2023-07-18 11:53:26 ET
Summary
- Robust financial performance and growth prospects: CPLP has shown a 199.60% increase in operating cash flow per share and holds $1.89 billion in backlogged revenue.
- Strong position in the liquefied natural gas market: CPLP's contracted revenues primarily come from LNG assets, which are witnessing a surge in demand.
- Strategic debt management: Despite a substantial debt burden, CPLP has used the funds to acquire new vessels and expand its fleet. The debt is well-covered by cash flow.
- Stable revenue stream: With a revenue backlog of $1.89 billion and a high charter coverage for the next two years, CPLP has a stable revenue stream which gives it the flexibility to manage its debt obligations.
- Attractive Valuation: CPLP may be undervalued compared to its peers based on forward-looking multiples and growth metrics. With a price target of $25, there is considerable upside potential for investors.
Imagine a company that reported a 199.60% increase in operating cash flow per share, has $1.89 billion in backlogged revenue, and exhibits an excellent outlook for the future. It's here with Capital Product Partners L.P. ( CPLP ). A high dividend yield, master limited partnership ((MLP)) stock that returns value to investors through buybacks and aggressively expands its earnings potential.
CPLP strikes a strong balance between growth and safe income. This is essential. As I continue to fail and succeed as an income investor, I've discovered that total return - not just dividends - is, in fact, the most crucial consideration.
My thesis for this maritime stock is as straightforward as sailing a boat on a calm sea. The company has a revenue backlog worth $1.89 billion, with 64% of the contracted revenues coming from liquefied natural gas ((LNG)) assets. LNG is a clean energy source experiencing robust demand. The company has plans for future growth by launching new vessels. CPLP also recently secured an additional contract, adding an estimated $34.4 million in gross revenue to its backlog. This, combined with management's strong execution, expanding margins, and efficient use of capital, adds more weight to my bullish stance.
So, does it make sense to rate CPLP a strong buy? I think so. Although the company has faced challenges recently, I am convinced it has turned a corner. So, if you're seeking a promising maritime stock to add to your investment portfolio, I highly encourage delving deeper into this one - it could be the valuable addition you've been searching for.
Company Overview
Capital Product Partners L.P. is a Marshall Islands-based international shipping company engaged in the seaborne transportation of a wide range of cargoes, including dry freight and containerized goods. The company operates a mixed fleet of vessels, including container ships, crude oil tankers, and product tankers. Its primary operating segments are Container Vessel Operations and LNG Carrier Operations.
In my opinion, the company has done very well over the past few years. Revenue grew $54,438,000 in 2020 to $146,103,000 in 2022. While its operating expenses grew in line, it was at a far slower rate than revenue. Operating expenses were $7,195,000 in 2020 and increased to $10,681,000 in 2022.
The issue of debt
Most analysts here on Seeking Alpha, however, have a different view. People say its debt burden is the company's significant risk and weakness. It's described as a red flag that's big and scary enough to wave them away from investing in the company altogether. Indeed, its total long-term debt is significant, growing from $338,514,000 in 2020 to $1,215,865,000 in 2022. But this debt figure alone is misleading. What is CPLP spending its money on?
The majority of its debt was poured back into the business. Namely, to acquire new vessels. For instance, they reported a new 13,000 TEU eco container vessel and a latest-generation LNG carrier last quarter. They also financed the acquisition of Itajai Express in January 2023 and Asterix I in February 2023 through new financing arrangements and sale and leaseback transactions. The correlation between total long-term debt and total assets is obvious, as seen below.
According to management in their latest earnings call, 10 out of its 22 total vessels are unencumbered by debt.
I consider a few crucial aspects when considering an investment in a leveraged company like CPLP. Firstly, I look at the company's ability to service its debt. More importantly, I assess whether the returns generated from this debt exceed its cost. In both these aspects, my evaluation of CPLP is positive.
It confuses me when some investors highlight the company's financial obligations as a significant objection. In my view, these investments have been strategic. Without the acquisition of new vessels, CPLP would not have been able to achieve a 168.5% revenue growth from 2020 to 2022 ($54,438,000 to $146,103,000). A considerable part of this revenue increase can be attributed to expanding its fleet size.
The investments have positioned the company to capitalize on the booming LNG market. I believe this area should be investors' main focus-anticipating future trends. Without its current level of leverage, CPLP would not have been able to seize the opportunities presented by this growing market fully.
The impressive growth of CPLP and the favorable trends in the LNG market alone convince me that the company's current debt level is warranted. Yet, a closer inspection reveals that CPLP also manages its financial risks effectively. For instance, the company has an interest coverage ratio of 2.60, as reported by Morningstar. This implies that CPLP's operating profit is 2.6 times more than its interest expenses, showcasing its ability to meet its debt obligations with its earnings comfortably.
Another key reason I'm not worried about the company's debt level is its substantial revenue backlog of $1.89 billion and the multi-year duration of its charters. A significant portion of this contracted revenue, amounting to $983.3 million, will be realized after 2026. This provides a stable revenue stream for the company, allowing it the flexibility to work towards paying off the debt on its other vessels.
Furthermore, the company's vessels are nearly fully chartered for this year and the next, with a charter coverage of 92% and 91%, respectively. This high utilization rate underscores the importance of continuously adding new vessels to maintain growth momentum, of which assuming debt is warranted. In particular, the company's LNG vessels, which are nearly fully booked until January 2028, account for 64% of its $1.89 billion backlog. This demonstrates the strong demand for its services and bodes well for its financial stability in the coming years.
My investment perspective has evolved since I built my portfolio over a decade ago. I've become more comfortable investing in companies that carry a high level of debt and appear to take significant risks. I've realized that the critical factor is not the presence of risk but how the company manages it. In the case of CPLP, the company counterbalances its significant leverage with strategies like long charter durations, diversification among seven top-tier customers, and securing orders well into the future. I see this approach as sound. I'm also interested to hear your opinion on the company's debt and if it's poised to deliver a desirable risk-adjusted return. Please let me know in the comments below.
So now that we've covered the past and some of the present, let's look toward the future. This is where my thesis for the company will take shape.
Charter rates & LNG outlook
Besides CPLP's debt levels, another concern investors may have are its future charter rates. This is a crucial consideration for some. But here's the problem. Trying to predict what will happen at the precise period the charters renew is dubious. Such a prediction would be highly speculative. My guess would be as good as yours. The charter rates might be lower, and they might be higher. Either way, I don't think this matters if you look back at it in another ten years. I'm much more concerned about what will get us there than the cyclical ups and downs of the industry.
The secular trends are what matters to me. In the case of LNG, I think this is a strong one. The global capacity of LNG is set to outstrip supply in less than a decade. And if Shell's forecast is correct, the gap will widen greatly as time progresses. The price of LNG has also gone through volatile swings, but this trend is again trending upwards. Both of these factors are good for CPLP.
Shell LNG report Shell LNG report
Here's me speculating a little, but the other thing is that these forecasts don't anticipate political swings toward more aggressive action against climate change. Natural gas is the go-to transitory power source instead of burning thermal coal. It's twice as clean, and the infrastructure is already here in many parts of the world. It's also relatively easy to scale natural gas plants up and down to meet demand. So its natural LNG would see a boost in demand as there aren't sufficient practical substitutes. Today climate change is being blamed for everything that ranges from earthquakes to the discoloration of the oceans. Also, the further we fall behind the emissions targets, the more pressure on governments will mount to get it under control. For these reasons and more, I believe that the forecasted demand will be higher than what is presented here by Shell.
Margins and dividend
CPLP managed to streamline its internal efficiency over the last three years, as evidenced by the growth of its gross and operating profit margins from 2020 to 2022.
Its net profit margin has been more volatile. Record charter rates were seen across the board in 2021 amid the pandemic. This is, therefore, an outlier, making its margins' wild swings more understandable. Overall, it has moved from strength to strength in controlling its costs.
Author supplied
In terms of CPLP's dividend, it has paid one for fifteen consecutive years. But it has only one consecutive year of dividend increases. Its yield has fluctuated around the 3% average and is 4.72% on a forward basis. One massive plus about its dividend is that it's very safe. The payout ratio for the stock is only 11%. Compare this dividend with some shipping stocks in the recent past, like ZIM Integrated Shipping ( ZIM ), which had a 49% dividend yield in March before cutting it to zero two months later. With ZIM, you didn't get capital appreciation or dividend safety. CPLP offers you the opportunity for both.
Author supplied
Valuation
Here's what I believe to be the best part of investing in CPLP. It's undervalued substantially on a book value compared to its peers and the median. This undervaluation comes from the forward revenue and EBITDA growth rates compared to today's present valuation ratios. These figures were taken from the Seeking Alpha comparison page for CPLP.
The companies I used in this comparison include:
Danaos Corporation ( DAC ), Navios Maritime Partners L.P. ( NMM ), Costamare Inc. ( CMRE ), and Golar LNG Limited ( GLNG ). These companies are all major players in the shipping industry. Most also have a major operating segment covering the shipment of LNG.
Based on forward-looking multiples and growth metrics, CPLP may be undervalued compared to its peers. While its forward P/E GAAP ratio is rated close to a bit higher than most of its peers, CPLP's forward Revenue and EBITDA growth rates are robust, potentially justifying a premium valuation. However, the anticipated decline in its forward EPS may be concerning for investors and could explain why the market has not fully priced in CPLP's growth potential.
Regarding a price target, we can aim for a sizable increase from its current levels, realized over the next year or so, to $25. It's $15 at the time of writing. I'm basing this projection on its FWD EV/EBITDA multiple and giving it a haircut to be safe.
My projection uses the following variables:
- Forward EBITDA growth : 25.12%
- Current Enterprise Value/EBITDA: 6.81
- Total debt: $1.2891 billion
- Total Shares Outstanding: 20.45 million
- Total Enterprise Value: $1.77 billion
- Cash and cash equivalents: $144.63 million
My calculation is below:
Equity Value = Enterprise Value - Total Debt + Cash and Cash Equivalents = $1.77 billion - $1.2891 billion + $144.63 million = $624.53 million
Share Price = Equity Value / Total Shares Outstanding = $624.53 million / 20.45 million = $30.53
With a $25 price target, I'm discounting assumptions such as increased shares outstanding, higher total debt, and a lower EBITDA growth rate.
Risks
As noted above, management's potential to continue diluting existing shareholders in pursuit of growth is relatively high. The company has historically financed its operations from equity and debt and may choose to do so again.
Its buyback program partially offsets this risk, which gives me confidence. During the first quarter of 2023, they repurchased approximately 129,000 common units at an average cost of $13.57 per unit. Although the language used in its most recent earnings call was not definitive, there could be the expectation that these buybacks will continue to reduce shares outstanding.
As for the matter of the company's debt, although its interest expense is well-covered by its operating cash flow, there's still the possibility it may have become over-leveraged. Management said charter rates were higher than average when the contracts were established. If the company then renews the contracts at a lower rate due to the cyclical nature of the shipping industry, it could fall into more challenging times.
Another note is that changes in CPLP's capital structure would also discount its intrinsic value from an EV/EBITDA point of view. More debt reduces this multiple, all else being equal. We may not have a clear long-term picture of how much the company is worth until it stops aggressively expanding its fleet size. Doing so would also let us see the large-scale impact of its debt and management's intention to pay it off and further reduce dilution.
Conclusion
CPLP presents an enticing investment opportunity backed by a sturdy revenue backlog of $1.89 billion, a robust focus on the booming LNG market, and strategic investments in expanding its fleet size. Despite concerns regarding its significant debt, I believe the firm has demonstrated its ability to manage its financial obligations effectively. The firm's growth-oriented approach, dividend payout history, and potential for capital appreciation offer investors a unique blend of income and growth.
Backed by these compelling points, I reiterate my strong buy recommendation for CPLP, setting an ambitious yet reachable price target of $20, representing a significant potential upside from its current level. This reflects my firm conviction that CPLP is aptly positioned to capitalize on industry trends while leveraging its financial strengths and risk mitigation strategies to deliver desirable returns for investors.
For further details see:
Capital Product Partners L.P.: Undervalued Growth & Income