DLNG - Gas Up Your Income Portfolio With Dynagas Preferred Shares

Summary

• The series A and series B preferred shares have been seeing consistent payouts (par 9% and 8.75%, respectively) since February 2016, despite the common unit's dividend being cut in 2019.
• The upcoming increase to shipping rates announced for Arctic Aurora provides further security that these payouts will keep flowing into shareholder's pockets.
• With an improved financial position, buying below par locks in intrinsic value, boosts yield, and reduces risk.

The preferred shares of Dynagas LNG Partners LP ( DLNG.PA )( DLNG.PB ) are attractively priced to provide steady streams of income, thanks to the controversy created by the Ukraine-Russia conflict. Purchasing below par offers a compelling return, which I believe will exist until the conflict is resolved or Europe completes the transition to supply their energy needs from sources other than Russia.

Dynagas LNG Partners LP

Dynagas LNG Partners LP ( DLNG ) operates a fleet of six VLGC (very large gas carriers) that transport liquified natural gas ((LNG)). The part that makes Dynagas unique is the specialty of their vessels.

With the exception of the vessel Clean Energy, the Dynagas fleet is comprised of ice class vessels that are utilized to navigate the Northern Sea Route (NSR). This allows transportation corridors to exist through the Arctic Circle at any time throughout the year because these specialized vessels can operate in areas with ice up to 1 meter thick (3.2 feet). This trade route is a competitive advantage as it provides significantly shorter routes from Northern Europe and Russia to importing countries in Asia and Western Europe.

Clearly, this fleet operates in a niche market that very few vessels are able to operate in. As a result, all of the vessels owned by the company are under long-term contracts to provide predictable revenue streams. The fleet's long-term contracts are outlined in their earnings presentations.

Subsequent to the earnings release, a three-year extension to Arctic Aurora's time charter was announced last December . This extension has capitalized on the high demand for LNG products as a result of the ongoing Ukraine-Russian conflict.

The new agreement leases the vessel at approximately $105,000 per day. This is significantly higher than the previous fleet average of $60,000 per day per vessel. This will serve to bolster the partnership's financial position, as well as boost the partnership's average contract length beyond the previous mark of 6.2 years.

The Distribution

The company has a somewhat checkered history, starting with eliminating the distribution to common unit holders in 2019. This was required as part of the terms of the $675 million credit facility that "restricts the Partnership from declaring or making any distributions to its common unit holders while borrowings are outstanding."

The company is permitted to continue to issue distributions to the series A and series B preferred units provided there is no event of default while the credit facility is outstanding. The company has maintained these payments since February 2016 and is in a solid enough financial condition to continue to do so - perhaps even more so than in the past.

The series A and series B preferred units were issued at rates of 9% and 8.75%, respectively, with a par value of $25/unit. The series A units are a fixed rate distribution of $2.25 per unit on an annual basis. This is paid out quarterly. The call date for these units was Aug. 12, 2020. This means the series A preferred units can be redeemed at any time, at a redemption price of $25 per unit. They continue to pay out until redeemed by the company.

The series B units are a fixed rate distribution of $2.1875 per unit on an annual basis through Nov. 22, 2023. After that, the units are payable at a variable rate plus a baseline of 5.593%. The variable rate is based on the three-month LIBOR, which has been valued at about 4.8% since the beginning of 2023. This would drive the distribution rate for the series B units to roughly 10.4% at today's rates. Keep in mind that this will not take effect until after the call date of Nov. 22, 2023. Getting a greater than 10% return should be an easy sell as it's widely anticipated that the U.S. and global markets will continue to raise rates over the course of 2023, and no reduction of rates has been forecast in the near future.

Keep in mind that Dynagas is a publicly traded partnership. The partnership has elected to be taxed as a C-corp. The company issues a 1099-DIV for tax returns, not a K-1 similar to other partnerships.

Financial Stability

Thanks to long-term contracts, the company has been able to produce consistent results in terms of revenue, EBITA, and adjusted net income.

It is noteworthy to discuss the drop-offs seen in Q2 and Q3 2022. In these quarters, special surveys (required every five years) as well as modifications were completed to the Clean Energy, Amur River, and Ob River vessels. This impacted earnings with a combined loss of 97 revenue days and a price tag of roughly $13.8 million. Aside from future dry dockings, it is expected to return to normal levels of revenue thanks to the long-term contracts that are in place. Additional margin is built in by the new time charter for Arctic Aurora starting in Q3 2023.

Since 2019, the partnership has been paying down the $675 million credit facility at $12 million per quarter. The total balance now currently stands at $512 million. Cash balances are approximately $78.7 million. This pay down agreement has allowed the company to slowly work down its balance while remaining cashflow positive and paying distributions to the series A and B preferred units.

The Risks

A high yield does not come without risks. A balloon payment on the $675 million credit facility is due in Q3 2024. At the current rate of repayment, the credit facility will have a projected balance of $416 million at that time. The company will not be able to pay this amount of debt before the balloon payment is due. Therefore, it will be at the mercy of the refinance market.

The company has refinance options in the wings as discussed in the latest quarter's earnings conference call. It is highly likely that interest expenses will rise due to higher borrowing costs once the loan is refinanced. The impacts of these started to take effect in Q3 where financing costs increased $2.1 vs. Q3 2021.

The ongoing conflict in Ukraine could result in additional sanctions against Russia and interrupt the flow of LNGs to Europe, thus impacting revenues. As of right now, LNGs have not been a subject of sanctions, but any political changes could result in nullifying the long-term contracts in place.

Although not formally announced, 2023 will more than likely see additional dry dockings for the remaining three vessels in the fleet. These vessels were constructed in 2013, and thus are due for their required 10-year dry docking intervals. This will materially impact availability of the fleet at various points throughout the calendar year.

Summary

Both the series A and series B preferred units offer a compelling income-generating vehicle. One generates a consistent payout while the other is variable based on interest rates.

Both of these often trade at value below par, resulting in an even higher yield. When captured at these prices, value is locked in should the partnership ever decide to redeem these units. The series A units have traded below par since February 2022. The series B units have only traded north of par for roughly one month of 2022. When purchased opportunistically the preferred units can offer a compelling yield, occasionally reaching 10% or higher.

The near-term risks are manageable. Plenty of time remains to negotiate a new refinancing structure before the Q3 2024 balloon repayment period expires. The reduced balance in the credit facilities will help to offset the interest expense incurred due to higher interest rates. The increased charter rates in Arctic Aurora will also help to offset these costs.

The dry dockings will make it difficult for the partnership to build its cash balance or make any additional debt prepayments. This bridge was previously crossed in 2022 and did not affect the ability of the partnership to continue paying its debt or distributions to the preferred units. I do not see this creating any meaningful change in 2023 vs. 2022. Things start to look a lot more promising in 2024 when the entire fleet's dry dockings are in the rear-view mirror, and the Arctic Aurora can contribute at the new charter rates for the entire year. These should serve to boost cash flows significantly and negate the risk of rising interest rates.

The risk that is not within the control of the management team is potential political risk from the Ukraine conflict. Since the German government has effectively taken control of the employing entity for the vessels Clean Energy, Ob River, and Amur River, I do not see this as an immediate threat. I am of the opinion that even if the EU did outlaw LNG deliveries, the cargo will find a home either in India or China as we have seen with most of Russia's oil exports.

Overall, the preferred units provide a compelling risk-adjusted return when purchased below par value ($25/unit). Treat them just like golf - below par is a reason to rejoice.

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