This article is copied from SeekingAlpha.com. It was published thid Monday. Since the publication the share price is up by 13%.
Summary
- KNOP is a leading company in the shuttle tanker industry.
- A dividend cut in January 2023 drove the share price 70% down.
- On 2Q23 call the CEO confirmed that most concerns that led to the dividend cut have been resolved.
- The board is expected to resume dividends, potentially leading to a significant share price rerating.
- The shuttle tanker market is tight and expected to tighten further due to increasing demand and limited supply. A strong market limits the downside and magnifies the upside.
Introduction to KNOP
KNOT Offshore Partners LP (NYSE:KNOP) is a leading company in the shuttle tanker industry. The company operates 18 shuttle tankers out of global feet of 78. The company is listed in New York with a USD175 million market cap.
KNOP form is a master limited partnership (MLP), and its general partner is Knutsen NYK Offshore Tankers Management AS (KNOT Management). An MLP is a type of publicly traded partnership that combines the tax benefits of a limited partnership with the liquidity of a publicly traded company.
KNOT Management is responsible for managing KNOP’s shuttle tanker fleet and handling the various operational aspects of the business. This includes vessel operations, maintenance, crew management, and adherence to safety and environmental standards.
After the company cut the dividend in January 2023, the stock went down by 70%. The company revenues and profitability remain stable, and most of the concerns have been resolved. It is only a matter of one or two quarters when dividends would be resumed and the share price would re-rate.
Once dividends are reinstated, the share price should start regaining the previous trading levels, which means tripling the current share price.
Shuttle Tankers
Shuttle tankers are specialized vessels used to transport crude oil from offshore oil fields to onshore facilities. There are only 78 shuttle tankers in the world serving the North Sea and the fields of offshore Brazil. They are designed to be able to work on high seas where conventional FPSOs cannot operate. The industry was pioneered by Knudsen, the parent company, in 1978.
Shuttle tankers transport oil from oil field to onshore facilities
The Shuttle Tanker Market is Very Tight
There are only 78 shuttle tankers globally operated by three companies in two regions (Brazil and Norway). Only five new ships have been ordered while over 20 ships that are more than 20 years old should be scraped soon. As it takes three years for a ship to be delivered there is very good market visibility for the next at least five years. The market on the supply side is tight and with the scraping will get even tighter.
Demand for shuttle tankers is increasing. There is a rapid expansion in production in both the North Sea (the large Johan Castberg field, for example) and Brazil via Petrobras, and others will require additional shuttle tankers.
Higher production, new fields about to start producing, and limited supply or potential supply of vessels make for a nice bottleneck situation later in 2023 and in 2024 as producers scramble to secure the transport of their oil on shore.
In the 2Q23 the CEO of KNOP reported:
The market for shuttle tankers in Brazil, where fourteen of our vessels operate, has continued to tighten in the second quarter, driven by a significant pipeline of new production growth over the coming years, a limited newbuild order book, and typical long-term project viability requiring a Brent oil price of only $35 per barrel… the contract that we have signed for the Brasil Knutsen in August 2023 demonstrates that market tightening in Brazil is underway…
…Looking ahead, based on supply and demand factors with significant forward visibility and committed capital from industry participants, we believe that the overall medium and long-term outlook for the shuttle tanker market remains favorable. Notably, the current shuttle tanker orderbook consists of only five vessels, all of which are scheduled to deliver by 2025, while any future new orders would be expected to deliver in 2026 or thereafter.
Shuttle Tanker Rates Have Limited Downside and Substantial Upside
While shuttle tankers can perform the regular function of the regular oil tanker fleet (they are a bit slower because they are heavier), regular tankers cannot substitute shuttle tankers. In periods of lacking demand for shuttle tankers, these operate as regular oil tankers, which limits the downside. When demand is high, the rates increase materially. This is happening now in the Brazilian market, where KNOP operates 14 of its 18 vessels. The Norwegian market should tighten from early 2024 as the new fields come into production.
Why is KNOP 70% Down in The Last 12 Months
Since the 3rd Quarter of 2022, KNOP stock has been totally annihilated. Several reasons caused the share price fall:
- Postponement of gigantic Equinor field due to Covid by over one year,
- need to refinance 40% of its debt in the 1Q,
- renewal of several charters creating uncertainty about 2023 and 2024 coverage, and
- the departure of a long-term CEO
The above resulted in a dividend cut from $2.08/year to $0.11. Reaction to this was predictable. Dividend investors sold in droves for tax reasons, for the lack of visibility and income. Moreover, many MLP investors became concerned that the group would buy 70% of what they don’t own on the cheap, like many other MLP sponsors.
By 2Q23 the Issues Were Resolved
As of 2Q23 none of the adverse scenarios have materialized. Most concerns were resolved:
- KNOP has renewed several of the charters that came due in 1H 2023,
- KNOP successfully refinanced the debt at the same terms as they had before, and
- a new CEO was named.
There are only two issues remaining for resolution, none of which is material:
- Two vessels in the North Sea (Hilda and Torill) are out of charter at the end of 2023. Based on my discussion with the management it does not matter. The company is trying to secure a new long-term charter and if that does not succeed the two vessels will operate as oil tankers at the spot market. Oil tanker rates are well above shuttle tanker rates at the moment. As the new oil fields will come into operation in 2024 these vessels are expected to be locked into long-term charters again.
- Two ships operating in the Brasil market (Dan Cisne and Dan Sabia) are smaller than would be ideal. Their charters are now scheduled to expire by the end of 2023. On the 2Q23 call, the CEO was confident that the issue would be resolved soon:
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.
KNOP secured charter coverage for 2023, is negotiating to extend the two Petrobras tankers coming due, and is starting to explore long-term charters for the remaining assets. It also appears that the best opportunity to take the company under the sponsor has passed, at least at the low. As the dividend was decreased, the company used its cash to pay down debt. The issues have been resolved and the remaining are being addressed.
The company’s stable financial position is visible in its financials:
KNOP Should Start Rerating
The company position has normalized – KNOP is now in a similar state it was when it was paying above USD2 in dividends per year:
- In 2Q23 the fleet operated with 99.3% utilization.
- Its Revenues were the highest in the last 10 quarters, EBITDA and EBIT were in line with previous quarters.
- Most of the charters have been secured
In the 2Q23 press release Gary Chapman, Chief Executive Officer and Chief Financial Officer of KNOT Offshore Partners LP, stated (emphasis added):
“We are pleased to report another strong performance in the second quarter of 2023, marked by over 99% fleet utilisation for scheduled operations and meaningful progress in filling the gaps in our charter portfolio. We have similarly made good progress in strengthening and de-risking our financial position, such that nearly all of our financing needs for 2023 have now been addressed…
Including those contracts signed since June 30, 2023, we now have 94% of our charters fixed for the remainder of 2023, providing us with good near-term visibility.
In Brazil, the main offshore oil market where we operate, the supply/demand balance is continuing to improve, with robust demand and increasing charter rates…
..As the largest owner and operator of shuttle tankers (together with our Sponsor, Knutsen NYK), we believe we are well positioned to benefit from such an improving charter market…
Despite all this progress, the company has been left for dead. Trading at $5.5 per share it is remaining at a steep discount to the $15-20/share NAV of the ships and the $3-4/share of free cash flow generating capacity.
Resumption of Dividend Payment
So what should we expect in 2024? Given that the FCF/share should expand to over $3/share, there should be a resumption of dividends.
It is not possible to model such a scenario with sufficient accuracy but given the previous precedents, it is not hard to imagine a $2-3/share dividend in 2024 and beyond. Either way, the net present value of any of the outcomes is very attractive. At a little over $5 per share, we should be able to get all our investment back over the next 3 years or so, representing a very attractive IRR. Given how oversold the shares are, any incremental good news should help to rerate the stock higher.
Risk Factors
Since this is not a biotech stock or economically sensitive equity, there are exogenous factors that can affect the stock. Delays of the Equinor project, geopolitical conflict near the Norwegian waters, an accident, or a belated offer by the parent company to take the stock under may cause the stock to underperform my expectations. However, given that the stock is already trading well below steel, the risk-reward of investing in KNOP is very positive.
Conclusion
KNOP is down 70% due to multiple concerns that resulted in a dividend cut. Most of the concerns have been resolved and the financial performance remains stable. As the issues have been resolved, the dividends should be reinstated. Before the dividend cut, the stock was trading at a dividend yield of over 12%. At the current share price, the previous dividend would represent a dividend yield of 40%. The stock is up for a material rerating.
Disclosure:
The goal of the blog is to provide investment ideas for further research. I/we have a beneficial position in the shares discussed above either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. The article does not represent investment advice. Please do your own research before making any investment action.
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