, if under LT contracts -- great. But to place a FSRU is a much tougher proposition due to the negotiated market for them (i.e., tied to gas import projects that take months and months, if not years, to put in place). Do you know, JM, if the HMLP FSRU being released in Egypt (lovely country, BTW [I drove from Cairo to the Valley of the Kinds once]) can be used in LNG trade? That would be another back-up in case of parental issues, if any.

[J Mintzmyer]

Yes, they can use in LNG transport, but what a waste...

[Thewaltzy]

Any thoughts on HMLP here? I’m adding now. TW

[J Mintzmyer]

I still hold my full position. Haven't added recently and took it off the buying list a bit ago as it approached our $20 FV target.

[Thewaltzy]

Thanks jm. I actually thought the earnings were good; and they can afford to keep the dividend going (maybe slightly growing).
I don’t like the atm-but they might mainly issue preferreds. I am liking HMLP more...so thanks for the tip here!

[RoHughes59]

I actually thought the opposite, TW - earnings seemed so-so, and the disclosure that the Egypt entity had been approached regarding an early out on the FSRU contract was disappointing (especially when taken in the context of the "hedged" language discussing the parental guarantee).

I kind of view HMLP and KNOP similarly in that they both compete in niche areas, and unless KNOP's upcoming call contains some bad news, at this juncture operationally they look like a much better risk-return than HMLP.

[RoHughes59]

KNOP down a buck today - did I miss some news?

[Joeri van der Sman]

Ex-div is part of it.

[RoHughes59]

D'uh - didn't even think of that.

[RoHughes59]

2nd day in a row with some nice price action on KNOP - knock on wood ;^)

I don't follow the stock, but why is DLNG down today?

[Night Shadow]

dividend was cut

[RoHughes59]

Thanks - missed that, but that would certainly account for the drop.

[Triple F Fred]

Jay,

Thanks as always for a concise update on 3 quite solid holdings. I recently trimmed back to KNOP of the 3 mentioned and did hold all 3. I trade around CPLP frequently when the stars line up. I took a nice profit and deployed deeper into KNOP and another couple of holding.

I have liked CPLP for a long while and sure I will be back in the name as a couple of other holdingings run their course.

[Night Shadow]

why the trim back on KNOP?

[Triple F Fred]

No trim on Knop, I trimmed the other 2 as I liked Knop better for now.

[devlau20]

I'm 65. Best experiences in my life were meeting, listening to & working with smart, analytical young people who continue growing in stature, rather than getting "swelled heads" at 25. You're one of them Jim. Keep it up. You know you're good at this!

[gimmeecoffee]

I don't know how good at this he is, he told me to invest in the SS Minnow, said that Skipper and Gilligan really know their way around boat chartering. Haven't heard from them in years, thinking my money is just lost on some deserted island somewhere.

[Quarter Section]

Invest in ginger.

[J Mintzmyer]

Thanks for the vote of confidence. Hopefully we can check back in a year and be very pleased with these companies.

[DhunterChapy]

JM - Concerning CPLP and the tanker market in general - with the U.S. importing much less oil over the years, and with shale production growth showing no end to the decline of the future need for tankers hauling oil to North America, how does this bold well for the current and future demand of tankers ? Thanks!

[tyler.freeborn]

Actually, US imports will not change that much, assuming we don't all of a sudden stop driving. A lot of our imports come from Canada of course, not via ships, but there are bottlenecks getting that oil down here.

Additional US production is fueling the increase in exports, as we do not have sufficient facilities to process light shale oil. Remember, the US is the first or second largest oil importer in the world, depending on what China's doing at any given time. We use a lot more oil than we produce.

[J Mintzmyer]

CPLP is product so that’s a different trade, but on the crude side as you’ve mentioned, AG-US trade has been stagnant or even dropping for the past decade as US consumption is flat and domestic production is far higher. Globally, Asia is fueling the growth.

Two of the longest routes in the world are US Gulf and Eastern SA (I.e Brazil) to China/India. These are the fastest growing routes, US is trying to expand its export capacity.

[rusty13]

Yes like not pulling the sell button on TNK and picking up ETE instead.. Decisions like that will keep me in the poor house..

[rusty13]

I kept lowering my buy order on ETE where I got ZERO shares in 2016.. Huge mistake on my part..

[stockinvestor1956]

Sometimes the best buys are the hardest to pull the trigger on.

[Jan Blanckaert]

why was Knop down to 10$ in 2016. Is their a chance they can drop again to 10$ in 2018 .
Need to clearly understand the downsite exposure and not just the upside opportunity.

[Joeri van der Sman]

TGP cut the distribution, MLP's were under pressure and oil prices were in the 20's. KNOP had stable cash flows on long term contracts, but the market just flushed everything through the garbage bin, no matter the fundamentals. GMLP/DLNG/NAP have similar graphs.

[RoHughes59]

Yeah, as Joeri says, for a brief period anything energy-related and MLP-related was systematically jettisoned from a lot of portfolios. ETE briefly traded under $5, so KNOP was certainly not alone in diving at that point in time.

To illustrate how bad that early February 2016 market was, I just went back and took a look at a couple trades I made. In mid-January, I bought shares of ETE for $10.42. On February 8th, which was right at the height of the hysteria, I purchased shares at $4.84, and later in the day at $4.30, so the stock was down over 10% intraday!

Now, in retrospect, I should have literally backed up the truck, because ETE is now $14.80, so it has become one of those triple-baggers that we all live for.

[J Mintzmyer]

Significant market sentiment collapse. GMLP traded into the $7s on one day. Returned 3x in a year. Others have mentioned ETE as a great example...

[jzwmnb01]

Thanks for the report.

Wake me up if CPLP ever increases the distribution. Too many articles and too much hype over these guys on SA over the last couple of years. Yes, 10% is nice but a share price over $4 would be much nicer.

[J Mintzmyer]

Product tanker markets need to recover... They’ve been in a weak market for over 2 years and CPLP’s fleet has lost nearly $300M in value.

[o8v8]

CPLP’s fleet has lost nearly $300M in value compared to when? 2015 peak?

[J Mintzmyer]

Summer 2016, when we first became super bullish on the name.

[KenVa]

JM,
How can you possibly write about CPLP and not even mention the fact that its founder and chairman, Evangelos Marinakis, has been criminally charged with drug trafficking and financing a criminal enterprise? Regardless of the merits of the charges, that is certainly a relevant fact anyone recommending the stock, as you are, should be including for his reader. As closely as you follow this company, I have to believe you were aware of the criminal charges. Your failure to include that info demonstrates a patent lack of objectivity on your part IMO.

Your description is of CPLP as a "coiled spring ready to explode upwards" is just silly and further impairs your credibility. I own these shares as well but I prefer to be objective about the merits of this holding when discussing it.

[J Mintzmyer]

Hi Ken, thanks for bringing up those issues. As you know, I’ve followed CPLP for quite some time and written several reports. Marinakis has been dealing with legal problems for years and he stepped away from day-to-day management of CPLP a few years ago. I covered this ‘risk’ factor significantly in some of my earlier reports. At this point, I don’t view the newsflow there as material to CPLP’s operations. They are a commodity tanker leasing firm. What happens to Marinakis is nowhere comparable to say Apple without Cook or Facebook without Zuck.

—

If product markets improve- note we’ve been in a terrible market for like 9 straight quarters- CPLP is going to shoot upwards.

I’ve written numerous reports explaining how their free cash flow is actually higher than their DCF due to their ultra conservative debt financing. This is one of the only MLP where this is the case. Usually DCF is a bit bloated...

Fine to disagree with me, but I stand 100% by my ‘coiled spring’ comments.

[Pablomike]

It is clear from many articles about CPLP that people still connect Evangelos to the company. Right or wrong it's about the perception and if there is a sensational headline, CPLP will suffer.

PS It would probably create a great buying opportunity.

[Ezedub58]

Jay I realize that you are not a psychic but just wondering what kind of time frame you would expect CPLP to buy back shares.

[NickDoun1711]

I believe that KNOP is by far the best option here. My only concern about KNOP is the lack of further dropdown candidates and hence future growth.

J, I recognize that CPLP is clearly undervalued but I believe is the same story with NMM. We tend to be carried away by financial metrics, forgetting whose interests those management teams serve.

Best of luck

[MicroValue]

Hi J.,

I concur with NickDoun1711. I know that you are great at trading tankers, but aren't some of these stocks like CPLP value traps? The company, like most of the shipping industry, has been notoriously horrible at allocating capital.

Regardless of what market conditions are they always seem to be issuing shares and acquiring more ships. Is there any shipper that is not always optimistic about tanker rates and will actually a do share buyback when appropriate?

This is not a rhetorical question -- I really am wondering that, as I don't track the sector like you do.

It seemed like DHT was open to share repurchases, but with their heavy spot rate exposure they seemed to be taking on too much rate risk.

Thanks!
MV

[J Mintzmyer]

MV & Nick,

Good questions and observations. DHT has a good management team, but they can’t do much with their high leverage and weak spot market rates.

Regarding CPLP, it’s important to realize their ATM actually had a very minimal impact on valuations, it was 90% damage on perception. It also seems they haven’t used it since like October, but I’ll have to see Q1-18 results to clarify.

[galicianova]

can anyone refresh my memory whether cplp is cursed by K-1?

[pro8]

You need to read the article

In addition, all of these firms are registered as corporations and offer 1099 forms as opposed to the more complex K-1 for pass-through income. This means these firms can be held in 401K and IRA accounts without hassle, or US investors can hold in taxable accounts and take advantage of the lower ‘qualified dividend’ tax rates.

[Pablomike]

Beating a dead horse now. Article and comments have fleshed out the 1099 status repeatedly.

[Norman Bates at Disneyland]

JM,

In your very first comment you say 'most bullish by far on CPLP'. I note what you say in your article about the entity, but am kind-of surprised you are most bullish on CPLP given problems in the shipping sector in general. KNOP and HMLP, which I both own, are at least niche companies. Happy to own all three....

[J Mintzmyer]

I like all three. I am the most bullish on CPLP because they trade at nearly a 20% free cash yield since their DCF is calculated in a redeculously conservative manner, at the same time that the product markets have been weak.

KNOP and HMLP are great companies, but they’re mostly income plays. Wildest expectations would be for both to be mid/upper $20s in a few years.

$CPLP could conceivably be $6,$7+

[Norman Bates at Disneyland]

OK. Many thanks. Will look to add CPLP as I cut down some other shipping shares. Have all of SSW, GLNG, TK and TOO (in addition to KNOP and HMLP), so not exactly light in the sector ATM.

[stockinvestor1956]

JM, If I'm correct your cost basis was around 2.50 on CPLP and you would not sell any stock until it reach a minimum of $5. Is that correct?
Very informative articles. All best SI1956

[BrutalHonesty]

Any thoughts on investing in HMLP's parent?

[J Mintzmyer]

High potential reward, much more risk. Not really comfortable here.

[sts66]

HMLP's parent is an odd bird - Bloomberg says it's privately held, but it apparently trades on the Oslo exchange as Hoegh LNG Holdings Ltd (HLNGH.OL). It also appears to be a diverse company that manages the Hoegh family assets:

http://bit.ly/2v50Vbl

Lo and behold, and to my surprise, it actually pays a dividend as well, although owning it in the US would be so expensive from foreign trading fees it would probably not be cost effective:

http://bit.ly/2HbUic5

"Hamilton, Bermuda, 28 February 2018 - Höegh LNG Holdings Ltd. ("Höegh LNG") today reports its financial results for the quarter and year ended 31 December 2017

Highlights:

EBITDA of USD 43.0 million
Profit after tax of USD 20.0 million
Dividend of USD 0.125 per share paid in the fourth quarter
Closing of the sale of the remaining 49% interest in Höegh Grace to Höegh LNG Partners

Subsequent events

Dividend of USD 0.025 per share declared in the first quarter of 2018
Höegh LNG Partners starts "at-the-market" (ATM) equity raising programme
Höegh Giant commences three-year time charter with Gas Natural Fenosa

The President and CEO of Höegh LNG Sveinung J.S. Støhle comments:
"We are pleased to report record EBITDA and net profit for the fourth quarter of 2017, confirming the outstanding operational performance of our assets. So far in 2018 we have delivered Höegh Giant on a hybrid LNGC/FSRU contract with Gas Natural Fenosa, which should have a positive effect on our financial performance from the next quarter. Meanwhile, our business development activity remains focused on securing long term contracts for our FSRUs under construction, and here we are in advanced stages in several tenders with near term decision points.

However, while we continue to make progress towards additional FSRU contracts, due to the project delays seen in 2017, the board of directors has decided it prudent to reduce the dividend payments in order to optimise our equity capital towards sustainable long-term value creation. We continue to see value in the provision of dividends to our shareholders, and the dividend amount is subject to re-evaluation as we firm up new contracts through the number of tender processes currently underway""

[D-inv]

Thanks for the article including info on the companies tax filing status. Without mention of corporate filing status I likely would have moved on to other articles without bothering to finish reading your clear, well written piece.

The distribution yields on each are attractive, but trading volumes are limited (which in part goes with their small capitalizations). Will delve deeper into each.

[Nathan5]

IMO KNOP is the best of the 3. The other ones are basically for the sake of portfolio diversification. CPLP management has their own agenda for CPLP- to get all those ships off of C-mar's books by dropping them down to their captured child, CPLP, in the name of "growth at the bottom of the cycle" ( almost cynical ). HMLP needs a longer history of success before I'ld look at them. KNOP, as the article correctly states, is firing on all cylinders. Their huge dcf excess currently is being used to reduce leverage - nothing wrong with that. At some point I think it's safe to assume they'll increase the divi. A solid company to hold long term.
Long - KNOP

[J Mintzmyer]

Thanks- of course I’d add some more color around the edges and I have a more positive view of CPLP, but I broadly agree with your post. The shuttle markets look strong and they are kept in check by the strict regulation on 15-20 year lives.

[Pablomike]

I agree KNOP is the best here. HMLP is having trouble with FSRU contracting and as you say they are "at the bottom of the bucket".
CPLPs biggest problem may the simple fact that they sell for less than $5; a Holy Grail number for too many investors.

[Greg_Maryland]

Nice article.
I'm long all three.

[J Mintzmyer]

Thanks Greg, best of luck to us!