OP - Pyxis Tankers Preferred: A Well-Covered 8.8% Yield With A Valuable Conversion Option

2023-05-30 19:31:16 ET

Summary

• Product tanker shipping rates remain elevated due to Russian sanctions.
• PXS now has a strong balance sheet due to windfall profits and gains from a recent ship sale.
• PXSAP offers a 2.6X covered 8.8% yield and trades at an 11% discount to par.
• PXSAP has a valuable conversion option which enables it to trade over par unless it is called at par.

The war in Ukraine and continued Russian sanctions have changed global shipping routes for oil products such as gasoline, diesel and jet fuel. This has resulted in windfall profits for owners of product tankers and higher ship valuations. Pyxis Tankers Inc. ( PXS ) is a small micro-cap that owns 4 product tankers.

What is PXSAP?

Pyxis Tankers Inc. 7.75% CNV PFD A ( PXSAP ) is a par $25 cumulative preferred convertible issue. Dividends are paid monthly and PXSAP now yields 8.8% at a recent price of $22.13. PXSAP may be called at par starting on 10/13/2023. PXSAP is a perpetual issue, which means that the company has no obligation to call it. There are currently only 420K shares of PXSAP with a par value of $10.5 million outstanding. The average daily trading volume is only about 3K shares. Use patience and limit orders when trading.

PXSAP is a convertible issue with a strike price of $5.60. Each PXSAP share may be converted at the owner's option into 4.464 shares of PXSAP. The company may force conversion ONLY if PXSAP trades above $9.52 (170% of the $5.60 strike price). The company's forced conversion option effectively caps the maximum possible value of PXSAP at $25 X 1.7 = $42.50. Note that PXSAP may be called at par in less than 5 months, and this limits potential gains above par. See the prospectus for details.

PXSAP protective covenants

Many preferred stocks such as Golar LNG Partners PFD ( OTC:GMLPF ), Höegh LNG Partners PFD ( OTC:HMLPF ) and Ladenburg Thalmann Financial Services PFD ( OTC:LTSA ) have traded lower after their parent companies were taken private and no longer provide SEC filings. These orphaned preferred stocks now trade as expert market / pink sheet dark issues. Most U.S. brokerages allow sell orders only for these issues, and all of them now trade at substantial discounts to par. Avoiding preferred stocks that may become orphaned has become a major concern for my Panick High Yield Report Investment Group members.

Fortunately, PXSAP has an important protective covenant to protect holders from this fate. PXSAP holders have the option to redeem their shares for $25 if there is a change of control, and it is delisted. From page 74 of the prospectus:

"Change of Control. If we undergo a "Change of Control" (as defined below) that was pre-approved by the Company's Board of Directors, holders of Series A Preferred Shares have the option to (i) demand that the Company redeem the Series A Preferred Shares at ((A)) $26.63 per Series A Preferred Share from the date of issuance until and not including October 13, 2021, ((B)) $25.81 per Series A Preferred Share on or after October 13, 2021 until and not including October 13, 2022, and ((C)) $25.00 on or after October 13, 2022, or (ii) continue to hold the Series A Preferred Shares"

Excellent liquidity

Balance sheet liquidity is always an important consideration for high yield investors. It's especially critical for micro-cap issues such as PXSAP. As of Q1 2023 , PXS had unrestricted cash of $28.1 as compared to just $1.9 million as of Q1 2022 . Cash holdings have soared due to windfall profits over the last year as well as a favorable ship sale. As CFO Henry Williams commented on the Q1 earnings conference call :

"I should point out that our total cash position at March 31 of $30.5 million should only increase in the current quarter due to free cash flow generated from operations."

2.6X dividend coverage

Adjusted EBITDA was $4.2 million for Q1 2023 with interest & finance costs of $1.4 million and $0.2 million of PXSAP dividends. Therefore, the PXSAP dividend coverage is about: 4.2 / (1.4 + 0.2) = 2.6X

Moderate balance sheet leverage

The Q1 2023 balance sheet shows total liabilities of $64.8 million and total assets of $134.8 million. Product tanker values have skyrocketed recently due to the war in Ukraine. The 4 MR product tankers currently owned by PXS are carried on the Q1 balance sheet at a total book value of only $96.7 million. The Q1 investor presentation (see page 10) notes that the current market value of a 10-year-old MR vessel is $33.0 million. Therefore, the 4 MR ships (average age of 8.6 years) owned by PXS should have a market value of at least $132 million.

Let's increase the liabilities of $64.8 by $10.5 million to $75.3 million so that the PXSAP preferred stock is treated as debt. The total assets of $134.8 million should be increased by ($132.0 - $96.7) million = $35.3 million to adjust for the current market value of the tankers. With these adjustments, total liabilities / total assets = 75.3 / 170.1 = 44%.

Balance sheet leverage is even lower if we look at net debt, taking into account the company's growing cash hoard. Net Debt / Total Capitalization is only 22% as shown on page 15 of the company's Q1 investor presentation .

The case for PXS

PXS has a book value of $5.78 per share. However, as noted above, the PXS book value understates the actual fair market value of its ships by about $35 million. Therefore, PXS is only trading for around half of its net asset value.

Good corporate governance

Unfortunately, some micro-cap shipping companies such as OceanPal Inc. ( OP ) and Performance Shipping Inc. ( PSHG ) have sullied the entire shipping sector with repeated and dilutive stock offerings made well below net asset value. PSX has been very careful to distance themselves from that type of shareholder dilution below par. I emailed CFO Henry Williams about the behavior by some of his peers, and his exact response was: "Those are not my peers".

The PXS Board reflects strong governance practices. Three of the four Board members are independent Directors. I encourage investors to read their bios . The PXS Board includes a current Board Member of Genko Shipping & Trading Limited ( GNK ) and the former CEO of Euroseas Ltd ( ESEA ).

Share buybacks may be a catalyst for PXS and PXSAP to trade higher

The Q1 2023 earnings report had a pleasant surprise as a share buyback program was announced:

"We continue to trade at a substantial discount to estimated net asset value, especially in relation to our pure-play product tanker peers. Consequently, the Board of Directors has authorized a common stock re-purchase program of up to $2.0 million through open-market transactions for a period of six months."

While a $2 million share buyback may not seem like a lot, bear in mind that PXS currently has only 10.7 million shares outstanding and a market capitalization of $45 million at a recent price of $4.16 per share. The fully diluted share count is 12.6 million shares if all PXSAP is converted and the Pyxis Tankers Inc - Warrants (19/08/2025) ( PXSAW ) warrants are exercised. However, the warrants and PXSAP both have a $5.60 strike. They are anti-dilutive with PXS currently trading at only $4.16 per share. The CEO and other insiders currently own 54% of PXS (see page 72 of the annual report ). Therefore, a $2 million buyback represents almost 10% of the public float.

PXSAP has a valuable conversion option

PXSAP provides a safe dividend while also providing investors with potential capital gains. The 52-week high for PXS is $6.26, and it's currently trading at $4.24. As detailed above, PXS has a share buyback program and is trading at a big discount to NAV. Suppose that PXS rallies to $6.50. That would value the PXSAP conversion option at $6.50 x 4.464 = $29.01. PXSAP may be called at $25 starting on 10/13/2023. While a call at par could limit the upside potential of PXSAP it would still provide a nice gain with PXSAP now trading at just $22.13.

What are the major risks?

See pages 89 - 90 of the annual report for a more detailed discussion about risks. I've highlighted a few of the major risks of PXSAP here. PXSAP is a tiny company with a market capitalization of only $45 million and PXSAP has only $10.5 million par value outstanding. Small company size can create additional risks. CEO Valentios "Eddie" Valentis owns a 53% stake. Investing in a controlled company can have additional governance risks. Balance sheet leverage is currently very moderate, but would increase if the company decides to buy additional ships. MR shipping rates are currently very favorable, but might decrease if there is a global recession. Shipping rates have increased due to Russian sanctions, and rates would decrease if the sanctions end.

Conclusions

PXSAP has a well-covered 8.8% dividend while also providing investors with potential capital gains. PXSAP trades at an 11% discount to par and may be called at par to prevent even larger potential gains from the conversion option.

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