Teekay LNG Partners: The Cash Flow Era Begins
Summary
- TGP has just completed one of the largest LNG Carrier newbuild programs on record, without diluting equity and even managing to maintain a sizeable quarterly distribution.
- We believe that TGP’s high-quality portfolio of vessels, combined with long-term charter contracts, will produce an attractive return to investors, once the full profitability of the newbuild fleet becomes evident.
- Valuation models underpin our $22/share price target, implying an upside of 100%, plus another 20-30% in distributions expected before the 2023 timeframe.
Introduction
LNG shipping company Teekay LNG Partners (TGP) is the MLP daughter of Parent Company Teekay Inc (TK), but unlike most other MLP’s in the LNG shipping space, TGP essentially behaves as a stand-alone entity, funding its own newbuilds without the use of the typical Parent Dropdown mechanism. TGP boasts an LNG carrier fleet of 49 total carriers, 24 of which are minority-owned Joint Ventures. TGP has a strong and diverse list of major LNG player counterparties, the likes of which include Shell, Ras Laffan, Cheniere, and Yamal LNG, and maintains a presence in every major region around the globe. It recently executed a large newbuild program which coincided with the latest wave of new LNG export facilities worldwide.
Newbuilds Growing Free Cash Flow
TGP concluded a newbuild program at the end of 2019 which saw 15 new MEGI-type vessels financed, built, delivered, and deployed onto long-term charter. These newbuilds will add $280 million in EBITDA annually. In addition, it has gained a minority stake in a Regas terminal in Bahrain which will produce dependable cashflow.
Similarly, distributable cash flow (DCF) will have experienced a sharp increase from 2018 levels through 2020, stabilizing around $2.50/share.
During 2021 and 2022, free cash flow (FCF) will see a dramatic increase as the newbuild Capex program rolls off the books and the newbuild, as well as legacy, assets produce consistent cashflow.
Management has stated the intention to use a majority of the additional FCF to reduce debt—a wise move in our view as lower leverage should lead to more financial stability during economic uncertainty due to COVID-19. Down the road, we expect capital allocation to markedly shift toward distributions until reaching an annualized level of $2/share by end of 2023. At today’s share price, this would equate to an attractive distribution yield of 18%.
One of Ashland’s key measures on LNG midstream companies is our metric “Cyclically-Adjusted Free Cash Flow” (CAFCF). It is a measure which normalizes the large bumps in FCF for a capital-intensive industry, such as LNG shipping, due to Capex programs. The CAFCF metric is similar to conventional FCF, except that it replaces actual Capex with Depreciation. We believe Depreciation is a better proxy for the replacement cost required to maintain modern assets. We also believe that it is a superior measure of investor returns than GAAP net income or EBITDA—essentially, it represents the investor’s cash return on investment through the market cycle.
TGP’s CAFCF yield—the investor’s annual return—currently registers a remarkable 27%. This level of yield is well in excess of the general stock market and even the MLP space where distribution yields are often observed in the mid-teens.
Corporate Structure
With TGP registered as a Marshall Islands LP, the entity is on the hook for just a minimal amount of tax—in 2019, TGP owed less than 2% of revenue in taxes. With few exceptions, most international cargo charters are not subject to local taxation. Even without a Form K-1, having elected to be taxed as a C-Corp, TGP has proven to be a relatively tax-efficient and accessible vehicle for shareholders.
Even though TK holds a controlling 42% stake (post IDR swap), TGP essentially operates as a stand-alone operating entity, which serves to provide more financial visibility, whereas other companies may be reliant upon a strong Parent Co. for growth projects.
With a vast market diversification of its fleet, including: Arc7 spec vessels for Russian Arctic circle routes, modern MEGI engine newbuilds, East Asia JV’s, and US Gulf Coast charters, management clearly strives for this business to be multi-dimensional. TGP is a prominent player in all major LNG trading hubs. This type of asset and market allocation could serve well should there be any geopolitical or economic disruptions arise in the near future.
IDR Schedule
Prior to May 2020, TGP had an IDR agreement with TK, which, although out of the money at current distributions, was expected to be well in-the-money considering the full DCF inclusive of the newbuilds. The IDR agreement was settled with the issuance of 10.75M shares to TK at $11.5/share in May 2020. The valuation represented a payout of $124 million, which by all appearances is a fair deal given TGP’s expected IDR expense of $14 million at a DCF of $200 million in 2023—implying a buyout multiple under 9x.
Although the IDR buyout diluted shares by 14%, we view the transaction as a positive event for TGP shareholders, as future distributions will come without the overhang of a large IDR payment. Additionally, such a simplified arrangement will better help analysts and investors to evaluate the business. Furthermore, by issuing shares, TGP managed to preserve liquidity, which will help with upcoming debt refinancing in 2021 during a period where some LNG midstream companies have had difficulty executing refinancings.
Capitalization
In addition to common stock, TGP has 9.0% Series A Preferreds, which currently trade at Par Value of $25, and 8.5% Series B units.
TGP has bought back $40M common stock since 2018 at an average price of $14/share and has a maintained a re-purchase program which has $60 million remaining. Management has declared the first capital allocation priority to be debt reduction, with a secondary priority being return of capital to shareholders via buybacks and distributions.
Having a look at the balance sheet, TGP has debt to assets of 66% and Net Debt/EBITDA of 6.6x, which we expect to be paid down to 50% and 5.4x, respectively, by end of 2023, as FCF is directed towards debt reduction.
TGP utilizes a mix of asset-backed term debt and sale-leaseback financing (SLB). It’s weighted-average interest rate of debt is 4.8%, which is a competitive rate. Nearly all of TGP’s floating interest-bearing debt is swapped to a fixed rate.
It has $125 million of net debt maturing in mid-2021 through its LPG JV with Exmar where the average remaining charter length is 3 years. Additionally, there will be $180 million of commercial loans maturing through Q2 2021, entirely backed by long-term chartered vessels. Management has stated that key terms have been agreed with lenders and that a refinance is expected ahead of maturity.
TGP has consolidated annual debt amortization of $390 million, inclusive of term debt and SLB financing. EBIT-to-Interest coverage is expected as 2.0x, inline with its peers.
Backlog
TGP has the largest backlog of LNG charters in the industry with a total backlog valued at $9.3 billion and an average remaining charter term of 11 years. Already more than 94% of available days are locked into charters for 2021 and a further 82% for 2022. This is after considering the sale of two TFDE vessels to Awilco in early 2020, the proceeds of which were used to reduce debt.
Ashland has developed a valuation measure which takes the present value of the backlog and compares it against the Enterprise Value (EV) of the company balance sheet. PV is taken as backlog net of Opex and less the cost of capital. This equates to roughly 65% of aggregate backlog value. In most cases, LNG shipping companies are valued well in excess of net backlog—after all, LNG carriers are a 35-year asset, and most charters last only 7-15 years. Amazingly, TGP is valued at only 1.05x of net backlog (EV $6.3B / PV $6B). Meaning that nearly any charter extension or new contracts whatsoever would lead to a positive return on investment at the current share price level. There is clearly a margin of safety in place to guard against unforeseen difficulties, such as an idle period for the few vessels coming off-charter in the near future.
Financials and Profitability
TGP’s fleet remains largely locked into long-term charters with the vessel count roughly allocated in half between wholly-owned vessels and minority-stake JV vessels, the latter of which TGP’s stake ranges from 20% to 52%. As per U.S. GAAP, equity-accounted JV’s are not consolidated on TGP’s financial statements, rather a single line item “Equity Income” is displayed on the income statement with a corresponding “Investments in Joint Ventures” as an asset to the balance sheet. To gain a more comprehensive view of TGP’s financial position, we have adjusted TGP’s GAAP statements to proportionally include the JV assets, liabilities, revenue, expenses, and cashflows (Figure 1). In this way, we can gain further insight into the full financial position of TGP.
Figure 1. TGP’s Pro-Rata Share of JV Financials (Source: TGP 2019 Form 20-F, calculations by Ashland)
We can see from this figure that TGP’s Joint Ventures alone, which comprise only one-third of the consolidated EBIT, are worth more than the current share price.
Looking forward, we forecast 2023 consolidated EBITDA to settle around $620 million, down from 2019 EBITDA of $687 million (Figure 2), a reduction which is due to the sale of the Awilco vessels. On a per share basis, we expect FCF and DCF to grow and stabilize (Figure 3) as long-term charters deliver cashflow and the few vessels coming off are re-chartered at potentially strong market rates.
Figure 2. TGP’s Growth in EBITDA (Source: TGP Investor Presentation Nov 2019)
Figure 3. TGP Projected Financials (Source: TGP SEC filings with certain adjustments and projections made by Ashland)
Distributions
TGP had historically paid an annual distribution of $2.8/shr prior to the latest newbuild program which placed a strain on liquidity. Subsequently, the distribution was reduced to $0.56/shr in 2016, but in 2019 raised to $0.76/shr and this year further raised 32% to $1.0/shr, representing a current yield of 8%. The current payout is covered more than 4x by DCF.
Going forward and based on growing FCF, we expect significant annual increases to the distribution, until reaching a value of approximately $2.0/shr by YE 2023. At today’s share price level that would represent a yield of 19%, indicating a potentially attractive shareholder return.
Potential Risks
With a substantial amount of TGP’s counterparties being Russian LNG export entities, there could be concerns regarding political risk. Already heightened economic sanctions could be further tightened by the U.S. or European Union as a result of diplomatic discord. Russia could remain a wildcard, but the fact remains that the Federation stands as the world’s 2nd largest exporter of LNG and holds a dominant position in energy trade globally. Extremely punishing sanctions may do more harm than good if such action plunges the world into deep economic recession. Furthermore, even surrounding the geopolitical circumstances of the last half-decade, the LNG export and transport market has been largely untouched. This could signal that perhaps LNG trade is of sufficient mutual importance to be buffered against the effects of state geopolitics.
Other key counterparties include LNG juggernauts Shell, Cheniere, and Ras Laffan (Qatar). The financial strength of these enterprises provide confidence in the underlying contracts and that performance will continue as a going concern. Another key counterparty is Angola LNG Supply Services LLC, which is a JV consisting of a who’s-who among the oil industry—BP, Chevron, Total, and Eni. Strong counterparties who are involved in some of the most developed LNG export projects worldwide forms a sound foundation upon which to base TGP’s backlog and underlying assets.
LNG Shipping Outlook
There remains a certain amount of risk related to TGP’s vessels coming up for re-charter in the near to medium term. In the fleet, there are 15 vessels, representing 28% of the consolidated EBITDA coming off charter from now through 2023. These vessels are mostly modern Steam or MEGI vessels built between 2008 and 2017, so concerns around re-chartering are more centered around the new charter rate itself rather than whether the re-charter will be actualized or remain idle. We have a high degree of confidence that at least a large majority of the vessels will be re-chartered given the trajectory of tonne-mile demand growth against a backdrop of a relatively muted newbuild order backlog in the industry (Figure 4). In fact, in the first half of 2020 only 3 new LNG vessel orders had been placed on shipyards, well below the 60 orders placed in 2019 (Figure 5). Nevertheless, we expect downward pressure on LNGC spot rates from the 2021-2023 period as new LNG supply projects have largely tapered off while the worldwide LNGC fleet continues to expand.
The next wave of LNG shipping demand may not materialize until 2024 as new project development investments have slowed, following a large wave in 2016-2018. In any scenario, the 2024 demand wave will be marginal in size compared to the previous one. Furthermore, much of this demand could be associated with the 30mtpa Qatar LNG expansion trains, which, at the moment, appears will be fully satisfied by Qatar’s growing captive fleet. A meaningfully large demand wave would require a longer shipping pattern, such as U.S. Gulf to Asia, and as a result would rely on substantial new projects from the U.S. Otherwise, a winter storage market in Europe and Asia could help to incrementally boost tonne-mile demand.
In light of the spot market uncertainty in the next few years, shippers with a significant long-term backlog, such as TGP, may be best suited to navigate this kind of environment.
In the last year, TGP has managed to renew charters at above-market rates (Figure 6), averaging $80k/day, far exceeding vessel break-even cost of $50k/day. While the LNGC spot rate could weaken somewhat in the near term due to COVID-19, TGP has only two vessels coming off charter through Summer 2021. Thus, we expect TGP to adequately navigate an intermittent disruption in LNGC demand.
Figure 4. Tonne-mile Demand vs. Supply & LNGC Utilization (Source: Cleaves Securities Weekly 36/2020)
Figure 5. Newbuild Carrier Orders (Source: GLOG investor presentation June 2020)
Figure 6. LNG Carrier Spot Rates (Source: TGP Investor Presentation, Nov 2019)
Valuation Thesis
There are three methods in which to value a firm such as TGP 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 TGP, and LNG shipping MLPs in general, are cashflow generation businesses.
All valuation methods point to a minimum $22/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 10.5%, and dividend growth in perpetuity of 1.5% (applied to 2023E distribution)--each of which are readily justified by historical performance relative to future prospects (Figures 7, 8).
While market participants have clearly not yet identified such value in this stock, we believe that TGP’s aggressive debt reduction and distribution increase program, fueled by growing DCF and lower interest expense, will provide the optics to justify higher valuations in the near to medium term. Furthermore, with natural gas being the lowest emission fossil fuel and the only constituent expected to gain energy market share in the coming decade, LNG trade is widely projected to grow by 2-4% annually.
Last year, we wrote about Hoegh LNG Partners (HMLP) and how we felt that it suffered from a halo effect of the oil industry downturn. Interestingly, the market price for HMLP is such that our projected 2023 yield is the same as for TGP at 19%, with both FCF yields being in the mid-20’s. One key difference is that HMLP has largely paid down its newbuild debt and is well into cashflow mode with a consistent distribution of 16%. TGP is entering the cashflow era with steady debt reductions and distribution increases. The market is discounting the durability of these distributions which are backed by resilient charter contracts. Furthermore, during this time of shifting sentiment toward renewable energy, there is a misconception of TGP as a “fossil fuel” business. In fact, TGP is in the business of transporting a low carbon fuel which is in increasingly greater demand in a post-Paris Accord era. Therefore, we believe that these structural tailwinds combined with TGP’s strong foundation, underpinned by performing counterparties in key markets, will give rise to the stock value before the 2023 timeframe.
Figure 7. DDM Valuation (Source: Ashland’s Calculations)
Figure 8. EV/EBITDA Valuation (Source: Ashland’s Calculations)
Analyst Opinion
Currently, TGP holds 5 Buy Opinions, with 3 Hold, and no Sell Opinions, and a blended average price target of $14.4/share. Recently, B. Riley FBR initiated TGP as a Buy with a $13 price target.
While analysts generally agree with our view of TGP’s long-term growth prospects, we believe that they are underweighting TGP’s cashflow potential, which will efficiently convert charter revenue into shareholder DCF. We justify our higher PT of $22/share on the fact that the fleet buildout has already reached completion and it is now just a matter of amortizing the debt profile for 2-3 years, while building the foundation for distribution capacity. As far as competitive forces, we view TGP’s business profile as having a strong barrier to entry as it is engaged in highly diversified areas of LNG shipping with modern vessel technology types.
Conclusion
TGP represents a unique investment opportunity. With a sector-leading backlog, modern and diverse asset base, long-term charters with quality counterparties, and an improving balance sheet, TGP brings investors the potential for long-term capital gain, as well as consistent income generation through quarterly distributions. With the financial strain of funding a large newbuild program in the rear-view mirror, TGP shareholders can look forward to increasing free cash flow and distributions. We believe that these benefits are de-risked by the fact that the majority of TGP’s vessels are on long-term charter and the vessels that are scheduled to come off charter in the near term are of higher quality and expected to retain economic employment.
Delivering asset-backed income and growth potential to investors is an attractive benefit regardless of market condition. And particularly during these times of uncertainty surrounding the ongoing COVID-19 pandemic.
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Article authored by: Eric Robken, P.E., MBA
