GASS - Stealth Gas: Significant Upside If Management Follows Through

2023-06-27 09:00:00 ET

Summary

• Stealth Gas is an owner and operator of small and mid-sized LPG vessels, a market which has significantly improved over the past two years.
• The company is trading at one of the largest discounts to NAV in the entire shipping industry: GASS currently trades at less than 25% of tangible assets!
• Capital allocation has been lackluster over the past few years, with management prioritizing fleet renewal over share repurchases (or dividends) even while trading at a huge discount.
• However, it seems the company has now turned a corner, with the Board recently instituting a $15M share repurchase authorization, which is more than 25% of the current free float.
• The corporate governance setup is lackluster (related party transactions), but they have not been abusive. At current pricing, I believe GASS is an asymmetrical bet with significant upside potential if they deliver on shareholder returns.

Note: This article was written by Climent Molins, with inputs from J Mintzmyer. Both Climent and J are long GASS, and StealthGas ( GASS ) is part of the Speculative Model Portfolio at Value Investor’s Edge.

A preliminary version of this report was previously shared on Value Investor's Edge on Thursday, June 15th.

Introduction

StealthGas is a shipping company with a large fleet of small and medium-sized LPG vessels. The company is trading at one of the largest discounts to NAV in the shipping industry, which provides a unique opportunity for the Board to accrete shareholder value. The company has taken an extremely conservative approach over the past two years, prioritizing debt repayment and moderate fleet renewal, but it seems they have now turned a corner after the institution of a $15M share repurchase program was announced alongside Q1-23 earnings.

StealthGas at a Glimpse

GASS owns a fully delivered fleet of 29 vessels (including two newbuilds) plus six additional vessels owned via joint venture structures (one of which is a newbuild). The company has resorted to the sale of the oldest portion of the fleet to lower its average age while also agreeing to acquire two MGCs from a related party.

However, they recently also agreed to dispose of some more modern vessels, the 2020-built “Eco Texiana”, the 2015-built “Eco Czar”, the 2015-built “Eco Nemesis”, and the 2015-built “Eco Enigma” for $70M and expected deliveries ranging from Q2-23 to Q3-23. The sales proceeds are aligned with current market values and will help the company further delever their already healthy balance sheet.

Despite the acquisition of two MGC resales from a related party, the company has successfully deleveraged its balance sheet substantially over the past couple of years. Pro forma for recent disposals, I estimate the company’s net loan-to-value (using current underlying asset valuations) at a conservative 26%, whereas I estimate their NAV at $14.58/sh (including several conservative assumptions on their JVs, more on this below).

In the past, the company pursued some limited share repurchases, for example via a tender offer in April-2020, but shareholder returns have been nonexistent since then as management was concerned about the impacts of COVID and instead focused on high-grading the fleet and strengthening the balance sheet. As can be seen in the image below, GASS is currently trading at the lower end of its historical P/NAV range; although most peers have re-rated higher on the back of the strong sectorial backdrop (especially on the VLGC side), GASS has significantly lagged behind.

The peers listed above are not “direct” in the sense that BWLPG, Avance, and Dorian LPG are VLGC owners, which follow different market dynamics (especially characterized by the spread between US and Asian propane prices), whereas NVGS, despite being a closer comparable, is also differentiated by the specific assets they own, especially by their crown jewel, the ethylene export terminal.

Market Trends

It is well known that VLGC rates have been extraordinarily strong over the past few years, and even more so recently. However, rates for mid-sized and small-sized vessels have risen much slower; current rates are above mid-cycle but remain a far-cry from what their larger counterparts are earning on a relative basis.

As can be seen in the image below, rates for mid-sized vessels finally started to improve over the past year. After a prolonged period of mediocre rates, owners are finally generating decent returns on their assets, whereas the outlook is also solid considering the expected stable demand growth going forward and the tiny forward orderbook.

The orderbook on the small and mid-sized LPG vessels is sitting at very attractive levels, as can be seen in the image below. The world fleet grew profusely until 2016, but a significant rebalancing has taken place since then, leading to limited net fleet growth. Once again, note the differentiated dynamics versus the larger VLGCs, which have experienced both significantly larger fleet and demand growth.

Over the past few years, the limited amount of ordering has led to an aging fleet, with 16% of the fleet now 25+ years old (in the 3k-8k cbm range). Despite the improved freight rate environment, owners have been reticent to order additional small and medium-sized vessels, and only two 8k cbm orders have been placed year-to-date. However, one 30k, two 40k, six 45k, and 17 VLGC orders have been placed (which is somewhat unsurprising considering how strong rates have been for the larger asset classes).

We are now amidst the seasonally weaker period, the “summer lull”, but performance should remain well supported over the next few months. Demand for small-sized LPG vessels is more closely aligned with GDP growth (or overall economic activity) relative to the larger counterparts, as these vessels are focused on regional trades.

The overall market outlook seems positive, mostly on the back of the small orderbook. Demand growth is set to be all but outstanding, but even small increases have the potential to further tighten the market. Albeit VLGCs are earning “peak-cycle” rates, small and mid-sized LPG vessels are earning far closer to mid-cycle averages.

Joint Ventures

On top of the 29 vessels fully owned (including two newbuilds), the company also has 50-51% interests in an additional six vessels (including one newbuild). They are accounted for using the equity method, which represents historical cost adjusted for earnings generated less dividends distributed.

GASS does not publicly disclose the financial details of the aforementioned joint ventures on a quarterly basis, but they do on an annual basis alongside the 20-F SEC filing . I am currently valuing GASS’ stake in the JVs using underlying asset values plus the cash base as of Q1-end ($61M) minus debt as of Q4-22-end (everything on a proportionate basis).

My valuations are arguably on the low side since I am valuing working capital ex-cash at $0 while including all liabilities, but I tend to prefer to be on the conservative side. Additionally, I am not including a placeholder for prepayments on the newbuild (although it seems likely some prepayments have been made so far).

Capital Allocation: The Attractiveness of Repurchases

Over the past two years, GASS’ Board has taken an extremely conservative approach. The company has not distributed any dividends whatsoever while also not buying back any shares either since April 2020, when a (smallish) tender offer was completed.

We have been critical of their approach at Value Investor’s Edge, especially considering the enormous discount to NAV provides an outstanding opportunity to accrete shareholder value. However, management’s tone started to change in the Q4-22 earnings conference call, and they delivered alongside Q1-23 earnings , with the company instituting a $15M share repurchase authorization (equivalent to around 12%-13% of the outstanding shares and more than 25% of the current public float).

Based on our estimated NAV of $14.58/sh, there is no better capital allocation policy than repurchasing shares with the company’s equity trading at $3.11/sh. For illustrative purposes, if GASS was to spend the whole $15M repurchasing shares at $3.00/sh, $3.50/sh, $4.00/sh, $4.50/sh, or $5.00/sh respectively, NAV/sh would increase to $16.32/sh, $15.97/sh, $15.72 /sh, $15.53/sh, or $15.39/sh respectively.

To further illustrate how accretive share repurchases are when trading at a discount to NAV, note that by allocating $15M to repurchasing shares between $3.00/sh-$3.50/sh, the company would add ~$1.55/sh in net asset value (i.e, nearly half of the company’s current share pricing!). Furthermore, the appeal of share repurchases is not only the NAV per share accretion, but also the increased earnings potential. This is simply outstanding value accretion, and an opportunity that the company cannot afford to miss! We understand taking a conservative approach, but after recent asset sales, the company is in a solid financial position and could easily allocate far more than $15M towards share repurchases.

Share pricing will most likely increase as GASS (hopefully) allocates excess cash towards share repurchases, but even then, buybacks continue to be immensely accretive. Unless the company’s relative valuation improves considerably, buybacks should be prioritized over dividends (and arguably also over any fleet renewal spending).

Overall, GASS’ management and Board have been given the opportunity to accrete substantial shareholder value by repurchasing their own fleet at 20-25 cents on the dollar. It remains to be seen whether they will deliver, but the opportunity is simply too good to pass on considering their balance sheet strength and the constructive market outlook.

Conclusion: Significant Potential, But with Associated Risks

GASS is trading at one of the largest discounts to NAV I have ever seen in the shipping industry. This provides the Board with the opportunity to buy their own ships at a fraction of their market value, accreting substantial shareholder value in the meantime. The Board’s stance has arguably been too conservative over the past few years, but it seems they are now ready to deploy excess capital.

It remains to be seen whether the repurchase program announced alongside Q1-23 earnings will be fully utilized, and if it is, whether additional repurchases are in the cards. If the company’s relative valuation does not improve, I believe share repurchases should continue to be prioritized; this is the single most accretive capital allocation decision that can be pursued in the current environment.

Although the company’s financial position is now very solid, the case could be made for financing additional share repurchases with asset sales, keeping leverage constant. However, this is unnecessary given the heavy deleveraging GASS has already pursued over the past few years. For instance, the company finished Q1-23 with $92.6M in cash (including cash and cash equivalents, restricted cash, and short-term investments), providing ample firepower to repurchase shares with existing liquidity.

The point of share repurchases should never be to increase share pricing. On the contrary, the lower the price is when repurchasing shares, the more attractive buybacks are. In GASS’ case, when assessing whether share repurchases are effective, we should look at NAV accretion. However, considering the CEO owns 23.5% of shares outstanding (and that there are several other institutions among the shareholder base), even the current $15M would represent over 25% of the current share float.

The acquisition of two MGC resales from a related party was, in my opinion, a negative since it pushed out a potential shareholder returns program. However, from an operating business point of view the transaction has so far proved to be attractive, since GASS paid $117M en-bloc and the vessels are now worth closer to $124M.

Furthermore, GASS spinning off Imperial Petroleum with its tanker assets and diluting it into oblivion is definitely not a good look either (to say the least). The spin-off had 4.8M shares outstanding as of December 31 ^st , 2021, which grew to 70.1M as of May 1 ^st , 2022, to closer to 194.6M as of December 31 ^st , 2022, and to 243.9M as of March 28 ^th , 2023 (amidst one of the strongest bull markets in crude/product tanker rates in modern history). This is simply unjustifiable, but behavior at the parent has been far more respectful; related-party transactions are a negative relative to fully in-house management, but they have been cognizant of shareholder value.

I view GASS as a highly asymmetric bet. If share repurchases are pursued, there is substantial upside potential, although if they do not buy back shares, the company may become dead money. On the other hand, the related-party structure is a negative, but they have not been abusive (although as mentioned above, the acquisition of the MGC resales is somewhat questionable from the shareholders’ perspective, whereas what has happened on the IMPP spin-off is unjustifiable). Our current ‘fair value estimate’ at Value Investor’s Edge is $6.00/sh (77% upside), but I believe there could be even further upside, perhaps to $10+/sh, if GASS is serious about share repurchases. I am long GASS, and it is currently my largest single-stock position.

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