Description

Recommendation

Buy TGP units.  TGP is a fixed-rate LNG carrier focused MLP that will shortly transition from a partnership structure to a corporation for income tax purposes.  There should be no change to the management of the business as it has always been run like a C-Corp instead of as an MLP.  However, there may be more trading volatility as the investor base transitions away from traditional MLP type holders fixated on yields. 

TGP currently has a market cap of ~$1.1bn and carries a heavy debt load of $4.6bn.  On an LTM basis, leverage is a whopping 9.9x EBITDA and the equity trades at 12.8x EBITDA. Sounds scary at first blush but TGP is a fast deleveraging story predicated on a massive ramp in contractual FCF generated from long-term charters with blue-chip counterparties. The current contract backlog is ~$10.6bn, or $320mm per LNG carrier.  TGP is (perhaps unfortunately) not a bet on the currently booming spot market for LNG shipping rates and it is most definitely not high distribution/dividend yield play.  While not as high as some of its peers with aggressive distribution coverage ratios, the forward yield on the units is still a respectable 5.6% and the distribution should grow nicely in the coming years.  

Assuming EBITDA grows to ~$740mm as the new charters come on line, leverage will come down to a manageable 6.3x by year-end FY20 and with newbuild capex down to zero at that point, the Company will be generating FCF in excess of $425mm, which compares favorably to the current market cap.  Levered equities are tricky in that you never know how they will trade on FCFe and so I’m hesitant to put a price target out there but at less than 3.0x FY20 FCF, I believe the units are attractively priced here today.  For those who prefer to use the ‘distributable cash flow’ convention, you can deduct $80 – 100mm per year of ‘maintenance capex’ from the FCF in FY20 and you’d still be creating the units are a very low multiple.  

While the sole focus for the next 8 – 10 quarters will be on debt reduction, I think the company will be in a strong position come late FY20 to be opportunistic with capital allocation.  However, I’m very aware that this is part of the Teekay complex and so the potential for (more) value destructive stupidity is not insignificant.  I’m also mindful of the fact that investors may continue to perceive TGP as an income vehicle and therefore upside during the deleveraging period may be capped as earnings and FCF multiples take a back seat to the modest dividend yield. Additionally, investors may simply shun the Company because of its complex organizational structure that includes eight material joint ventures – even the sellside analysts are not consistent in their presentation of the Company’s financials which no doubt adds to investor confusion.  Ideally, TGP would be a LNG pure play but it has some LPG exposure via 29 vessels in the portfolio and this may impact how the market values the units.  Finally, if we’re at that part of the cycle where HY spreads, particularly of energy related credits, start blowing out in force, then a name like this will not trade well no matter how much cash flow it throws off – but I’m comfortable with this risk because I believe it can be hedged (famous last words!) in a variety of ways.  

Company/Business Overview

TGP was formed in 2004 by Teekay Corporation to expand its operations in the LNG shipping sector and began trading publicly in 2005.  TGP’s sole General Partner is Teekay GP L.L.C., which is a wholly-owned indirect subsidiary of Teekay Corporation.  Teekay Corporation owns ~32% of TGP. 

The Company’s strategy has been to grow its fleet of LNG and to a lesser extent, LPG carriers, under long-term, fixed-rate charters. The majority of their services are provided through either a time-charter or bareboat charter contract, where vessels are chartered to major energy and utility companies for a fixed period of time at rates that are generally fixed but may contain annual escalators.  As of December 2017, the average remaining term for these contracts, including assets under construction, is ~12 years for LNG vessels and regasification terminal and ~2 years for LPG vessels.  

LNG Segment

LNG carriers transport LNG all over the world between liquefaction facilities and import terminals. After natural gas is transported by pipeline from production fields to a liquefaction facility, it is supercooled to a temperature of approximately negative 260 degrees Fahrenheit. This process reduces its volume to approximately 1/600th of its volume in a gaseous state. The reduced volume facilitates storage and transportation by ship over long distances, enabling countries with limited natural gas reserves or limited access to long-distance transmission pipelines to import natural gas. LNG is transported overseas in specially built tanks in double-hulled ships to a receiving terminal, where it is offloaded and stored in insulated tanks. In regasification facilities at the receiving terminal, the LNG is regasified and then shipped by pipeline for distribution to natural gas customers.

LNG vessels are chartered to carry LNG pursuant to time-charter contracts, where a vessel is hired for a fixed period of time and the charter rate is payable to the owner on a monthly basis. Most shipping requirements for new LNG projects continue to be provided on a long-term basis, though the levels of spot voyages, short-term time-charters and medium-term time-charters have grown in the past few years.  New LNG carriers generally have an expected lifespan of approximately 35 to 40 years. TGP’s LNG fleet has an average age of ~6.5 years, compared to the world LNG carrier fleet average age of ~8 years. 

In LNG, TGP competes with private and state-controlled energy and utilities companies that generally operate captive fleets, and independent ship owners and operators. Many major energy companies compete directly with independent owners by transporting LNG for third parties in addition to their own LNG. Given the complex, long-term nature of LNG projects, major energy companies historically have transported LNG through their captive fleets. However, independent fleet operators have been obtaining an increasing percentage of charters for new or expanded LNG projects as some major energy companies have continued to divest non-core businesses.

LPG Segment

LPG shipping involves the transportation of liquid petroleum gases, including propane, butane and ethane; petrochemical gases including ethylene, propylene and butadiene; and ammonia.  LPG carriers are mainly chartered to carry LPG on time-charter contracts. The two largest consumers of LPG are residential users and the petrochemical industry. Residential users, particularly in developing regions where electricity and gas pipelines are not developed, do not have fuel switching alternatives and generally are not LPG price sensitive. The petrochemical industry, however, has the ability to switch between LPG and other feedstock fuels depending on price and availability of alternatives.

New LPG carriers generally have an expected lifespan of approximately 30 to 35 years.  As of December 2017, the Company’s LPG vessels had an average age of ~9 years, compared to the world LPG carrier fleet average age of ~15 years.

Terminal

TGP also has a 30% ownership interest in an LNG receiving and regasification terminal under construction in Bahrain. The construction of this terminal is expected to be completed in early-2019 and will be operated under a 20-year agreement with National Oil & Gas Authority.  This business is expected to generate significant cash flow for the Company going forward.

Conventional Tankers

TGP owns four conventional tankers but two are under contract to be sold and the remaining two will be divested fairly shortly.  

Joint Ventures

A substantial portion of TGP’s operations are conducted through JVs. Generally, the Company is obligated to provide proportionate financial support for the JVs even as control of the business entity may be limited. Due to this limited control, TGP has less flexibility to pursue its own objectives or to access available cash of the JVs.  Pro rata share of dividends from JVs are paid to TGP over the course of the year.   

Below is a quick summary of the 8 JV’s:

Angola LNG - TGP has a 33% ownership interest in the Angola LNG JV.  The JV owns and operates four young LNG carriers with an average age of seven years and has been a strong earnings contributor.  All four vessels are on long-term contracts until 2031 and zero newbuilds are on order.

Yamal LNG - TGP has a 50% ownership interest in the Yamal LNG JV. The JV is operating one brand new LNG carrier and has another five vessels on order.  All six of the LNG carriers are on 26+ year contracts to support the Yamal LNG liquefaction terminals coming online.

Exmar LPG - TGP has a 50% ownership interest in the Exmar LPG JV. The JV owns and operates a fleet of 22 LPG carriers with an average age of about eight years. Nine of these vessels are operating in the spot market with five coming off contract by the end of 2019.  Earnings for this JV will likely decline as the vessels coming off contract reprice to the current spot rates, which are lower than the contracted rate.  The JV has zero newbuilds on order.

MALT LNG - TGP has a 52% ownership interest in the MALT LNG JV. The JV owns four LNG carriers with an average age of about ten years. Two of the vessels are contracted until 2029 while the other two operate in the spot market which will allow the Company to participate in the hot spot market.  The JV has zero newbuilds on order.

Bahrain LNG - TGP has a 30% ownership interest in a $960mm regasification terminal located in Bahrain that will come on line in early 2019. The terminal has been contracted out to the Kingdom of Bahrain for 20 years and will be a material contributor to TGP's profitability over the years.

Regas 3 LNG - TGP has a 40% ownership interest in the Regas 3 LNG JV that owns and operates four LNG carriers with an average age of almost 11 years. All four vessels are contracted to Ras Laffan LNG through 2033. The JV has been and will continue to be a strong contributor to TGP’s profitability.   

Pan Union JV - TGP has a roughly 25% ownership interest in the Pan Union JV that operates three LNG carriers on long-term fixed rate contracts through 2037. In addition, the company has a newbuild on order which will be delivered in early 2019 and has already been fixed to a 20-year time charter. All four of the vessels are contracted to Methane Services.

Exmar LNG - TGP has a 49% ownership interest in the Exmar LNG JV that operates just one older LNG carrier contracted to Excelerate Energy until 2022. The JV has zero newbuilds on order.

Fleet

TGP owns one of the most extensive and youngest vessel fleets in the industry.  Including JVs, TGP owns and operates a fleet of 49 LNG carriers, including 7 newbuilds, 29 LPG carriers and 2 unsold conventional tankers.  This would make TPG the largest LNG carrier in the industry.  Stripping out the JVs, TGP’s wholly-owned fleet includes 24 LNG carriers, including 2 newbuilds, 7 LPG carriers and 4 conventional tankers.  

Below is a summary of their existing and newbuild vessel fleet:

Some Quick Thoughts on the LNG Market

There’s no shortage of information out there on the LNG market and so I won’t spend too much time rehashing it here.  While the crux of the thesis here isn’t a direct bet on strong spot prices for LNG or shipping rates, it goes without saying that a strong LNG market would be a major positive and so its comforting that there’s a long runway for growth over the coming decade and beyond.   

LNG has played an increasing role in the global energy system over the last few decades. Since 2000, the number of countries importing LNG has quadrupled and the number of countries supplying it has almost doubled. International trade in LNG continues to be one of the vibrant growing in 2017 by 35.2mm tonnes, or 45.8bn cubic meters, of natural gas, to 293.1mm tonnes in global trade. That’s enough gas to generate power for around 575mm homes.  Year over year, this represents growth of 12% and comes as projects in Australia and the U.S. bring new capacity on line and Asian markets continue to grow. 

Japan remained the world’s largest LNG importer in 2017, while China moved into second place as Chinese imports surged past South Korea’s. China and South Korea led Asian growth with additional demand of 12.7mm tonnes and 4.9mm tonnes, respectively. China has focused on aggregate energy demand toward natural gas and away from coal in its fight against air pollution.

Future long-term LNG demand projections (whatever they’re worth) remain strong, but in order to meet them, will require substantial additional supply investment.  Based on current demand projections, some see potential for a supply shortage developing in mid-2020s, unless new LNG production project commitments are made soon.

Qatar is the world’s leading exporter of LNG followed by Australia, Malaysia, Nigeria, Indonesia, and the U.S.  Australia and the U.S. led in growth of exports by increases over 2016 of 11.9 MTPA and 10.2 MTPA, respectively. There are 92mm tonnes per annum of liquefaction capacity under construction worldwide, and about one-third will come online this year. Thus far, the global market is absorbing new supply with minimal distortion, as new buyers and existing markets alike demonstrate a high need for natural gas to meet growing energy demand. The need for cleaner fuels that are available on-demand is a key part of this trend.  

LNG buyers continued to sign shorter and smaller contracts. The mismatch in requirements between buyers and suppliers is growing. Most suppliers still seek long-term LNG sales to secure financing. But LNG buyers increasingly want shorter, smaller and more flexible contracts so they can better compete in their own downstream power and gas markets.  This mismatch needs to be resolved to enable LNG project developers to make final investment decisions that are needed to ensure there is enough future supply of this cleaner-burning fuel for the world economy.

LNG carrier spot charter rates have shot up in recent months and are now at six-year highs of ~$190K/day and 1-year charter rates moving up to $100K/day due to high LNG prices and new liquefaction projects ramping up. Although spot charter rates may come in from these sky high levels, there appears to be good support in the near-term as Asian demand continues to strengthen and several LNG export facilities come online in the coming quarters. Additionally, the LNG spot charter market will continue to benefit from firm spot LNG prices above $10/mmbtu, leading to increased trading and geographical arbitrage opportunities. However, TGP is less exposed to the gyrations in the spot market due to their immense amount of time charter coverage. Therefore even though rates are near yearly highs, TGP only has one vessel operating in the spot market and therefore the effects of better rates are not that pronounced, although it does help for any vessels that come of charter in the near-term. 

Capitalization

With ~$6.0bn of capital invested in their fleet financed almost entirely with debt, TGP’s balance sheet is clearly stressed.  Total net debt, including its pro-rata share of JV debt, is $4.7bn and this will further increase to $5.0bn by the end of FY19 as the Company finally completes its newbuild program.  However, leverage metrics, currently at 9.9x EBITDA, have peaked and will improve considerably in the coming years as FCF ramps up.  

The Company has two USD revolving credit facilities available that provide for borrowings of up to $401mm of which $151mm was undrawn. Interest rates on the facilities are LIBOR plus 1.25% to 2.25%. The facilities may be used to fund general partnership purposes. While I’ve included all the RCs in the secured bucket above, one is technically unsecured, while the other is collateralized by first-priority mortgages granted on two vessels, together with other related security, and includes a guarantee from its two subsidiaries.

TGP also has eight USD term loans totaling $1.1bn. Interest rate on the term loans are LIBOR plus 0.30% to 3.25%. The term loans are collateralized by first-priority mortgages on 20 vessels to which the loans relate, together with certain other related security. All term loans also have a guarantee from the parent.

There are also two Euro term loans outstanding totaling $206mm. Interest rates on the loans are EURIBOR plus 0.60% to 1.95%. The term loans are collateralized by first-priority mortgages on two vessels to which the loans relate, together with certain other related security and are guaranteed by the parent and one of its subsidiaries.

Capital lease obligations of $1.3bn mostly relate to eight LNG carriers where upon delivery of these vessels between February 2016 and July 2018, the Company sold them to third parties lessors and leased them back under 10-year bareboat charter contracts ending in 2026 through to 2028. The bareboat charter contracts are accounted for as obligations related to capital leases and have fixed-price purchase obligations at the end of the lease terms.

There are unsecured Norwegian Kroner bonds totaling $374mm that mature through 2023.  The interest rates on these bonds are NIBOR plus 3.70% to 6.00%. These bonds currently trade above par suggesting that the credit markets are, for the time being, comfortable with the high leverage at TGP.  

In October 2016, the Company issued Series A preferred stock with a liquidation preference of $125mm at a distribution rate of 9.0% per annum.  In October 2017, the Company issued Series B preferred stock with a liquidation preference of $170mm at a distribution rate of 8.5% per annum.  Both these issues currently trade on yield at slightly below par.

The Company has $140mm in unrestricted cash and total liquidity of $346mm post the November refinancing of its revolving credit facility. While one newbuild remains unfinanced (I expect this to get done shortly), I’m very comfortable with the liquidity situation at TGP.  

Summary Financials

TGP’s financial statements are a bit confusing because of all the JVs, use of derivatives and hedging programs, among other things.  I find it helpful to separate the P&L of the wholly owned assets from the JV assets to get a better sense for how cash moves around within the Company.  

Below is the P&L if you exclude all the JVs. 

Below is the P&L for just the JVs.  JV disclosure could be better but you can piece together a pretty good sense for the profitability of these assets.

Putting the two together and you get to see what the EBITDA and DCF for the entire asset base looks like.

Main takeaway is that EBITDA and distributable cash flow have been relatively stable but FCF has been negative as the Company invests heavily on its newbuilds.  However, the earnings and cash flow from the delivery and contract start-up of recent newbulidings have started positively impacting financial results and will continue to do so in the coming years.  With 8 newbuilds having been delivered since the start of 2018 and an additional 7 LNG carriers, and the Bahrain regasification facility, expected to commence their fixed-rate contracts during 2019, EBITDA is expected to improve substantially in FY19 and FY20.  In total, the newbuilds will contribute EBITDA of $310mm per annum. The first full year where you see the full impact of cash flow from the entire fleet will be FY20 when EBITDA should reach in the neighborhood of $740mm.  

Below is a rollforward of the Company’s net debt position. While the overall debt balance doesn’t change a whole lot over the next few years, the leverage metrics improve substantially.  By year-end FY20, Debt/EBITDA will have declined to ~6.3x and will drop by an additional ~0.7x each year thereafter. 

Valuation Thoughts

Given the leverage profile here, valuation will obviously be very sensitive to the multiples assumed. If the market starts valuing TGP below 8.0x fully loaded EBITDA, investors would lose money buying the units here.  However, if the market rewards the Company a multiple of 9 – 10x, investors would enjoy significant upside owning the units over the next couple of years.  At 9.0x, for example, the units would be worth ~$22.00 in 18 – 24 months and investors would also clip ~6.0% annualized along the way.   Given the visibility of cash flows resulting from long-term charter contracts with reputable counterparties, 9.0x doesn’t seem unreasonable to me but the multiple contraction scenario puts this investment in the above average risk category.

It’s also possible that the units end up trading on yield so we can take a look at where they might trade in 18 – 24 months under different distribution scenarios.  The Company has guided to ‘modest’ growth of the distribution post FY19 which could mean anything (investor communication is not a management strength) but I’m assuming 15% annual bumps in my base case given the huge ramp in cash flows.  Upside would be significant if the units trade closer to a 5% yield and investors would lose money if they traded closer to 10%.  Personally, I believe a 5 – 7% scenario is more reasonable than a 8 – 10% scenario given the extremely conservative distribution coverage ratio here and the lack of any insolvency issues. 

Not reflected here is any potential upside from value accretive capital allocation decisions.  In my conversations with management, I got the sense that they see the most value in the common units and so its possible that they initiate a meaningful buyback sometime in FY20.  Even taking out the rich preferreds would save $26mm per year that could presumably go towards higher distributions to the common units.  But I’ll believe it when I see it as I can easily envision a scenario where they go out and buy more vessels.  This is a Teekay company after all.  

Catalyst

There are no near-term catalysts other than the Company's plan to amend their tax structure to remove the K-1 filing burden.  This could open the name to a wider investor base.