2023-10-04 09:00:00 ET
Summary
- Tsakos Energy Navigation is a shipowner focused on the ownership and operation of crude and product tankers, with some limited exposure to shuttle tankers and LNG carriers.
- Shareholder returns have lagged those of peers, ultimately leading to cratering sentiment and an extremely low relative valuation.
- The company is trading at ~0.33x NAV, the highest discount (by far) in the tanker industry, potentially creating an opportunity for patient investors.
- TNP’s operating and financial leverage is unparalleled in the sector; they are well positioned to benefit from strong markets, whereas substantial charter cover offers downside protection.
- If shareholder returns are not comparable to peers, TNP stock should trade at a discount, but it appears the market has overshot to the downside, creating a potential opportunity for investors.
Note: This article was written by Climent Molins, with inputs from J Mintzmyer. Both Climent and J are long TNP and Tsakos Energy Navigation (TNP) is part of the Speculative Model Portfolio at Value Investor’s Edge.
Introduction
Tsakos Energy Navigation is a shipowner focused on the crude and product tanker markets, but with some limited exposure to LNG carriers (they own three LNGCs) and to shuttle tankers. The company’s balance sheet was in a rickety position before the recent upturn, but strength in tanker rates from early-2022 onwards has allowed the company to materially improve its financial position.
Shareholder returns have been substantially weaker than those of peers (it is difficult to compete against DHT’s 100% and EURN’s 80%+ payouts of net income, or FRO’s and OET’s generous distributions), which has disappointed investors. Furthermore, some questionable capital allocation decisions were made, exemplified by the ATM utilization last October ($10M of shares sold for about $18/sh, which represented a substantial discount to NAV at the time). However, I believe TNP is trading at an outsized discount to NAV despite the questionable decisions and lower payout. If someone has a constructive view on the tanker markets, TNP’s cash flow generation prospects are undoubtedly industry leading; the question is whether the current discount is appropriate due to the lack of substantial shareholder returns.
Fleet & Employment Overview
TNP owns a fleet of 58 on-the-water vessels along with ten vessels on order. The company is mostly focused on the Suezmax and Aframax sectors, with 18 and 19 vessels in each of those sub-sectors respectively including a few shuttle tankers (plus two additional LR2s). Suezmax and Aframax rates have been exceptionally strong since the Russian invasion of Ukraine but have suffered over the past few months as Urals oil traded above the price cap (displacing the sanctions-compliant fleet from the trade) and Russia curtailed its exports.
The company follows a balanced approach, employing some vessels on the spot market and others on fixed and variable charters, which is a differentiated strategy from most peers in the sector, which tend to employ their vessels virtually 100% on spot. This allowed the company to survive the downturn despite their levered balance sheet but has weighed on potential returns once the market turned upward, since Tsakos still has several vessels earning well-below market rates. On the other hand, the charter coverage provides downside protection if rates would happen to notably weaken in the near- to medium-term.
TNP’s current fleet employment can be seen in their “ data kit ”, which was updated on August 30 th . The company has done a good job rolling legacy contracts at higher rates (whereas they have also done some blend-and-extend deals). For example, TNP recently disclosed it had agreed to fix the “Neo Energy”, a 2007-built LNG carrier at $115.5k/day until February 2024 (the charterer also has a one-year extension option at $100k/day). Annualizing the increased contribution from the steamer relative to the previous $37k/day contract equates to ~$0.96/sh in annual EPS from this single ship alone, illustrating the company’s substantial operating leverage. Additionally, they also have a modern LNG carrier on a variable hire contract with a floor of $50k/day and a cap at $145k/day; LNGC rates have increased materially over the past couple of months, so the contribution from this vessel should also improve materially throughout the second half of the year.
Of the 10 vessels on order, six are already fixed on medium- to long-term contracts (including the four dual-fuel Aframaxes and the two shuttle tankers), whereas the two Suezmaxes with delivery in 2025 and the two recently ordered MR2s remain unchartered. Considering current newbuild pricing, I believe it makes sense to secure charter cover to derisk the investments (although that is obviously contingent on the deals potentially available).
Overall, TNP has (by far) the highest operating leverage in the tanker sector, but that has partly gone unnoticed given their substantial charter cover (part of it remains at below market rates). However, if market balances remain tight, TNP will continue to roll its exposure going forward, leading to higher EPS and FCF, helping illustrate their true earnings potential.
Looking ahead, I expect TNP to also divest the older portion of the fleet; they own four 2005-2006 built Suezmaxes that look like prime disposal candidates, as well as two 2007-built Aframaxes, two 2006-built LR2s, the Handysizes (all built in 2007), and a 2003-built Panamax. I do not expect the disposal of this older tonnage in one fell swoop, but for TNP to pursue a more gradual approach, potentially coupled with some additional newbuild orders (although yard pricing remains extraordinarily strong, weighing on its relative attractiveness).
Financial Position
TNP carried a heavily indebted balance sheet over the past few years, especially when including their outstanding preferred shares, but recent cash flows have gone a long way to improving their financial position. Management has allocated excess cash towards the redemption of preferred shares; in Q3, TNP redeemed in full its 8.75% Series D preferred series (for $88M) and the privately owned 7.5% preferred (for $19.4M).
The move to redeem the two preferred series came as no surprise considering management had acknowledged their willingness to reduce preferred equity. However, the argument could be made for repaying variable debt instead and focusing on the repurchasing the much cheaper common equity to drive stronger shareholder return. However, no additional preferred redemptions are to be expected anytime soon, since the two remaining series, the TNP-E and the TNP-F, will not become callable until mid-2027 and mid-2028 respectively.
TNP finished the quarter with $529.2M in cash and cash equivalents, plus an additional $4.9M in restricted cash (for a combined balance of $534.1M). Even after adjusting this amount by the preferred paydowns (a combined $107.4M) and expected dividend payments for the remainder of the year (a mere $0.70/sh, or $20.65M), the company will still have a substantial amount of excess cash.
An argument could be made to also exclude the $149.3M in remaining yard installments for the newbuild program for H2-23, but I expect a substantial portion of that amount to be covered by new financing facilities (two dual-fuel Aframaxes are set to be delivered throughout the second half of the year). Regular debt repayment could also be included, but I expect operating cash flow for H2-23 to cover this amount in addition to the initial yard installments for the recent MR orders.
Looking ahead, I would not be surprised to see some debt prepayments, whereas they could also decide to finance recent newbuild orders at a lower loan-to-value than typical to derisk the operations (although returns on equity could come a bit under pressure). The company suffered a lot throughout the downturn, but they have now made solid progress in strengthening the balance sheet.
Shareholder Returns
This is the elephant in the room and the main factor behind TNP’s extremely low relative valuation (both on a standalone basis and relative to peers). Alongside Q4-22 earnings, the company disclosed that the Board had decided to declare a $0.60/sh distribution, to be paid in two $0.30/sh installments throughout 2023.
Alongside Q2-23 earnings, TNP announced that the Board had decided to pay a $0.40/sh special dividend on top of the previously declared distribution, bringing total payouts during 2023 to $1.00/sh. This represents a very low payout relative to other product and crude tanker peers, with most of them distributing 50%+ of EPS (and some up to 100% of EPS or all excess FCF). However, the low payout is not the only problem. In early January, at a Capital Link Event , management had mentioned that in-line with their actions in previous upcycles, they intended to distribute between 25% and 50% of net income as dividends “during the good times”, which partly explains the negative market reaction to the company’s Q4 earnings release (coupled with the ATM utilization at a large discount to NAV when they did not seemingly need additional equity in the near-term).
Despite trading at an outsized discount to NAV, management seems to be somewhat opposed to share repurchases, which is surprising considering the value accretion opportunity the market is providing. Albeit it may seem counterintuitive, TNP did pursue share repurchases in the past, spending $9.8M in 2020 and $20.7M in 2016, although these share repurchases did not benefit the stock due to the challenging market environment.
However, I believe share repurchases at the current juncture phenomenally more attractive than the limited efforts pursued in 2016 and 2020. The balance sheet has improved materially, providing certainty, whereas the overall market outlook has also improved significantly (in 2016 and 2020, the outlook was mediocre at best). Furthermore, the discount TNP’s shares are trading at has continued to widen (more than twice as cheap as last cycles), increasing the attractiveness of share repurchases.
We currently assess TNP’s adjusted net asset value (“NAV”) at $59.57/sh, which includes a substantial $250M discount for their below-market legacy contracts. If they were to spend $100M buying back shares at $20/sh or $25/sh, pro-forma NAV would increase to $67.67/sh or $65/sh respectively (every incremental dollar used to buy back shares at current pricing creates enormous value for long-term shareholders). The point of share repurchases is not to boost share pricing, but to create value for the remaining shareholders. Furthermore, if they are to shift towards heavier dividend payouts in the medium-term, they will also be able to afford relatively higher dividends given the lower number of shares outstanding.
Communication could and should have been better. There is no question about it, but I believe the discount has gotten out of hand. TNP has shown no problem in paying out large dividends when times were good in the past, and I expect payouts will improve over the next few years, hopefully to the 25%-50% range management acknowledged in recent communications.
As can be seen in the image below, the 2022 payout was remarkably low relative to previous bull cycle years, and the 2023 numbers will show a similar picture if additional distributions are not declared (all dividends for 2023 but only H1-23 EBITDA are included in the chart).
TNP’s Q2 earnings presentation, slide 10.
Even when looking at net income, TNP’s distributions have been somewhat limited relative to peers. Since 2002, and including dividends to be paid on 2023 earnings, the company has distributed around 33% of positive net income (i.e., without taking into consideration EPS losses). However, even by the company’s own historical standards, payouts as a portion of net income have been very low over the past couple of years.
Author’s Own Work.
TNP’s dividend distributions have been lackluster so far, but the current discount has, in my opinion, gotten out of hand, potentially creating an opportunity for investors today. Although I view share repurchases as more attractive at the current juncture (they are akin to buying their own ships at 35 cents on-the-dollar), management has been clear they favor dividend distributions. Pro forma for preferred paydowns and yard installments, the company still has a substantial free cash position, providing optionality to pursue more aggressive payouts while renewing the fleet and deleveraging going forward.
Conclusion: Potential for Significant Upside
TNP is trading at a significant (60%+) discount to NAV despite solid operational performance and a significantly improved balance sheet. Shareholder returns have lagged those of peers, leading to cratering sentiment and ultimately to the enormous discount we are currently witnessing. Sentiment swings tend to overshoot, and I believe TNP to be a prime example of this.
If someone has a constructive view on the overall tanker market, TNP is an arguably attractive candidate given the company’s operating and financial leverage, especially as the company continues to roll legacy contracts at improved terms. The current balance sheet is night and day relative to the one they had in 2020 and should allow for relatively higher payouts going forward.
Our current TNP ‘fair value estimate’ at Value Investor’s Edge is $26.00/sh, but if management improves their shareholder returns policies (either via higher dividends or share repurchases) there could be substantially more upside in the cards. With reasonable shareholder return policies, there is a viable road to a valuation of $40/sh or higher within the next 12 months, but that is contingent on higher dividends/repurchases and the overall tanker market remaining strong. On the other hand, the company’s charter cover and discount to NAV also provide downside protection should markets turn to the downside. This makes TNP a very attractive risk/reward proposition at this juncture and one of our favorite tanker positions at Value Investor’s Edge, although if shareholder returns are not increased, it has the potential to become a value trap for the foreseeable future.
For further details see:
Tsakos Energy Navigation: Low Valuation With Significant Upside Potential