In recent years, Liquefied Natural Gas ("LNG") has become a more prominent player in the global energy economy. Where previously there was a geographical barrier between the gas demand centers, found in Europe and Asia Pacific, and the large gas fields, typically found in parts of Russia, Qatar, Australia, and, more recently, the United States, there is now a link formed via LNG. The process consists of a high-powered “liquefaction” stage to chill the gas to cryogenic temperatures for the purpose of shipping the liquid volumes on a carrier to a coastal receiving terminal. Upon reaching its maritime destination, the liquid gas then goes through a regasification process which returns the liquid to its original state at which point the volumes are injected into a local pipeline for further network distribution to the final point of demand - typically industrial facilities or large-scale power generation stations.
Source: HMLP 2018 Annual Report
Most regasification terminals are established on permanent onshore structures in regions that expect to have a baseload of LNG demand for decades to come. These terminals are customarily owned by the local utility or national oil & gas company. Other terminals consist of a floating storage and regasification unit (FSRU), whereby most of the infrastructure is embedded within the offshore FSRU, which allows for a more expedient construction cycle and greater flexibility in repositioning the terminal according to prevailing market conditions. In many cases, the floating receiving terminal is a lower cost solution for newly established importers. FSRUs are also chartered as leases rather than purchased with capital investment and thus present a sound solution for credit-limited project developers. This method of regasification is more prominent in areas of developing economies where the political risk of a permanent asset is viewed to be too high, regions that are geographically unable to route a main pipeline, or locations that exhibit a seasonal demand profile and therefore do not require the complete baseload infrastructure.
As a result, floating regasification terminals are becoming the technology of choice for newly-established import facilities - a trend which is likely to continue as the trade of LNG increases in flexibility and commoditization.
The FSRU market consists of four major players - Golar LNG (GLNG)(GMLP), Excelerate (privately held), Exmar NV [Brussels: EXM] and Hoegh LNG (NYSE:HMLP)(HLNG). In total, there are 24 FSRUs in operation worldwide, while an additional 6 units are being constructed and some 33 units are in various stages of development. The average construction time for an FSRU newbuild is 24-30 months.
Source: HMLP Q2 2019 Investor Presentation
Golar is a diversified operator which, in addition to FSRUs, owns assets of carriers and floating LNG ("FLNG") production ships. Golar’s FSRUs are primarily built from overhauls of retired ships and are therefore smaller in size, tend to cost less to acquire, and trade in a short-term market. Hoegh, Exmar, and Excelerate focus on newbuild FSRUs of large-scale proportion, which are typically term chartered for up to 15 years.
FSRU vessels are in fact able to operate as traditional LNG carriers and are often employed in such a manner by their owners in order to bridge idle periods between long-term FSRU service contracts.
A typical newbuild FSRU price tag runs $290-300 million, compared to an LNG carrier newbuild of around $190 million. The additional $100 million of cost goes into the regasification and sendout equipment as well as the permanent mooring structure which is used to dock the vessel offshore. Therefore, owners of FSRUs require a higher contract rate in order to cover the cost of capital. However, manning and operational costs are essentially the same between the two types of vessels, so a short-term operation of an FSRU as an LNG carrier, while not ideal, can be a palatable short-term solution.
As with LNG carrier owners, FSRU owners do not take commodity price risk and typically earn a fixed rate regardless of sendout volumes and unit utilization.
Hoegh LNG Partners (HMLP) is the LP daughter company of Oslo-listed Hoegh LNG. HMLP holds three wholly-owned FSRU vessels and owns a 50% interest in a JV which holds two FSRU vessels. In all, HMLP lays claim to five distinct vessels, or the equivalent of four wholly-owned net vessels.
Source: HMLP Q2 2019 Investor Presentation
The most recent dropdown of the Hoegh Grace was transacted at an overall price of $360 million, which occurred over two instances of 50% ownership transfers. Our estimate of the Grace’s annual EBITDA is $40 million, assuming market-level charter rate at a typical gross margin of 80%. This would place the acquisition multiple of the Grace at 9x EBITDA.
As of the end of Q2 2019, HMLP’s balance sheet consists of $493.6 million of common and preferred equity capital, $458.3 million of long-term debt at the LP level with an additional estimated $200 million at the JV level, $64 million of current liabilities, and estimated JV level equity of $100 million to yield $1.32 billion in consolidated assets. To gain an in-depth view of overall indebtedness, we’ve adjusted the figures to include the proportionate share of the JV-level capital structure, which is not consolidated in HMLP’s financial statements. Inclusive of JV adjustments, HMLP’s D/A ratio is only 55% with net debt to EBITDA ratio of 4.7x - one of the lowest debt ratios in the LNG shipping/regasification sector, where D/A of 60-65% and ND/EBITDA of 5.5-6.5x are commonplace. Unadjusted GAAP balance sheet figures demonstrate even lower leverage.
Current assets total $51 million which result in a negative working capital position of $13 million. HMLP has a cash balance of $27 million and undrawn revolving credit facilities of $91 million. The company’s consolidated annual debt amortization is $53 million.
HMLP has proactively managed maturing debt facilities, most notably on the refinanced Gallant/Grace facility in January 2019 which would have had a bullet due in November 2019. As a result, there are not any major scheduled maturities until April and October 2022, respectively. The upcoming debt maturity totals $330 million for the 2 JV vessels (Neptune & Cape Ann), of which HMLP’s share is 50%, or $165 million. Both vessels are chartered to French oil & gas major Total until 2029/2030, are moored in Turkey and India, respectively, and have options for further extension. As a result, there is no reason to expect any significant roadblocks to refinancing, and, in reality, it is possible the principal amount could be increased.
Following the $305 million Gallant/Grace refinance, HMLP established a new “$385 million debt facility”, which consists of commercial and export credit ("EC") tranches. The commercial tranche accrues interest at a margin of 230 bps (2.3%) over LIBOR and has a bullet due in 2026 in the amount of $136 million. The EC tranche has a fixed interest rate of 3.9%. The terms of both tranches are materially improved over the Gallant/Grace facility which had a commercial margin of 270 bps and EC rate of 4.1%. The new facility includes a revolving debt portion totaling $63 million.
Source: HMLP 2018 20-F
The final debt facility on HMLP’s balance sheet is the PGN FSRU Lampung facility and is approaching maturity in September 2020 with a minimal bullet payment of $16.5 million. The facility maintains a commercial LIBOR margin of 340 bps with an EC margin of 230 bps. As this debt is replaced, a lower margin on LIBOR is likely.
Approximately 80% of the company’s debt is hedged against USD LIBOR inflation.
The Preferred equity consists of an 8.75% Series A issue with $150 million capitalization and is callable from October 2022. These issues currently trade for well above par at circa $27/share. With the company’s average interest rate margin and LIBOR falling in 2019, it is possible that management seeks to replace it with either a lower-yielding Preferred or additional term debt, either of which would reduce the cost of capital and increase DCF.
With the Gallant coming off prime contract from April 2020 and receiving 90% charter reimbursement from parent thereafter until July 2025, cash flows will see a corresponding reduction from present levels. A future dropdown must be strategized accordingly in order to shore up DCF and, therefore, distribution coverage. Nevertheless, HMLP’s current coverage of distribution has ample margin as evidenced by the trailing twelve months coverage ratio of 1.15, illustrating that a dropdown is not necessary to maintain the current level of distribution. Coverage in 2020 is expected to exceed 1.20 as none of the ships are scheduled to undergo a drydock.
HMLP is cash flow positive, with an average vessel dayrate of $117,000, compared against total cost of operation and capital, inclusive of operating costs, debt service, and common/preferred distributions, of only $97,000/day. Annual operating cash flow will eclipse $90 million by 2021, with little in the way of ongoing maintenance capex required.
HMLP’s fleet maintains an average contract duration of more than eight years, which is superior to that of GMLP’s FSRU fleet which achieves a duration of only five years. Furthermore, HMLP’s average FSRU asset age is five years compared to seven for GMLP and eleven each for Exmar and Excelerate’s aged fleets.
The FSRU Hoegh Gallant was originally chartered to serve an Egyptian regasification terminal. With Egypt’s upstream gas development burgeoning once again, this contract was terminated by the charterer ahead of its scheduled April 2020 maturity date, as the country resumes LNG exports. As part of the original dropdown agreement, HMLP was assured at least 90% of the original charter rate by the GP until July 2025. In the meantime, this vessel serves as an LNG carrier in spot duty, however the previous agreement allows for full reimbursement as per the original provision. HMLP management is actively marketing the FSRU capability for new projects, in order to fully monetize the value of the onboard regasification equipment.
The HMLP distribution has been consistently rising since the IPO in late 2014. In fact, the company is one of the few LNG midstream owners to have avoided a dramatic cut to the distribution level during the recent industry downturn. The distribution has grown at an average annual rate of 3% over the past two years.
Source: HMLP Q2 2019 Earnings Presentation
Turning now to DCF, Q2 2019 saw a dip due to the scheduled drydocks of Gallant and Lampung. Otherwise, the company has demonstrated a near flawless track record since IPO in maintaining a positive distribution coverage ratio.
HMLP’s coverage of distribution has ample margin as evidenced the trailing twelve months coverage ratio of 1.15, illustrating that a dropdown is not necessary to maintain the current level of distribution. Coverage in 2020 is expected to exceed 1.20 as none of the ships are scheduled to undergo a drydock, even as Gallant begins its charter rate reduction.
Q3 and Q4 quarterly DCF should resume the previous uptick of circa $17-18 million.
Source: HMLP Q2 2019 Earnings Presentation
An equally important metric of payout sustainability is the TTM operating cash flow relative to financing cash flows. At end of Q2, the company had TTM OCF of $86 million, which comfortably covered the primary financing cash flows, common and preferred distributions, of $72 million - inferring annual free cash flow available to shareholders of $14 million.
HMLP’s quarterly interest expense, inclusive of the JV, totals $10.2 million, while preferred distributions total $3.4 million. Quarterly run-rate adjusted EBITDA of $36.5 million covers interest plus preferred distributions at a multiple of 2.7 times. We adjust EBITDA to exclude non-cash derivative gains and losses (i.e. interest rate hedging) as these are only mark to market securities and not related to the company’s ongoing operations. Debt service coverage levels are healthy and should actually improve following the lower interest rates on the new debt facilities.
At the current quarterly distribution per share of $0.44, the annual IDR payout to the GP is $1.42 million (refer to figure below on IDR calculation). The distribution has an expansion capacity of 15% before reaching the highest IDR tier of $0.50625/share. At this level, the annual yield would rise to 13% given the current share price. The annual IDR payout to GP would amount to only $4 million at the current IDR schedule and would be easily covered by free cash flow.
Here is a brief rundown of the IDR math:
The LP unitholders are entitled to the Incremental Distribution in a proportion which begins at 98% from the minimum quarterly distribution (MQD) and drops to 50% at the highest tier. So, when Tier One is completely filled, the Incremental Distribution of $0.0338/shr gets multiplied by the 32.6M LP units to yield $1.10 million in quarterly distribution to the LP unitholders in that tier. Thereafter, the total Distribution payable is in effect back-calculated by taking the LP distribution and dividing by the LP percentage split—85% in the case of Tier One. Dividing by 0.85 results in a larger overall Distribution payable and then the difference between the two, $0.19 million, becomes the Distribution payable to the GP as an IDR. The highest tier, Tier Three, results in no incremental distribution and therefore no IDR payable to the GP since the $0.50625 threshold is not surpassed. In the end, all of the tiered LP distributions sum to match the quarterly $/shr distribution rate and the tiered GP distributions get added on top. It is a common misconception that the declared distribution amount is somehow divided between LP and GP - this is not the case - the LP unitholders receive the full declared quarterly distribution, and the GP receives a small amount on top via the IDR.
Source: HMLP 2018 20-F
Calculations of IDR payouts to GP – Hypothetical quarterly distribution of $0.50/shr (up to highest tier)
The next dropdown is likely to be the GP-owned 2019-built Hoegh Galleon (170k cbm volume, 750 mmscfd sendout) which will service the Port Kembla Australia project under a 10-year charter from January 2021, pending final investment decision from the project owner. Until such time, the vessel is chartered as a carrier to Cheniere. According to the HLNG 2018 Annual Report, the Galleon would bring $30 million in annual EBITDA operating as an FSRU - somewhat below market rate for such a vessel, but attractive nonetheless due to the longevity of the charter and lack of political risk.
Additionally, the vessel Hoegh Esperanza is slated to begin a 10-year term for AGL in Australia from the first half of 2022 and could serve as an additional dropdown.
With the 50% GP IDR tier approaching, it would be likely that HMLP management would buy down the highest tier percentage split, perhaps to a 75/25 level, as part of the dropdown deal. Our estimates show that this buydown could occur for a price of roughly $12 million in cash or stock.
In a pro forma scenario for the complete 100% dropdown, HMLP’s D/A would remain flat and ND/EBITDA would slightly rise to 4.9x. This is possible due to the $53 million in annual debt amortization, which serves to deleverage the balance sheet, as well as the fixed rate charter contracts sustaining revenue.
Increasing net vessels from four to five would increase DCF by 20% and take quarterly distribution up to the 50% IDR tier of $0.50625/shr, resulting in a current yield of 13% at the present share price.
As previously mentioned, Grace was acquired for $360M, in two halves during 2017. HMLP would likely take a similar two-fold approach to the next drop-down. Given the lower EBITDA for Galleon, a likewise EBITDA multiple would result in total cost of $270 million ($30m x 9). Therefore, the initial 50% capital outlay would be $135 million. Assuming a typical project financing leverage of 70%, only $40.5 million of HMLP capital would be required to close. This funding could easily be met with the $27M of cash on hand and tapping undrawn portions of the two revolving credit facilities which enumerate $91M.
Alternatively, the company may decide to issue additional preferred stock units in order to avoid further balance sheet leveraging. The remaining 50% purchase of the vessel could then be consummated within the following 12-18 months by use of any combination of these sources plus additional free cash flow.
For the 2 JV vessels Neptune and Cape Ann, both dry-docks are scheduled for 1H 2022. As a 50% owned JV, these vessels essentially aggregate to one wholly-owned vessel.
For the 3 wholly-owned vessels, Lampung is scheduled for 2H 2022 and Grace for 1H 2021. It is assumed that Gallant has undergone any needed maintenance during its recent drydock from the Egypt project in which all engines saw overhauls and will not become due for scheduled offhire for at least three more years.
Each scheduled drydock and associated idle time typically reduces revenue by approximately $3 million. EBITDA is only minimally affected as drydock expenses are capitalized and amortized on a 5-year profile, leading to a slight increase in run-rate depreciation expense.
There are three methods in which to value a firm such as HMLP which produces consistent EBITDA and pays steady distributions - An Enterprise Value to EBITDA multiple based on industry averages, a dividend discount model ("DDM") which sums the present value of all future dividends given an assumption on cost of equity capital and annual dividend/distribution growth and a multiple on DCF. EV/EBITDA is a more appropriate metric than other traditional stock valuation methods, such as P/E ratio based on GAAP net income, since HMLP, and LNG shipping MLPs in general, are cash flow generation businesses. Therefore, GAAP net income measures provide only limited insight.
All valuation methods point to a $25/share price target. In our base case, we used conservative valuation figures - EV/EBITDA multiple of 10x, based on long-term industry average and applied to forecasted 2023 EBITDA, cost of equity of 9.5% (which inverts to DCF multiple of 10.5x), and dividend growth in perpetuity of 1.5% - each of which are readily justified by historical performance relative to future prospects.
We forecast 2023 consolidated EBITDA to reach $195 million, up from 2019 expected EBITDA of $145 million, and vessel NAV to reach $1.47 billion from $1.18 billion. For the NAV calculation, we are taking a blended average of the estimated 30-yr amortized newbuild cost and NPV of unlevered cash flows based on our 2019 estimates and discounted at 10%.
Source: Author’s projections, HMLP and HLNG Company filings
Source: Author’s calculations
As a company which holds interests in only five operating assets, HMLP is a highly-concentrated investment vehicle which comes with associated risk factors. A disruption in one of the operating projects would detrimentally affect HMLP’s financial performance and ability to maintain the current level of distribution. HMLP’s vessels operate predominantly in the offshore waters of developing nations, which carries a heightened level of political risk, though concerns about counterparty risk are largely alleviated by the facts that the two JV charters are with investment-grade oil major Total, the Indonesia charter client has government backing, and another charter is held with the parent company. Seemingly, the only counterparty of any tangible concern is the Colombia terminal with operator SPEC, a majority subsidiary of Promigas, Colombia’s largest gas distributor.
As alluded to previously, the market for newbuild FSRUs is essentially limited to three major players, HMLP, Exmar, and Excelerate, with HMLP holding the most modern fleet. Such position in this market yields HMLP a strong competitive edge against new market entrants and shields the company from price and margin erosion. Shareholders therefore have access to the long-term growth prospects and quarterly cash flow.
A risk to the 2020 dropdown thesis is that the GP may not have incentive to unload the vessel, given that three of its others, Hoegh Giant, Hoegh Esperanza, and Hoegh Gannett, as well as the aforementioned Gallant, are yet to secure long-term FSRU charters. In this respect, the FSRU market remains a bit “soft”.
Source: HMLP Q2 2019 Earnings Presentation
Nevertheless, the surge in LNG supply hitting the market in the early 2020s, particularly from U.S. gulf coast projects, could firm demand for FSRUs. International Maritime Associates ("IMA") estimates that there are currently 21 FSRU projects - nearly matching today’s global capacity of floating regasification - in development which are probable to move forward. For example, German utility Uniper is in advanced stages in developing an FSRU project as a supplement to the Nord Stream pipeline. Given that the FSRU orderbook consists of only 6 vessels and there are approximately 6 more in layup or in LNG shipping duty, this points to a possible demand for an additional 8-10 FSRU newbuilds. An effect of the LNG supply surge, seasonally lower global LNG benchmark prices, should incentivize new FSRU demand. Nevertheless, the GP must have a strategic rationale to redeploy the dropdown cash flow in order to facilitate a deal.
Many new FSRU vessels hitting the market in a short time frame may result in increased price competition. This is particularly the case for older vessels with smaller storage volumes, which is the majority of the fleets for Golar, Exmar, and Excelerate. Newbuild vessels with larger volumes, such as the aforementioned units held by HMLP should remain shielded from intense price competition to a large extent. Currently, the other two major market players, Exmar and Excelerate, combined have only one newbuild under construction, so they would be obligated to bid on new projects with older and lower specification vessels, or offer to initiate an expensive construction cycle which would not deliver a vessel until 2023 at the earliest.
To secure employment for the Gallant and finance dropdowns for two additional vessels through 2023 is a tall order in the purview of recent industry history, but one that is attainable, given the future prospects of floating regasification worldwide.
Global LNG price indexes – since 2010
Source: Shell 2019 LNG Outlook
The average analyst rating is a “Buy” with a price target of $18.75. In August, three analysts issued revised opinions and price targets:
Analyst Opinion Target
Barclays Equal Weight $ 18
Citigroup Buy $ 16
B. Riley Buy $ 21
In general, analysts hold a similarly positive opinion of this stock issue. However, we believe that there is much more room to grow due to the improved credit profile, broad FSRU demand prospects, and the company’s balance sheet capacity to fund at least one additional vessel in the new few years.
The realization that our price target is 33% higher than the analyst average piques the question - Why are analysts and other investors not considering these apparently favorable factors?
We think it is primarily two reasons - a halo effect of the lagging energy sector and a lack of foresight on future prospects.
Although HMLP’s business model does not take commodity price risk, the share price movement seems to indicate that the market has labeled it as an “energy” stock - a group which is struggling amid a sustained decline in oil & gas prices.
Even when looking solely at the LNG midstream segment, an area where the market has historically rewarded steady distributions and heavily punished distribution cuts, HMLP seems to have not received due credit for having maintained and grown the distribution since IPO in late 2014. The present yield stands at a historical high of nearly 11% - a full 300 bps above the current yield of the Preferred issue.
The improved credit position has evolved in a quiet and inconspicuous manner. This evolution has not been featured on quarterly conference calls or in investment reports. These details are obscured in SEC filings and are not regularly reported by analysts.
With HMLP’s most recent dropdown initiation now being three full years in the past, analysts are perhaps extrapolating a long-term trend and therefore forecasting only one further dropdown in the 2020-2023 period. However, a continuation of the previous tempo does not make sense when considering the macro LNG market shifts.
Since January 2017, there has been 50 mtpa, or 18%, of supply added to the global market, and the number of importing countries has jumped from 35 to 40. The market has cemented a new LNG export powerhouse, the United States, to the fold. Also, the LNG price indexes for the high demand regions of East Asia and Europe are roughly in line from 2017 and even demonstrably lower in recent months in the case of the European NBP index. Furthermore, the financial backing of FSRU project sponsors is improving - the FSRU concept is no longer confined to just higher-risk developing countries seeking lower cost solutions. Major economies, including aforementioned Australia and Germany, have many developments planned and moving toward finalization. In summary, a combination of higher supply and lower pricing is a recipe for more floating regasification development. And a primary benefactor of such development is Hoegh LNG Partners.
We are bullish HMLP and have set a price target of $25/share. We see distributions per share continuing an upward trend until reaching an annual yield of 13% at the current share price.
Look for an FSRU dropdown in 2020 which contributes to further EBITDA growth and underpins further increase in the common distribution.
We believe that this season of share price decline from highs of $20 to $16s presents an opportunity for investors to participate in the upcoming demand surge for FSRU vessels in light of sustained lower global LNG pricing.
On a final housekeeping note, HMLP is organized as a C-Corp and therefore issues a 1099 (not a K-1) during tax season.
Article authored by: Eric Robken
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Disclosure: I am/we are long 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.
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