What to Buy: Navios Maritime Partners LP (NYSE: NMM)

Why to Buy Now: Navios’ unitholders have been on a wild ride the past few years, as the dry bulk shipping market has suffered a steep contraction. Following their trough amid the Great Recession, unit prices climbed as high as $21.38 in early 2011, falling as low as $11.31 later that year, and have essentially traded in a range between $14 per unit and $16 per unit since then.

While a number of aggressive investors had been enticed by the master limited partnership’s (MLP) double-digit yield during that time, we had been leery of Navios’ near-term prospects, in general, and the sustainability of its distribution, in particular, since it was barely covering its payout amid a depressed shipping market. And with a number of long-term charters expiring next year, with new charters likely at substantially lower rates, a distribution cut was a distinct possibility.

But the MLP’s shrewd management team engineered a transformative acquisition of five container vessels that, according to Wells Fargo analysts, should mean the distribution is largely secure through the end of 2015. Management, itself, has committed to the current $0.4425 quarterly distribution, which sums to $1.77 annually, through 2014.

The deal was announced via the company’s third-quarter earnings release on Oct. 31, and unit prices jumped as high as $17.06 per unit from just over $15 per unit prior to that. Prices have since fallen to around $16.50 per unit, for a current yield of 10.8 percent.

Even if the dry bulk shipping market suffers further headwinds in the near term, we’re being amply compensated to await a rebound over the medium term. Buy Navios Maritime Partners LP below $17.70.

Ari: This month’s play is a bit riskier than our usual fare because it operates in the dry bulk shipping market, transporting commodities such as iron ore, coal, grain and fertilizer, which makes it extraordinarily sensitive to changes in the global economy. And obviously there’s substantial uncertainty at present about when the US and other developed-world economies will finally produce a solid rebound.

Though we’ve been tempted in the past by Navios Maritime Partners LP’s (NYSE: NMM) double-digit yield, we’d studiously avoided recommending its units because we had been leery of its near-term prospects, in general, and the sustainability of its distribution, in particular, since it was barely covering its payout amid a depressed shipping market. And with a number of long-term charters expiring next year, with new charters likely at substantially lower rates, a distribution cut was a distinct possibility.

But the MLP’s shrewd management team engineered a transformative acquisition of five container vessels that, according to Wells Fargo analysts, should mean the distribution is largely secure through the end of 2015. Management, itself, has committed to the current $0.4425 quarterly distribution, which sums to $1.77 annually, through 2014.

But it’s also on the lookout for other deals that could be accretive to cash flows and support further increases in the distribution, which has risen a modest 2.1 percent annually over the past three years.

The deal was announced via the company’s third-quarter earnings release on Oct. 31, and unit prices jumped as high as $17.06 per unit from just over $15 per unit prior to that. Prices have since fallen to around $16.50 per unit, for a current yield of 10.8 percent.

Khoa: What are the details of the deal?

Ari: Navios acquired five South Korean-built container ships, each with a capacity of 6,800 twenty-foot equivalent units (TEU), for $275 million. The ships are just seven-years old and are under 10-year charters to an investment-grade counterparty through November 2023, at a net charter rate of $30,150 per day.

At that rate, management expects the ships to collectively generate $27.5 million in free cash flow per year during that period. Navios financed the deal with $189.5 million from its credit revolver and the balance in cash raised from previous secondary offerings.

Wells Fargo projects that the deal should help the MLP fully cover its distribution over the next two calendar years, with its estimates for each coverage ratio rising to 1.02 and 1.0 from 0.78 and 0.76 for 2014 and 2015, respectively.

Khoa: When will the dry bulk shipping market finally emerge from its malaise?

Ari: It’s too soon to tell, especially given the global macroeconomic headwinds.

The fourth quarter of the year is typically a seasonally strong period for the industry. Though JP Morgan says forward rates suggest a weak first quarter of 2014, the bank’s analysts also believe that 2013 could mark the bottom of the cycle. However, Wells Fargo doesn’t expect a sustained improvement in the industry until 2015-16.

Back in February 2012, the Baltic Dry Index (BDI), which measures the cost of seaborne transportation of materials such as coal and iron, hit a low of 647, a level not seen since 1986. Subsequent to that, the index made several runs at the 1,000 threshold, before decisively breaking above this level in mid-September, climbing as high as 2,146 in early October.

But in the weeks since then, the BDI slumped to its most recent level of 1499, which is 131.7 percent higher than the aforementioned low, but still down 30.1 percent from its recent high. More important, the BDI is a far, far cry from its all-time high of 11,793, set back in May 2008, just as the Global Financial Crisis was gaining steam.

The BDI is regarded as a leading economic indicator because the supply of dry bulk carriers is extraordinarily sensitive to any shifts in global demand for the raw materials they transport. That sensitivity is clearly evidenced by the BDI’s extreme volatility.

Fortunately, Navios has remained largely insulated from the dry bulk industry’s woes because many of its fleet of now 30 vessels–including eight Capesize, 14 Panamax, and three Ultra-Handymax dry bulk carriers along with its five new container ships–are already under contract. In the near term, 99.7 percent of its fleet’s available days are contracted out for the remainder of 2013, while 60.5 percent are contracted out for 2014, and 48.2 percent for 2015.

In general, the firm focuses on securing long-term charters with investment-grade counterparties. The average current charter duration of its fleet is 3.8 years.

In terms of average daily charter-out rates, also known as the time charter equivalent rate (TCE), this year has shown a disturbing erosion, with rates down 20.9 percent year over year during the third quarter, to $23,202 per day. That underscores why Navios needed to score a lucrative long-term deal.

Thanks not only to this latest deal, but also to its conservative management team and a diversified and creditworthy customer base, the company should have the financial strength to endure an anemic global economy. The health of the dry bulk shipping industry is considered a leading indicator of future global economic growth, so it bears watching closely.

And Navios’ management team has used its superior position to exploit industry weakness. In addition to the five container ships in the most recent deal, it’s also purchased another four vessels this year, increasing the size of its fleet by nearly 43 percent, to 30 vessels from 21. Its dry bulk fleet is also relatively young compared to industry peers, at 6.5 years versus 9.6 years. And it’s poised to make additional opportunistic acquisitions.

Meanwhile, the oversupply of ships in the industry should finally wane. The portion of the overall industry’s fleet forecast to face demolition this year is projected to come in at 22.8 million deadweight tonnes (DWT), or 3.4 percent of the total fleet, on top of the 33.6 million DWT, or 5.5 percent of the fleet, that was scrapped last year.

And the glut of new ships slated for delivery, known in industry parlance as newbuilding, is expected to plunge nearly 64 percent for full-year 2013, to 50.5 million DWT from 138.9 million DWT. The actual amount of new deadweight tonnage could actually be even lower than that, as only 65 percent to 70 percent of orders are typically delivered in the calendar year for which they were originally scheduled. In fact, on a year-to-date basis, only 56 percent of orders have been delivered.

Since the global demand picture is so uncertain, this reduction in vessel supply will be key for the strongest players in the industry to survive for the better days eventually ahead. And until that time comes, Navios is well positioned to take advantage of competitors’ misfortune.

The $1.2 billion MLP boasts a solid balance sheet with $198 million in cash and $344.7 million in debt.

Khoa: What about tax considerations?

Ari: In general, MLPs should be owned in taxable accounts, as a significant percentage of the distribution is tax-deferred. Of course, that also means contending with a Schedule K-1 at tax time, but the high yield coupled with the ability to shelter income from taxes more than offsets the tedium of dealing with this tax form.

Even if the dry bulk shipping market suffers further headwinds in the near term, we’re being amply compensated to await a rebound over the medium term. With a yield of 10.8 percent, buy Navios Maritime Partners LP below $17.70.

We’ll issue updates on our existing Portfolio positions via email next week.