2023-04-24 05:29:57 ET
Summary
- Following a very tough year in 2021, Tsakos Energy Navigation saw the tide change during the second half of 2022 and early 2023.
- Thanks to the charter rates surging for oil tankers, their common dividends were recently increased by 100%.
- Whilst positive, their common dividend yield is only a low 3.32% and thus a mere fraction of the high near-10% offered by their preferred shares.
- I see scant prospects for their common shares to make up for this gap via further dividend increases or sustained capital gains given they are already enjoying an upcycle.
- I believe that a hold rating is appropriate for their common shares with a buy rating for their series F preferred shares, which is my favorite series.
Introduction
After a very tough year during 2021 when publishing my previous article , the tide started to change for Tsakos Energy Navigation ( TNP ) during the second half of 2022 with charter rates surging. Whilst it might be tempting for investors to jump aboard in the hope of lucrative spoils, I feel it would be wise for shareholders to favor their preferred shares during an upcycle (TNP.PD) (TNP.PE) (TNP.PF).
Coverage Summary & Ratings
Since many readers are likely short on time, the table below provides a brief summary and ratings for the primary criteria assessed. If interested, this Google Document provides information regarding my rating system and importantly, links to my library of equivalent analyses that share a comparable approach to enhance cross-investment comparability.
Author
Detailed Analysis
Across the years, they continuously face up and down cycles with their financial performance often swinging widely and whilst unappealing, it is par for the course within the shipping industry, regardless of their cargo. This dynamic is easily visible when viewing their operating cash flow that landed at $288.5m during 2022, which represented their highest result since at least 2019 and far surpassed its meager result of only $53.1m from as recently as 2021. Despite this cash windfall during 2022, their high capital intensity still resulted in negative free cash flow of $87.6m, largely driven by their capital expenditure landing at $333.3m, alongside their miscellaneous cash expenses of $42.7m, as listed beneath the above graph.
When looking into their quarterly operating cash flow, their inherent volatility is fully displayed with their reported results improving from a depressed start in the first half of 2022 to a very strong performance during the second half, thanks to charter rates for oil tankers swinging to an upcycle. As a side note, due to their quarterly reports not containing a detailed cash flow statement, their quarterly working capital movements remain a mystery and whilst not ideal, it does not derail the analysis because their reported results are more important.
Thanks to their improving financial performance, management saw fit to increase their dividends early in 2023 with a new annual rate of $0.60 per share representing a 100% increase. Whilst this sounds exciting, I nevertheless feel that investors should skip their common shares and instead, buy their preferred shares, especially as they enjoy an upcycle.
Whilst they have various series of preferred shares, my favorite is their longest-dated series F preferred shares because they are not eligible to be redeemed until July 2028, thereby giving investors plenty of years of income. If they opt not to redeem at this time, their quarterly dividend rate goes from its present fixed $0.59375 to the three-month LIBOR plus 6.54% of the initial liquidation preference value of $25, which is normal for preferred shares.
When it comes to investing, especially income investing, higher risks are normally rewarded with higher returns and vice-a-versa. Despite this simple concept, their common shares only provide a low dividend yield of 3.32% as of the time of writing even after the recent 100% increase, whilst their preferred shares see a yield of 9.51% for their Series F. This disconnect means that investors can grab almost three-times the income from their preferred shares straight away, whilst incurring materially lower risk given that preferred dividends are predetermined and importantly, paid as a priority to common dividends.
Whilst yes, it is true that in theory, their common shares have more prospects for capital gains via a share price rally, although the opposite is also true, as their common shares have more prospects for capital losses when they inevitably face another down cycle in the future. The future may not replicate the past but realistically, I cannot see anything driving a long-term fundamental change for their industry. Naturally, their share price ebbs and flows with their operating conditions and therefore, it is difficult to imagine a sustained rally year after year that makes up for the lower dividends, especially with their share price already increasing circa 50% in the last twelve months to sit towards the upper end of its five-year range.
The key word here is sustained, not just a rally in isolation because sure, given the inherent volatility of their industry, it is possible to see another short-term blip higher. Although, I see no reason to expect it would be sustained into future years and importantly, continue building year-on-year given their recent charter rates that clearly place them in the midst of an upcycle. Whereas their preferred dividends should be sustained for many more years to come, barring an unexpected catastrophe that if forthcoming, would also hurt their common share price anyway.
The other possible avenue whereby their common dividends can outshine their preferred dividends would be via continued increases but alas, I see scant prospects this will be forthcoming, certainly not to a sustained extent that can make up for the present gap in yields. When operating cash flow is known for swinging widely, their inherent volatility makes it essentially impossible to sustain large common dividends, especially given the capital intensity of their industry and importantly, the present state of their financial performance.
Even though the second half of 2022 enjoyed very strong operating cash flow, alas due to their high capital expenditure, 2022 still ended with net debt of $1.302b that actually increased marginally versus at the end of 2021, which saw a level of $1.256b. This is unlikely to change once 2023 ends because they have another $220m of purchase obligations for new vessels during this year that will likely consume most, if not all of their operating cash flow, as per their 2022 20-F . Unfortunately, this elevated net debt creates headwinds for common shareholder returns going forwards, not just into the remainder of 2023 but also, into further years beyond and thus by extension, it increases the appeal of their preferred shares versus their common shares.
Despite their net debt not budging, their leverage still decreased during 2022 thanks to their improving financial performance. As a result, their net debt-to-EBITDA ended the year at 3.27 versus its previous result of 10.87 at the end of 2021, whilst their accompanying net debt-to-operating cash flow followed along in tandem with respective results of 4.51 and 23.63, thereby seeing a world of difference. Whilst the former is now down into the moderate territory of between 2.01 and 3.51, I prefer net debt-to-operating cash flow because it is not only more tangible as a cash-based metric but also, it is less open to variations due to accrual-based accounting. Unfortunately, despite their improving financial performance, it remains well into the high territory of between 3.51 and 5.00.
Even if we ignore their aforementioned depressed operating cash flow from the first half of 2022 and annualize their very strong results from the second half, the theoretical result of $430m would see their net debt-to-operating cash flow at 3.02. Whilst not terrible per se if considered in isolation, if instead viewed in the wider context of their up and down cycles, it is concerning to see very strong results can only push their leverage down to the moderate territory.
Whilst high leverage poses risks to their preferred shareholders, it poses a far greater risk to their common shareholders who are the first to see their dividends cut whenever operating conditions weaken, as their present upcycle inevitably turns to a down cycle in the future given the inherent volatility of their industry. Whereas, unless they face a liquidity crisis they are unlikely to cut their preferred distributions and even if done, they would have to be made whole before the common shareholders could receive anything.
Similar to their leverage, their debt serviceability also benefitted thanks to their improving financial performance with their interest coverage now healthy, given its results of 5.25 and 5.89 when compared against their EBIT and operating cash flow, respectively. Although once again, if not for their very strong financial performance during the second half, this would have been a vastly different story since their previous respective results at the end of 2021 were negative 0.68 and 1.30, thereby down to critical levels in the case of the former and dangerous in the case of the latter.
It is undesirable to see their debt serviceability vary so greatly, which together with their leverage sees their elevated net debt place a handbrake on their common dividends, not to mention, it also increases the downside risk for their share price when they inevitably face another down cycle in the future. Thankfully, this does not automatically pose risks for their preferred dividends, providing they do not also face any issues within their liquidity.
When it comes to their liquidity, thankfully it consistently remains strong across the years with 2022 also improving given their current ratio ended the year at 1.22 versus its previous result of 0.72 at the end of 2021. This is underpinned by their large cash balance of $304.4m at the end of 2022, which leaves their accompanying cash ratio with respective results of 0.82 and 0.35 across these same two points in time. Unless they rapidly drain this cash balance to the barebones, they should not require their credit facilities to operate and thankfully, this did not occur in the past even during down cycles given their lowest cash ratio during 2019-2022 was still a strong 0.35.
Admittedly, the one risk to monitor stems from their wave of debt maturities during the next five years with $168.9m during 2023 followed by another $551.8m collectively during 2024 and 2025. At least the present upcycle provides an opportunity for refinancing ahead of time but going forwards into the remainder of 2023, it will be important to monitor their progress.
Tsakos Energy Navigation 2022 20-K
Conclusion
I personally see no reason to hold their common shares instead of their preferred shares, especially during an upcycle that already saw their share price rally circa 50% in the last twelve months. Apart from offering materially lower downside risk when operating conditions inevitably begin swinging to a down cycle in the future, investors can instantly grab a high dividend yield of near-10% from their preferred shares that is almost three times that of their common shares.
The high capital intensity of their industry, alongside its volatility and their elevated net debt places a handbrake on their common dividends that in my eyes, leaves scant prospects for sustained increases that could make up for the present gap in the yield offered by their preferred units. As a result, I believe that only a hold rating is appropriate for the common shares, whilst a buy rating is appropriate for their Series F preferred shares.
Notes: Unless specified otherwise, all figures in this article were taken from Tsakos Energy Navigation's SEC Filings , all calculated figures were performed by the author.
For further details see:
Tsakos Energy Navigation: Favor Their Preferred Shares During An Upcycle