2023-08-30 21:21:26 ET
Summary
- Leading shuttle tanker operator reports mediocre Q2 results with profitability and cash generation again impacted by scheduled dry dockings, increased interest expense, and ongoing weakness in the North Sea.
- Absent any major new developments on the chartering front during the quarter, total contracted revenue of $620 million was down approximately 10% sequentially.
- Limited prospects for the smaller shuttle tankers Dan Sabia and Dan Cisne resulted in the requirement to take a $49.6 million impairment charge.
- As the long-term outlook for the shuttle tanker market has improved in recent quarters, I continue to expect parent Knutsen NYK to make a move for the partnership after the dust from the recent distribution cut has settled.
- With the North Sea markets expected to remain weak for the time being and a potential bid by the parent likely still several quarters in the future, I continue to see little reason for investors to own the common units at this point.
Note:
I have covered KNOT Offshore Partners LP ( KNOP ) previously, so investors should view this as an update to my earlier articles on the company.
On Wednesday, leading shuttle tanker operator KNOT Offshore Partners LP or "KNOP," reported another set of mediocre quarterly results, with profitability and cash generation again impacted by scheduled dry dockings, increased interest expense, and ongoing weakness in the North Sea markets.
Absent any major new developments on the chartering front during the quarter, total contracted revenue of $620 million was down approximately 10% sequentially while the company's calculated average dayrate decreased just slightly:
Please note that these numbers are only an approximation based on the company's disclosures of contracted revenues and average contract duration in years (emphasis added by author):
At June 30, 2023, the Partnership's fleet of eighteen vessels had an average age of 9.2 years, and the Partnership had charters with an average remaining fixed duration of 2.0 years , with the charterers of the Partnership's vessels having options to extend their charters by an additional 2.2 years on average. The Partnership had $620 million of remaining contracted forward revenue at June 30, 2023, excluding charterer's options and excluding contracts agreed or signed after that date.
Subsequent to quarter-end, KNOP managed to secure some additional backlog:
- In July 2023, the partnership agreed commercial terms for a new time charter contract for the Windsor Knutsen with an oil major to commence in H1/2025. The new charter is for a fixed period, at the charterer's option, of either one year with an option for the charterer to extend the charter by one further year, or, a single firm period of two years.
- The company also agreed with Equinor (EQNR) to substitute the Brazil Knutsen for the Windsor Knutsen for a previously-agreed contract expected to commence in late 2024 or early 2025.
- On August 8, 2023, the Partnership entered into a new time charter contract for the Brasil Knutsen with a major independent operator in Brazil to commence in January 2024 for a fixed period of one year.
- On August 18, 2023, a 100-day extension to the existing bareboat charter contract for the Dan Cisne was agreed with Transpetro, which will extend the vessel's fixed employment to the end of this year.
Unfortunately, my previously discussed concerns regarding potential issues with securing further long-term employment for the smaller shuttle tankers Dan Cisne and Dan Sabia have been well-founded (emphasis added by author):
Impairments in respect of the Dan Cisne and Dan Sabia of $24.5 million and $25.2 million respectively were recognized in the second quarter of 2023. In accordance with US GAAP, the Partnership's fleet is regularly assessed for impairment as events or changes in circumstances may indicate that a vessel's net carrying value exceeds the net undiscounted cash flows expected to be generated over its remaining useful life, and in such situation the carrying amount of the vessel is reduced to its estimated fair value. This exercise in the second quarter resulted in an impairment in respect of these vessels due to their current charter contracts moving closer to expiry, their high carrying value, and their smaller size not being optimal for the Brazilian market, therefore affecting the outlook for their future employment.
(...)
We remain in discussions with our customers and continue to evaluate all our options for the two Dan vessels, including but not limited to redeployment in the tightening Brazilian market, or a sale of the two vessels.
Failure to negotiate an extension would leave the partnership with very little options other than the conventional markets or an outright sale, which apparently weakens the company's bargaining position in the negotiations with Transpetro.
At this point, I would expect the vessels to be sold rather than commencing new long-term contracts offshore Brazil at substantially reduced rates.
Aggregate sales proceeds might be in the range of $50 to $55 million, a far cry from the vessels' aggregate purchase price of $206 million approximately 9 years ago.
Should the company indeed dispose of the Dan Sabia and Dan Cisne , I would estimate an additional impairment charge of between $25 million and $30 million.
Thankfully, remaining debt on the vessels is rather low with $13 million in aggregate near-term balloon payments expected to be made with cash on hand (emphasis added by author):
The $172.5 million senior secured loan facilities, which are secured by the Dan Cisne and Dan Sabia respectively, will be fully paid down over the term of the facilities on maturity in September 2023 and January 2024 respectively. On each maturity date, a final scheduled balloon payment of $6.5 million per facility will be paid from the Partnership's own liquidity . There are no plans to incur additional borrowings secured by these two vessels until such time as the Partnership has better visibility on the vessels' future employment.
On a more positive note, the company recently closed on a new five-year $240 million senior secured term loan facility:
The new facility, like the previous facility, which was scheduled to mature in September 2023, is secured by the Windsor Knutsen, the Bodil Knutsen, the Fortaleza Knutsen, the Recife Knutsen, the Carmen Knutsen and the Ingrid Knutsen. The $240 million term loan bears interest at a rate per annum equal to SOFR plus a margin of 2.4% and is repayable in 20 consecutive quarterly installments, with a final payment at maturity in May 2028 of $85.4 million, which amount includes the balloon payment and last quarterly installment. The loan is guaranteed by the Partnership and secured by mortgages on the related vessels.
In addition, KNOP managed to refinance the first of its two $25 million revolving credit facilities with Japanese lenders and expects to refinance the remaining facility at similar terms in due course.
Commenting on the company's outlook, management now expects weak shuttle tanker demand in the North Sea to persist for several more quarters until major new oil production projects come online.
In contrast, the market offshore Brazil is showing robust demand and increasing charter rates, at least for vessels of the right size:
While the Dan Cisne and Dan Sabia stand out among the KNOP fleet as being of a smaller size than is optimal in today's Brazilian market, the contract that we have signed for the Brasil Knutsen in August 2023 demonstrates that market tightening in Brazil is underway.
Considering ongoing headwinds from scheduled drydockings and higher interest rates, I do not expect the company's second half results to show material improvement while 2024 will likely be impacted by the fate of the Dan Cisne and Dan Sabia.
With the long-term outlook for the shuttle tanker market having improved in recent quarters, I continue to expect parent Knutsen NYK to make a move for the partnership after the dust from the recent distribution cut has settled.
That said, it might require more time for the common unitholder base to turn over from disappointed income investors to more speculative market participants to increase the chances for approval of a potential going-private proposal.
Lastly, KNOP recently announced that Mr. Derek Lowe will become the partnership's new Chief Executive Officer and Chief Financial Officer in mid-September.
Mr. Lowe will join the Partnership from Telford Offshore, a provider of accommodation, construction and pipelay in the global offshore energy services industry. He has served as the Group Company Secretary of Telford Offshore since its formation in 2018, having provided consultancy services to its predecessor since 2015. He worked from 2011 to 2015 for the debt capital markets group of Pareto Securities, and from 1994 to 2010 for the equity capital markets group of UBS.
Bottom Line
KNOT Offshore Partners reported another set of less-than-stellar quarterly results, with profitability and cash generation again impacted by scheduled dry dockings, increased operating and interest expense, and ongoing weakness in the North Sea markets.
While the partnership made important progress in its efforts to refinance upcoming debt maturities, the requirement to substantially impair the value of the smaller shuttle tankers Dan Sabia and Dan Cisne doesn't bode well for the prospects of these vessels.
In fact, the company appears to be stuck between a rock and a hard place with the options to either agree on new contracts at substantially reduced rates or selling the vessels at a large loss.
With the North Sea markets expected to remain weak for the time being and a potential bid by the parent likely still several quarters in the future, I continue to see little reason for investors to own the company's common units at this point.
For further details see:
KNOT Offshore Partners: More Bad News