What to Buy: Capital Product Partners LP (NSDQ: CPLP)

Why to Buy Now: Capital Product Partners LP is an international diversified shipping company and a leader in the seaborne transportation of a wide range of cargoes, including oil, refined oil products and chemicals, as well as dry cargo and containerized goods.

Its vessels are chartered under medium- to long-term, fixed-rate time and bareboat charters with strong counterparties.

Although the master limited partnership (MLP) has faced significant headwinds from overcapacity in the refined-products shipping space, industry fundamentals are gradually starting to improve. Additionally, the MLP should have the opportunity for additional dropdowns of vessels from its general partner, which should further boost cash flows over time.

In fact, with a high-yielding distribution that’s largely secure, this turnaround play is starting to become a growth story once again.

It appears that management has successfully navigated through the worst of it, as the MLP’s unit price has already rebounded sharply from its low.

Although a management transition is underway, current CEO and CFO Ioannis Lazaridis is staying on until his successor is chosen, thus facilitating a smooth transition. Still, the near-term uncertainty has caused a modest decline in the unit price, thus affording an attractive entry point.

Finally, CPLP offers a welcome respite for income investors who are ordinarily leery of MLPs because of having to contend with a K-1. The MLP has elected to elected to be treated as a C corporation for tax purposes. This means investors receive Form 1099 at tax time instead of a K-1.

With a current yield of 8.8 percent, Capital Product Partners LP is a buy below 11.50.

Ari: I first looked at Capital Product Partners LP (NSDQ: CPLP) about a year ago, at a time when its business was facing significant challenges from overcapacity in the refined-products shipping space, as well as the bankruptcy of a customer with whom three of its medium-range (MR) tankers were under long-term charter. Since then, however, the maritime master limited partnership’s (MLP) units have climbed nearly 37 percent. What’s changed?

Khoa: Well, the market in which it operates is finally starting to improve, while CPLP continues to add new ships to its fleet that are accretive to cash flow. In 2013, for instance, the MLP acquired five high-specification, eco-type Post-Panamax container vessels, all built that year, employed on 12-year time charters with Hyundai Merchant Marine Co.

And according to analysts, the product tanker market is strengthening, with both ton-mile demand and chartering activity increasing, along with firm crude tanker rates. Instead of locking in long-term charters in a low-rate environment, CPLP shrewdly placed many of its product vessels on one-year charters, so they would be available to contract out at better rates once the market started returning to normal.

For example, at the end of January, one- and three-Year MR timer charter period rates had risen to a range of around $15,250 to $16,000 versus a range of $14,000 to $14,500 a year ago.

Additionally, its parent company Capital Maritime & Trading Corp has a robust order book, with four container vessels and eight product tankers slated for delivery in 2015. Presumably, many of these assets will eventually be dropped down to CPLP under attractive terms.

Despite the headwinds it’s endured, CPLP’s coverage ratio is a healthy 1.2x. This coverage ratio is expected to improve even further this year, and management has indicated that it may soon offer guidance toward future distribution growth, which could trigger further appreciation in the unit price.

As a side note, the MLP essentially halved its distribution in early 2010, then gave its lower payout a modest bump later that year. Since then, the quarterly distribution has held steady at $0.2325, or $0.93 annualized.

Ari: Well aside from the aforementioned distribution cut, which was understandable considering the industry-wide downturn, the stable payout is certainly enticing, as is the prospect of an eventual boost. How about some more background on the company, as well as how it operates?

Khoa: Based in Greece, CPLP is an international diversified shipping company and leader in the seaborne transportation of a wide range of cargoes, including oil, refined oil products and chemicals, as well as dry cargo and containerized goods.

Its vessels are chartered under medium- to long-term, fixed-rate time and bareboat charters with strong counterparties. The master limited partnership (MLP) was formed in early 2007.

At the time of its initial public offering (IPO) that year, its fleet consisted of just eight vessels. Since then, its fleet has grown in size to 30 modern high-specification vessels (2.1 million deadweight tonnes (dwt)), with an average age of approximately 5.8 years. That makes it a relatively young fleet compared to its peers.

Among its different vessels are four Suezmax crude oil tankers, 18 modern MR tankers, all of which are classed as IMO II/III vessels, seven post-Panamax container carrier vessels and one Capesize bulk carrier. The wide range in size and geographic flexibility of CPLP’s fleet is attractive to its charterers, since it provides them with a high degree of flexibility in the types of cargoes and variety of trade routes.

All of CPLP’s time and bareboat charters are for a fixed base rate for the life of the charter, while 12 of the 17 time charters also provide for profit-sharing arrangements in excess of the base rate. Though the weak operating requirement necessitated short-term charters in recent years, CPLP typically pursues medium- to long-term fixed charters. The average duration of the fleet’s charters was approximately 8.8 years as of Dec. 31.

Its counterparties are typically large, established shippers. At year end, Capital Maritime, BP Shipping Limited, Maersk Line and HMM accounted for 32 percent, 17 percent, 14 percent and 13 percent of revenue, respectively.

Ari: What about its acquisition strategy?

Khoa: Like other MLPs, CPLP is all about boosting cash flow through accretive acquisitions. The MLP has already more than tripled the size of its fleet since its 2007 IPO, and management intends to continue evaluating potential acquisitions of both newbuildings and second-hand vessels from Capital Maritime, as well as unaffiliated third parties.

In fact, its relationship with Capital Maritime goes beyond mere asset dropdowns. CPLP’s parent company helps attract new charterers for its vessels, since it already has a reputation for meeting the rigorous vetting and selection processes of leading oil companies, as well as those of other charterers in the tanker, drybulk and container sectors. It also has a strong track record for safety, which is of paramount importance when transporting energy products over very long distances.

Ari: It looks like its general partner (GP) is wholly owned by Capital Maritime. Does it have incentive distribution rights (IDRs)?

Khoa: Indeed, it does. Capital Maritime has a 1.6 percent GP interest, as well as a 19.9 percent interest in the LP’s common units.

The GP’s IDRs represent the right to receive an increasing percentage of quarterly distributions after the minimum quarterly distribution and the target distribution levels have been achieved.

The GP currently receives 2 percent of the total cash distribution, though as certain targets are met over time, its share could rise to 15 percent (once the quarterly payout exceeds $0.4313), 25 percent (above $0.4688), before it finally maxes out at 50 percent (above $0.5625), in what is known in the MLP space as the high splits.

While CPLP could have room to boost its distribution in the near future, the payout is unlikely to rise to the next percentage tier for at least another several years. However, IDRs exist to incentivize GPs to facilitate dropdowns and other accretive acquisitions, so sometimes this picture can change dramatically in relatively short order.

Ari: What about secondary issuances?

Khoa: During 2013, CPLP issued 9.1 million Class B Units, which are convertible into common units on a one-for-one basis. In fact, 5.7 million Class B Units were already converted into common units by the end of last year.

CPLP used the proceeds from this issuance, along with approximately $54 million from its existing credit facilities as well as its cash balance, to acquire two 5,023 twenty-foot equivalent unit (TEU) Container Vessels for $130 million.

CPLP also issued nearly 13.7 million common units, and used the net proceeds, along with approximately $75 million from its 2013 credit facility and part of its cash balance, to acquire three 5,023 TEU container vessels from Capital Maritime for $195 million.

Ari: Among the recent news, I see that CFO and CEO Ioannis Lazaridis has announced he’ll be stepping down soon. Is that a concern?

Khoa: While it does mean there will be some uncertainty, particularly since this is a relatively lean company, where the top executive fulfills multiple roles, Mr. Lazaridis will remain in place until the company identifies his replacement. Additionally, he’ll be involved with the firm in a non-executive position after he formally steps down.

But really, the Marinakis family, including Chairman of the Board Evangelos Marinakis, who own a 27.3 percent interest in the MLP, are the ones calling the shots here. Presumably, their substantial ownership stake means they’re incentivized to make sure they get this transition right.

In the meantime, this uncertainty has caused a modest decline in the unit price, which offers a more attractive entry point.

Ari: What does CPLP’s balance sheet look like?

Khoa: At year end, total debt outstanding stood at $583.3 million, all of which was drawn from various credit facilities.

Total cash and cash equivalents were $64 million, while total liquidity including cash and undrawn long-term borrowings was $229 million. So CPLP has plenty of dry powder to pursue future acquisitions.

Ari: What about analyst sentiment?

Khoa: As a company that’s still in the midst of engineering a turnaround, the mix of analyst sentiment is almost evenly split between bullish and neutral, with five “buys,” five “holds” and one sell.

The consensus 12-month target price is $12.00, which suggests potential appreciation of 12.4 percent above the current unit price.

Ari: What about tax considerations?

Khoa: First, it should be noted that we’re not tax professionals, and that investors should ultimately consult their tax advisor or accountant with regard to these matters.

Like many of its maritime MLP peers, including current Portfolio Holding Navios Maritime Partners LP (NYSE: NMM), CPLP has elected to be treated as a C corporation for tax purposes. That means investors receive Form 1099 at tax time instead of a K-1.

The components of the distribution include both a qualified dividend (52.7 percent of last year’s total distribution) and a non-dividend distribution (47.3 percent of last year’s total distribution).

The former is taxed at rate of 15 percent, assuming a joint filing with taxable income below $457,600.

The latter is derived largely from the MLP’s substantial depreciation, which is added back to net income when determining distributable cash flow because it’s a non-cash expense. This component is considered a return of capital, which means it’s tax-deferred and reduces the unitholder’s cost basis over time on a dollar-for-dollar basis.

Please note that the “return of capital” designation is a technical characterization for tax purposes, and it does not mean that unitholders are literally receiving a portion of their investment back.

Ari: It looks like the unit price has been on a wild ride the past few years.

Khoa: Given the challenges the refined-product shipping market has faced in recent years, CPLP’s unit price has suffered tremendous volatility. However, the units are up 117 percent from their trailing five-year low in August 2011.

Even though the MLP currently trades just below its five-year high, the unit price is merely a fraction of the all-time high of $31.75 hit in July 2007, prior to the onset of the Global Financial Crisis.

The MLP has had strong upward momentum since early December and has risen 24.7 percent over the trailing year. But it’s down about 5.2 percent since its near-term high at the beginning of April, which offers an attractive entry point.

With a current yield of 8.8 percent, Capital Product Partners LP is a buy below 11.50.

Portfolio Updates

Bonavista Energy Corp (TSX: BNP, OTC: BNPUF) announced that fourth-quarter revenue grew 10 percent year over year, to CAD245.5 million. Funds from operation (FFO) rose 13 percent, to CAD124.3 million, or CAD0.62 per share. The company’s all-in payout ratio for 2013 was about 127 percent.

For the full year, total production revenue grew 16 percent, to $964.3 million, and FFO rose 26 percent, to CAD477.6 million, or CAD2.42 per share.

In 2013, Bonavista drilled 128 wells and said it plans to spend about CAD460 million to CAD500 million in 2014. The company plans to drill another 150 wells and expand its daily average production about 5 percent, to between 76,000 barrels of oil equivalent per day (boe/d) and 78,000 boe/d. When factoring in current commodity prices and the company’s hedge portfolio, management expects a 2014 all-in payout ratio of about 106 percent.

The mix of analyst sentiment tilts slightly bullish, at nine “buys,” eight “holds,” and one “sell.” The consensus 12-month target price is CAD18.55, which suggests potential appreciation of 6.6 percent above the current share price.

Analysts forecast full-year 2014 sales growth of 34 percent, to CAD1.13 billion. Adjusted earnings per share are projected to jump 92 percent, to CAD0.73. The company is expected to report first-quarter earnings in early May. Bonavista remains a hold.

BreitBurn Energy Partners LP (NSDQ: BBEP) announced that fourth-quarter production increased 40 percent, to 3,086 million barrels of oil equivalent (MBoe). Oil and natural gas liquids (NGL) production saw a 90 percent increase, to 1,909 MBoe, compared to the prior year’s quarter. Natural gas production declined to 7,060 million cubic feet (MMcf) from 7,243 MMcf in the fourth quarter of 2012.

During the quarter, BreitBurn drilled 27 gross wells and completed 9 gross workovers. Distributable cash flow (DCF) for the fourth quarter grew 43 percent, to $55.4 million, or roughly $0.46 per unit. Adjusted earnings before interest, taxation, depreciation and amortization (EBITDA) grew 50 percent, to $109.38 million.

For the full year, net production rose 32 percent, to 10,983 MBoe, and adjusted EBITDA rose 34 percent, to $370.37 million.

Total NGL and natural gas revenues rose 60 percent, to $660.7 million, in 2013 due to higher average gas prices, as well as a significant improvement in volumes. For 2013, the LP drilled 138 gross wells and completed 61 gross workovers.

In late December, BreitBurn completed $302 million in oil and gas acquisitions in the Permian Basin, bringing the total it’s spent on acquisitions in 2013 to $1.2 billion. The company is targeting about $600 million in new acquisitions for 2014.

Full-year DCF rose 29.4 percent, to $200.3 million, for a distribution coverage ratio of 1.0x at the end of 2013.

The company is targeting total production of about 13,600 MBoe to 14,400 MBoe in 2014, roughly a 23 percent to 31 percent increase from last year.

The master limited partnership (MLP) recently converted to a monthly distribution from a quarterly distribution. It recently bumped its monthly payout by 1 percent, to $0.1658, or $1.99 annualized.

The mix of analyst sentiment is strongly bullish, at 14 “buys” and three “holds.” The consensus 12-month target price is $22.32, which suggests potential appreciation in the unit price of 10.9 percent.

The MLP is scheduled to report first-quarter earnings on May 8.

With a forward yield of 9.9 percent, BreitBurn remains a buy below 21.

Crestwood Midstream Partners (NYSE: CMLP) reported that fourth-quarter adjusted EBITDA rose 7 percent, to $90.9 million, compared to the prior year’s quarter. DCF for the fourth quarter was $56.8 million, or $0.32 per unit, covering its $0.41 distribution by a ratio of 0.76x, a shortfall of about $20 million.

In the fourth quarter, Crestwood entered a new five-year revolving credit facility with the capacity to borrow up to $1 billion.

Management announced the majority of its capital spending in 2014 will be focused on the Marcellus ($220 million), Bakken ($106 million) and Niobrara ($106 million) shale plays.

Crestwood reaffirmed its 2014 Adjusted EBITDA of about $465 million to $510 million.

The mix of analyst sentiment remains largely bullish, at nine “buys” and six “holds.” The consensus 12-month target price is $25.70, which suggests potential appreciation in the unit price of 13 percent.

The MLP is scheduled to report first-quarter earnings prior to the market’s open on May 6.

With a forward yield of 7.2 percent, Crestwood remains a buy below 25.

Lightstream Resources (TSX: LTS, OTC: LSTMF) reported fourth-quarter 2013 average production fell 4 percent, to 45,521 barrels of oil equivalent per day (boe/d), while full-year average production rose 9 percent, to 46,438 boe/d.

The company reported fourth-quarter cash flow of CAD146 million, which slightly exceeded analysts’ estimates of CAD144.6 million. Full-year 2013 cash flow came in at CAD670 million, as Lightstream experienced a CAD1.3 billion impairment of goodwill relating to its SE Saskatchewan (CAD886 million) and Cardium (CAD463 million) operations.

In 2013, Lightstream paid out CAD133.8 million in cash dividends and CAD719.1 million on net capital expenditures.

With a monthly dividend of about CAD0.04 per share, the company expects to pay out roughly CAD96 million in 2014. It also expects to spend about CAD525 million to CAD575 million in capital expenditures in 2014.

Management projects the company will generate cash flow between CAD635 million and CAD665 million this year, which would result in a 2014 all-in payout of under 100 percent.

Given the company’s numerous challenges, the mix of analyst sentiment is decidedly neutral, at one “buy,” 15 “holds” and two “sells.” The consensus 12-month target price is CAD6.72, which suggests potential appreciation of just 2.3 percent above the current share price.

The company is expected to report first-quarter earnings in early May.

Lightstream remains a hold.

LRR Energy LP (NYSE: LRE) announced fourth-quarter revenue rose 1.3 percent, to $30.7 million. For the full year, total revenue fell 4.8 percent, to $115.1 million.

Average production came in at 6,466 boe/d for full-year 2013. The partnership expects daily production for 2014 between 6,400 boe/d and 6,600 boe/d.

DCF for the year came in at $49.6 million, which equated to a coverage ratio of 1.0x per common unit.

The MLP has boosted the level of its payout each quarter since late 2012, with the current distribution rising to $0.4925 per unit, or $1.97 annualized, from $0.49 per unit.

The mix of analyst sentiment is neutral with a strong bullish tilt, at five “buys” and six “holds.” The consensus 12-month target price is $18.17, which suggests potential appreciation in the unit price of just 1.9 percent.

The MLP is scheduled to report first-quarter earnings after the market’s close on May 1.

With a forward yield of 11.1 percent, LRR Energy remains a buy below 18.

Memorial Production Partners (NSDQ: MEMP) announced that fourth-quarter production grew 33 percent, to 167.7 million cubic feet equivalent (MMcfe), and 30 percent, to 154.3 MMcfe, for full-year 2013.

Fourth-quarter adjusted EBITDA increased 49 percent, to $65 million, and full-year adjusted EBITDA increased 24 percent, to $222.2 million.

DCF for the fourth quarter totaled $34.4 million, or $0.57 per unit, for a coverage ratio of 1.02x. For the full year, total DCF came in at $116.7 million, for a coverage ratio of 1.03x.

The partnership also completed a $603 million acquisition of assets in the Permian Basin, the Rockies and East Texas, its largest since its initial public offering (IPO). In all, Memorial spent $832 million on acquisitions in 2013, adding about 459 billion cubic feet equivalent (Bcfe) in proved reserves and net production of roughly 71.6 million cubic feet equivalent per day to its portfolio.

Memorial Partners has about 92 percent of its expected natural gas production hedged through the end of 2014 and 83 percent hedged in 2015 and 2016. Its crude oil production is 91 percent hedged through the end of 2014 and 89 percent hedged for 2015 and 2016.

The mix of analyst sentiment is strongly bullish, at 10 “buys” and three “holds.” The consensus 12-month target price is $24.50, which suggests potential appreciation in the unit price of 7.4 percent.

Memorial Partners is scheduled to report first-quarter earnings prior to the market’s open on May 7.

The MLP pays a $0.55 quarterly distribution, or $2.20 annualized. With a forward yield of 9.6 percent, MEMP remains a buy below 20.50.

Natural Resource Partners LP (NYSE: NRP) reported that fourth-quarter revenue fell 7.5 percent year over year, to $94.7 million. DCF for the quarter came in at $69.6 million, down from $87.6 million a year ago.

While the company’s main business, which is coal, continues to decline, management is attempting to diversify operations through investments in OCI Wyoming, a soda ash business, and crude oil.

Full-year 2013 revenue fell 6 percent, to $358.1 million, due to weak coal royalty revenue, which fell 18 percent, to $212.7 million. Income from its interests in OCI Wyoming and increased oil and gas sales helped offset some of these losses.

Coal production for the year dropped to 53.3 million tons, and the average royalty revenue per ton fell 17 percent, to $0.99.

Total DCF for the year rose to $309.4 million from $298.4 million, mainly due to cash distributions from OCI Wyoming.

While NRP’s coal production is expected to drop to a range of about 43 million tons to 50 million tons in 2014, it expects significant growth from its oil and gas operations, mostly due to increased crude oil production from its two recent Williston Basin acquisitions. With the soda ash market forecast to remain stable this year, NRP expects to receive about $42.5 million in distributions from OCI in 2014.

Coal royalty revenue for 2014 is estimated at $175 million to $195 million, down about 13 percent from 2013. Oil and gas revenue is expected to surge about 128 percent to $37 million to $41 million.

NRP plans to invest an additional $365 million into non-coal-related businesses to further diversify its revenue. Distributions for 2014 should boast a healthy coverage ratio of about 1.2x to 1.4x.

Given the headwinds facing the coal industry, the mix of analyst sentiment is largely neutral, at one “buy” and six “holds.” The consensus 12-month target price is $17.50, which suggests potential appreciation in the unit price of 9 percent.

The MLP is expected to report first-quarter earnings in early May. NRP remains a hold.

Navios Maritime Partners LP (NYSE: NMM) reported fourth-quarter net income fell 43 percent, to $10.1 million. Earnings for the year fell 20 percent, to $59 million.

Nevertheless, CEO Angeliki Frangou said Navios is committed to a minimum total annual distribution of $1.77 through 2015. And as drybulk shipping recovers and charter rates improve, the company will be positioned to increase distributions in the medium term.

At its current rate, analysts expect the distribution to be secure through 2015, with a distribution coverage ratio of about 1.0x.

Navios ended 2013 with a fleet utilization of 99.6 percent, with average daily charter-out rates for the fleet of about $24,233.

The company announced that so far it has 74.7 percent of its available days contracted out for 2014.

The mix of analyst sentiment is weighted toward neutral with a strong bullish tilt, at five “buys” and six “holds.” The consensus 12-month target price is $20.00, which suggests potential appreciation in the unit price of 8.5 percent.

Navios is scheduled to report first-quarter earnings on April 29. With a yield of 9.6 percent, Navios remains a buy below 17.70.

QR Energy LP’s (NYSE: QRE) fourth-quarter production came in at 18,522 boe/d. Despite a negative impact of 150 boe/d due to weather in the Permian Basin, daily production was in line with its estimate of 18,500 boe/d to 18,900 boe/d.

About 73 percent of total 2013 crude oil production was hedged, while 81 percent of natural gas production was hedged, with an average price of $98.51 per barrel. The company’s NGLs are not currently hedged.

Fourth-quarter revenue came in at $119.3 million and adjusted EBITDA stood at $72 million, up 22 percent and 28, respectively, from the prior year’s quarter. Full-year 2013 revenue rose 22.5 percent, to $455.6 million.

The company announced it excited the year with a 10 percent increase in its proved reserves, which now total 109.1 MMboe.

QR Energy generated $131.9 million in DCF for 2013, with a distribution coverage ratio of 1.0x. Management expects full-year 2014 average daily production of about 19,700 boe/d to 20,400 boe/d.

The mix of analyst sentiment is strongly bullish, at 10 “buys,” five “holds” and one “sell.” The consensus 12-month target price is $20.00, which suggests potential appreciation in the unit price of 10.1 percent.

The MLP is scheduled to report first-quarter earnings prior to the market’s open on May 7.

With a current yield of 10.7 percent, QR Energy remains a buy below 21.

Spyglass Resources Corp (TSX: SGL/OTC: SGLRF) reported full-year 2013 FFO of CAD60.6 million, or CAD0.54 per share.

During the year, the company’s CAD0.225 monthly dividend was covered with an all-in payout ratio of 104 percent.

Average daily production rose 14 percent, to 15,215 boe/d. The increase was due to a planned arrangement it completed in early 2013, which combined Pace Oil and Gas, AvenEx Energy Corp and Charger Energy.

Spyglass plans to sell off non-core assets in 2014 to reduce debt and boost capital spending. About 47 percent of the company’s estimated crude oil production is hedged for 2014.

The mix of analyst sentiment is largely neutral, at two “buys,” five “holds” and two “sells.” The consensus 12-month target price is CAD2.06, which suggests potential appreciation of 12 percent.

The company is expected to report first-quarter earnings in mid-May. Spyglass remains a buy below USD2.25.

On April 7, Starwood Property Trust (NYSE: STWD) announced an underwritten public offering of 22 million shares of its common stock. The underwriters have a 30-day option to purchase an additional 3.3 million shares.

The company will use the net proceeds of about $496.1 million to purchase additional commercial mortgage loans and other assets and investments. Starwood Property also said it may use a portion to pay off liabilities and other working capital needs.

Starwood remains a buy below 24.50.

Windstream Holdings (NSDQ: WIN) announced that strategic revenue–sales for its broadband and business services operations–grew by 2 percent during the fourth quarter, to $149 million. The company’s fourth quarter showed better growth in business and wholesale revenues, which offset a weaker-than-expected consumer segment.

For the year, total revenue fell 2 percent, to $6 billion. Strategic revenue grew 2 percent, to $4.3 billion, and now represents about 71.6 percent of total revenue.

For the year, Windstream was able to shave $200 million from its debt and refinanced $4 billion in debt by extending maturities and cash interest expenses.

Management expects 2014 revenue growth in the range of negative 2.5 percent to a 1 percent increase. The company projects 2014 adjusted free cash flow of $775 million to $885 million, which should result in a dividend payout ratio of between 68 percent to 78 percent. The company continues to maintain its quarterly payout of $0.25 per share.

Given the company’s muted growth prospects, the mix of analyst sentiment is largely neutral with a bearish tilt, at two “buys,” eight “holds” and five “sells.” The consensus 12-month target price is $8.34, which is actually 6.1 percent below the current share price.

The company is scheduled to report first-quarter earnings on May 8.

Windstream is now a hold.