Capital Product Partners - Dividend Sustainability

By Barry Parker, bdp1 Consulting Ltd.

I have been following Capital Product Partners, L.P. (NASDAQ: CPLP) and Crude Carriers Corp. (NYSE:CRU) since their inception. Earlier this year, the two companies  announced a merger which is expected to close in the third quarter of 2011. Though the market has had bumps, it’s still a story that I like. The executive team is hard at work concluding the merger, so I could not talk directly to them. But, there’s quite a bit of good public information out there which I’ve tried to synthesize in an informative way.

Capital Product Partners L.P. (NASDAQ: CPLP), a Master  Limited  Partnership, is an international owner of modern double-hull tankers. They own 22 vessels, including 18 modern MR tankers, two small product tankers, one Suezmax crude oil tanker, and one capesize bulk carrier. Most of its vessels are under mediumto long-term charters to BP Shipping Limited, Overseas Shipholding Group, Petrobras, Arrendadora Ocean Mexicana, S.A. de C.V., Cosco Bulk Carrier Co. Ltd and Capital Maritime & Trading Corp. 

In early May,  CPLP announced a definitive agreement to merge with Crude Carriers Corp. (NYSE: CRU) in transaction where partnership units would be used to acquire shares of CRU. CPLP will be the surviving business. The merger continues on a path to completion in Q3, as planned. Shareholders of CRU will be receiving proxies this week. On September 20, 2011, Crude Carriers will host the Special Meeting of Shareholders to approve the merger. If the Crude Carrier shareholders approve the transaction, the merger is expected to be completed by the end of the month. The CRU management team, along with the Crude Carriers Investment Corp- which together own all the Class-B common shares have agreed to vote “Yes”.

The name of the game is dividend distributions. When I talk to investors, or get feedback from readers of this column, I continue to hear that distributions are important to them. This transaction provides attractive accretion in distributable cash flow per unit and in distributions to CRU shareholders. For example, given CPLP’s annual distribution guidance of $0.93 per unit, and the fixed 1.56x merger exchange ratio, Crude Carrier shareholders are expected to receive $1.45 in distributions per year per CRU share. Working back, the annualized implied yield, at CRU’s closing share price of $ 6.60 on Friday, August 12, 2001, is almost at 22%. There are also significant balance sheet benefits to each of the CPLP and CRU shareholders. The transaction strengthens the combined balance sheet, creates a market leader in both the products and crude sectors with expanded opportunities for growth.

Investors also love sustainability of dividends (from corporations) and distributions (from partnerships); both are periodic forms of payouts. Given the merger agreement with Crude Carriers, along with the acquisition of the Cape Agamemnon (the 2010 built Capesize bulker- on charter to Cosco), the current annual distribution guidance for CPLP of $0.93 remains sustainable. Looking ahead, future distribution growth will be enhanced through the combination of these two transactions; as the tanker market recovers, distributions could be fueled further.

Management believes that the $0.93 annual distribution guidance is sustainable, as stated in the CPLP Q2 2011 earnings conference call and press release. Ioannis Lazaridis, who serves as CPLP’s CEO & CFO and CRU’s President, stated in CRU’s earnings conference call that because of the very high percentage of period coverage in place for CPLP’s current fleet, the combined company, after the merger, will generate quite secure cash flows going ahead. He elaborated that if you look at the combined company, $16.5 million of cash flow is required each quarter to pay the 0.2325 quarterly distributions or 0.93 annually as per the stated distribution guidance of CPLP. Analysts predict CPLP’s current fleet alone will generate cash flows of approximately $14 million per quarter for Q3 and Q4- excluding any contribution of cash flows from the Crude Carriers vessels. CPLP intends to gradually fix all the Crude Carriers vessels on period charters. With period rates reflecting perceptions of market recovery, the combined company will generate better cash flows than the minimum required paying the pro forma distribution. The balance sheet for the combined company also includes a healthy cache of cash- $55 million at mid-year. The bottom line- the target annual distribution level of $0.93 per unit is sustainable in today’s market environment. As the market picks up, the payout could grow as the market recovers.

Recently a major transaction, around $1 billion in magnitude, in the product tanker space, involving 30 ships has been announced. In the deal (with private equity funded Diamond S buying 30 ships from Cido), the price per vessel exceeds previous vessel prices. The management team believes that the prices indicate stronger prospects for product tankers.

For bigger ships, the recent picture has been disappointing; the average quarterly spot earnings for VLCC and Suezmax tankers reached ten year lows. Recent IEA data shows that overall demand did not grow in June. The increased supply of tonnage available in loading areas resulted in an overall weak crude tanker spot rate environment.  High bunker prices reduced Time Charter Equivalents to owners.

With that being said, Chinese oil import demand growth is expected to remain robust throughout the remainder of 2011, while global refinery throughput is expected to increase by 2.3 mb/ day in Q3 in anticipation of seasonally higher demand.  The long term demand trajectory remains positive as growth is driven mainly by non-OECD countries with OECD demand declining slightly. Analysts expect this to translate to an increase of approximately 3% crude tanker deadweight demand in 2011. The longer haul routes are expected to benefit from the increased oil demand. Even after all the recent economic gyrations, the IEA, in a mid August monthly report, said: “Our own base case demand trend <for oil demand> remains remarkably unscathed…”

In the first part of 2011, the crude tanker order book has experienced extensive slippage, as analysts estimate that approximately 35% of the VLCC and the Suezmax order book were not delivered as expected. This is a higher rate compared to a year ago.  The weak market environment will likely result in further newbuilding delays and cancellations. As a result, the slippage in the crude tanker market order book is expected to stay high, effectively pushing supply increases farther out into the future.

Following the completion of the merger management intends to gradually reduce the crude tanker spot market exposure of the combined CPLP fleet during the next 6-18 months, as the crude tanker market improves and opportunities arise. Using a layered strategy, the company plans to enter into fixed period charters. In addition, longer period charters are higher than what one can fix for the short term period, which also reflects the  expectations for an improved market in the future.   Certainly the willingness to fix for period is going to improve as visibility improves in the crude spot market.   

As stated, management’s priority at this point is to first finalize the merger. While
management continues to look for period employment for the Crude Carrier vessels, they plan to accelerate this effort when the merger is completed. I emphasize the “gradual” part- careful timing of entry points will produce a better result than just dumping the entire fleet into period charters at one time.

To reiterate, post-merger, the combined fleet will be diversified in both the product and crude tanker space having one of the youngest high specification tanker fleets allowing the unit holders of CPLP to benefit from a recovery in both segments. In addition, management has stated that CPLP can benefit from the technical and commercial support of Capital Maritime and Trading Corp which brings with it the vetting qualification of oil majors around the world.

Management also expects that trading liquidity in CPLP’s units will improve as the combined group will be one of the largest listed US tanker companies. Besides payouts, investors also value situations where management and insiders have their objectives aligned with holders. CPLP executives have drawn attention several times to the fact that CPLP’s sponsor, the privately held Capital Maritime received 7.1 million units in CPLP, in June as partial payment for Cape Agamemnon, worth in excess of $73 million at the time of the announcement. That’s a strong inducement to be on the same side as investors.

Summing up- the company believes that the combination of the acquisition of the M/V Cape Agamemnon and the Crude Carriers merger strengthens the balance sheet, is accretive to the distributable cash flow per unit, and enhances long-term distribution growth.

About Barry Parker
Barry Parker is a financial writer and analyst. His articles appear in a number of prominent maritime periodicals including Lloyds List, Fairplay, Seatrade, and Maritime Executive and Capital Link Shipping.

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