Value Investors Club / CAPITAL PRODUCT PARTNERS LP (CPLP)

Description

This idea may be better suited for PA accounts as many institutions can’t hold small cap

MLPs despite CPLP being treated as C Corp for tax purposes.

Cue the eye roll. This is a pitch for a shipping MLP that just slashed its dividend from

35 cents a quarter to 10 cents. Its shares which traded in the low teens early this year

have fallen to sub $6 following the company’s move to slash its dividend. The

company’s shareholder base is mostly retail, yield oriented investors who are

aggressively selling as they are not interested in long term value creation but focused

on short term income. Meanwhile the company’s operational results continue to remain

strong despite COVID as nearly 90% of its revenues are fixed by long term charters.

The company is retaining income to build a war chest to make accretive acquisitions in

the second hand ship market as capital availability for the industry has all but

evaporated.

Background

Shipping has been a notorious boom and bust industry for decades and we are

currently experiencing a bust. CPLP is a container shipping MLP with a GP, Capital

Maritime, headed by Militiadis Marinakis and Evangelos Marinakis who has been

accused of match fixing among other transgressions in Greece. He is one of the

wealthiest men in Greece and is a celebrity there. This MLP was founded as a way for

his Capital Maritime to raise capital from public markets to facilitate the purchase of a

wide variety of ships. The ships were purchased by Capital Maritime who fixed charters

for these ships and then dropped them on MLP holders. Most of the ships currently

owned by CPLP have long term charters attached and have provided strong cash flows

for CPLP holders. The company has historically paid very large dividends but since the

2016 energy/MLP collapse, its shares have been ignored or orphaned in a market

where small MLPs lost access to capital to grow and institutional capital fled the space.

In 2019 the company spun off its oil and product tankers business and merged it with

DSSI thereby removing the volatile tanker exposure from the partnership. The company

now owns 13 containerships and one dry bulk vessel. The future strategy is focused on

fixing long term charters on container ships at profitable rates, paying out cash flows to

holders, and of course buying more ships to replenish a naturally aging fleet. The latter

has become impossible as the capital markets for a small shipping MLP are essentially

closed. The company’s fleet is very new compared to other public shipping firms and as

a result its ships have commanded strong prices for long term charters. Unfortunately,

when COVID hit this year the company had three ships coming off long term

employment in May/June. These three ships were redelivered to the company and are

currently earning much less than they were. However, at current rates the company’s

EBITDA hit for the full year is less than 10%.

The previous chart shows the company’s fleet and employment contracts:

13 containerships and 1 drybulk vessel with 4.8 years remaining on charter on average.

89% and 80% charter coverage for 2020 and 2021, respectively.

The Akadimos f/k/a CMA Amazon was redelivered to the company in May. It was

previously earning $39,250 per day and has now been re chartered at $29,800 for 2

years or a nearly $10,000 decline from its previous contract. This ship along with the

Uruguay and Magdalena shown above are all identical 9300 TEU Wide Beam Eco ships

which command premiums in the market. The rates for these ships in February were

about $40K and fell $17K in May and have now recovered to about $30K where the

Akadimos was fixed. The company must fix the Uruguay which has been renamed the

Adonis in this current environment and the Magdalena in January. The company has

noted improving demand for its modern ships in the last month and the Uruguay should

be fixed at similar rates to the Akadimos.

The third ship delivered to the company was a sole dry bulk vessel which is currently

earning spot payments of mid teens per day as the company is exploring long term

charter for the vessel or an outright sale of the vessel. The sale would focus the

company’s capital on container ships. According to management this ship is worth

$20M and has $8M in debt attached to it.

Asset Values and Valuation

Below is a chart of the company’s fleet by age compared to competitors in public market

as well as some relevant valuation multiples vs peers:

As we can see the company’s fleet is the youngest in the group meaning we have the

longest income tails from these ships. The company’s fleet at current rates can produce

$105M in EBITDA and fully amortize its debt at $37M per year, pay $11M in interest and

still generate $57M in FCF. Previously the company was paying a $1.40 annual

dividend or about $27M per year. The company has slashed the dividend to 40 cents or

$7.6M per year as it has decided it will hold the capital to deploy on purchasing new

ships. During the Q2 call management highlighted what it sees as attractive

opportunities to deploy capital at 25% equity returns in the second hand market.

The charter free NAV per share as provided by the company is $13 per share and with

the above market charters attached its NAV is $21.50 per share. Of course, this

means little as rates for ships could be much higher or lower in the future when the

company must re fix ships rolling off current contracts. So why would anyone care

about a volatile shipping company that is no longer paying most of its income to holders

but retaining capital to try to grow? Reinvesting the cash through a GP who may or not

give the partnership the best deals available is fraught with risk. However, at these

levels unless new ships are purchased at loss making rates, we have a huge margin of

safety.

GP/LP Model Conflicts

IDR’s kick in if quarterly distribution rises above $1.6975

For tax purposes CPLP is structured as a C-Corp with investors receiving a 1099.

However, the GP/LP remains a source of potential conflict for CPLP unit holders.

Historically, the GP, Capital Maritime has sought to create as high a unit price as

possible for CPLP to lower its cost of capital thereby facilitating more liquidity that allows

for more drop downs. This model broke down in 2016 during the MLP collapse. Since

the collapse, CPLP has not issued ANY equity and indeed Capital Maritime bought

shares in the open market in 2018 when units remained depressed and operating profits

improved. Since 2016 the company has not cut distributions to holders despite a high

yield and indeed boosted in January before COVID hit on the back of an accretive 3

ship drop down announced in late 2019. Examining this transaction in terms of fairness

to unit holders highlights the GP’s desire to deal fairly with unit holders while also

getting paid for its work to acquire and secure charters for ships.

The purchase price for three 2011 built Samsung built 10,000 TEU containerships was

$162.6M (Korean ships trade at premiums to Chinese built ships). These ships had a

bit longer than 4 years of charters attached to them with a quality counter party, Hapag

Llloyd at $28,000 per day with 1 year options after at $32,500 per day. The cost to

operate these ships is at most $7,000 per day but the average is closer to $6.400.

CPLP used $47.4M in cash to pay for the ships along with sale leaseback financing for

the remaining $115M with ICBC. The rate for this financing is LIBOR + 260 bps and

includes a 7-year lease with a $77M balloon payment. For simplicity we will assume

similar financing at the end of 7 years. Simple economics of the transaction depends

assumption of the remaining life of these ships. Most containerships have useful lives

of 20 – 25 years. Assuming 20 years and no scrap value (current scrap value of these

ships is about $7M each) in the first 4 years the ships generate $7.6M in EBITDA per

year. If remaining useful life is 11 years we need to amortize each ship at $3.6M per

year. Interest costs at 3% add $1.2M per year. So, each of these ships generates

$2.8M per year of FCF. In 11 years total FCF after all amortization and interest is

$30.8M vs. an equity investment of $15.4M per ship. The IRR here is 8% assuming no

residual value for operating past 20 years and ignoring scrap value. Adding

conservative scrap value of $5M per ship (fair to assume steel prices in 11 years

will be at least at current nominal prices) our IRR is approximately 16.3%. This is

well above the company’s cost of capital given 73% debt financing for these ships at

3%. I believe this drop down, at current rates, is fair for CPLP unit holders who are

compensated for taking charter rate risks post the initial 4-year period. If we assume

these ships have closer to 25-year useful lives our IRR improves.

The Macro Environment

The container shipping industry is highly correlated to world GDP growth, globalization,

and corresponding gains in trade. The recent nationalism emerging across the globe

does not bode well for increased globalization as the US and Europe recoil from China.

This is clearly a risk to future container shipping demand growth and is difficult to

forecast. There are a number of houses from Clarksons to McQuillen, who issue

forecasts but they have never proven to be very accurate.

However, one clear positive for charter rates is the outlook for supply growth of the

global container shipping fleet. Numerous industry sources show that the orderbook to

replace aging container fleets is at all time lows, below 10%. This is before slippage or

ordering delays due to COVID slowing shipyards. In addition, increased demolition of

older ships due to IMO 2020 should also decrease supply. Demolition has also seen

delays as demo sites in in the Indian subcontinent are also operating at reduced rates.

Lastly, and most important in my opinion, is financing for ships has become impossible

in the short term and will likely remain very difficult for many years. The easy financing

that created the huge shipping fleet surplus leading up to 2008 is no longer available

nor is any public equity financing following COVID. Indeed, the supply picture may very

well outweigh the retraction from globalization that seems likely in the years ahead

providing strong support for shipping rates.

Current Value Proposition

The current equity capitalization is $105M and total debt $395M offset by $54M in cash.

At current charter rates the company’s full year guidance is $106M in EBITDA and

$49.6M in operating surplus or fully amortized FCF as the chart below shows. Most

ships are in service for 20-25 years and the current fleet age is 8.2 years. The scrap

value of these ships is an added asset when the ship useful lives have passed. The

company is generating nearly 50% of its equity capitalization in the next year while

amortizing its debt! Given the company’s 4.8-year charter coverage we will likely see

this type of cash flow generation for the next 3-4 years at least. If the company has any

success buying assets that yield positive returns the value proposition will only be

enhanced. This security is priced for Armageddon in the next few years despite solid

cash flows with strong counter parties. At current levels, the margin of safety is

incredibly high while total returns may be 300-400% in 24 months.

Risks

Globalization retreats dramatically depressing container shipping growth and pushing

charter rates much lower in the future.

Low interest rates eventually encourage a huge boost in new ship orders boosting

supply to the market.

Management makes poor acquisitions with internal cash flows that destroy value

Severe economic contraction from COVID or any other factor that hurts the highly

cyclical shipping industry.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Accretive purchase of ships

Increase in dividends following COVID

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			2020	2021
Price:	5.58	EPS	1.51	1.42
Shares Out. (in M):	19	P/E	0	0
Market Cap (in $M):	103	P/FCF	0	0
Net Debt (in $M):	348	EBIT	0	0
TEV (in $M):	451	TEV/EBIT	0	0