Within the highly cyclical LNG shipping industry, spot rates have recently been weak due to the Covid slowdown and a warmer than expected winter. However, Teekay LNG Partners (TGP) benefits from longer-term fixed-rate contracts with well-established partners allowing it to earn rates that are well in excess of the current market spot rate. And in addition to the strong cash flows, this generates for the company, Teekay has also been strengthening its balance sheet and it eliminated incentive distributions rights (two more positives for the investors). In this article, we review the health of the business, cash flows, balance sheet strength, valuation, risks, dividend safety, and then conclude with our opinion on investing in the 9.4% yield common units versus the 9.3% yield preferred shares.
Overview: Teekay LNG Partners
Teekay LNG Partners LP is a master limited partnership (“MLP”) that owns, operates, and acquires LNG carriers. It was created by Teekay Corporation (TK) in 2004, which currently owns ~32.5% of limited partnership (LP) units and a 2.0% general partner (GP) interest. The MLP structure often comprises two entities: a limited partnership that owns the underlying assets and a general partner that is responsible for managing day-to-day operations of business.
As of Q220 (June 30, 2020), TGP’s fleet consisted of 47 LNG carriers and 30 LPG and multi-gas carriers. Additionally, TGP owns a 30% interest in regasification terminal in Bahrain. The fleet is relatively young and has an average age of just 9.5 years compared to world averages of 10 to 15 years.
Also, important to note, the company completed an IDR buyout in May, thereby better aligning management and investor interests. IDRs (Incentive Distribution Rights) entitle a general partner to an increasing share of a partnership’s incremental distributable cash flow). Following the buyout, management and investor interests are now better aligned.
Long-Term Fixed-Rate Contracts Provide Revenue Visibility
Currently, all 47 vessels are chartered under long-term contracts thereby providing future cash flow visibility. The LNG fleet is 100% fixed for 2020 at nearly $80,000/day. This is far higher than the current spot LNG carrier market rates of $35,000 to $40,000 per day. Further, TGP’s fleet is 94% fixed for 2021 as well which again is very encouraging in the current environment where the LNG markets have been volatile and unpredictable. These fixed rate contracts are not impacted by LNG prices or cargo cancellations.
Importantly, Teekay’s LNG carriers have a remaining fixed contract life in excess of 11 years, and these contracts are servicing the needs of blue-chip customers such as Shell (NYSE:RDS.A) (NYSE:RDS.B), BP (NYSE:BP), and Cheniere (NYSEMKT:LNG). For these reasons, we do not see any dramatic risks to future revenues (knock on wood). Based on the remaining tenure of its long-term contracts, TGP expects to generate total forward fee-based revenue of ~$9.3 billion. This will translate to adjusted EBITDA of ~$7 billion (given an EBITDA margin of around 75%). This level of EBITDA compares favorably to its current total adjusted net debt balances of $4.5 billion, which includes the company’s proportionate net debt of its JV interests.
(source: Company Presentation)
Financials Continue to Improve
The company’s financial performance has been improving over the past two years. For example, second quarter adjusted net income increased to a record $62.6 million and total adjusted EBITDA also reached a new record level of $192.3 million. As shown in the graphs below, both adjusted EBITDA and adjusted net income have remained on an uptrend during the last eight quarters. And despite the pandemic, TGP reaffirmed its previously provided 2020 guidance. It expects earnings per unit to be in the range of $2.40 to $2.90 for 2020.
(source: Company Presentation)
Additionally, the leverage continues to decrease which further highlights the stability of its cash flows. The company has reduced its total adjusted net debt by $428 million or nearly 10% since the end of 2019 and expects it to be within its targeted leverage range in 2021. The leverage moved from an annualized 6.7x one year ago to 5.9x as of the end of Q2 2020 on an annualized basis. The current debt profile is very manageable. TGP has current liquidity of over $305 million and no further debt maturities in 2020.
(source: Company Presentation)
High Distribution Coverage Ratio Supports the Dividend
TGP’s cash distributions (or dividends) to shareholders have grown at an average annual rate of over 30% in each of the last two years. The current annual dividend payout of ~$1.00 per share implies a yield of ~9.6% which is very attractive in our view. TGP has signed multi-year charters with multiple high-quality customers, including Shell, Cheniere Energy, Inc., and BP. The leases provide predictable cash flows and allow TGP to return cash to investors on a regular basis. In fact, because the company is structured as a master limited partnership (MLP), it is required by law to distribute most of its available cash to unitholders.
It is important to note that the distribution coverage ratio as of Q220 was 4.1x. A ratio of greater than 1 indicates that the company generates more cash than that is required for distributions and shows strength of the company’s business. We are encouraged by high distribution coverage ratio as it validates our view that the dividend is relatively quite safe, and TGP will not only be able to maintain its payout but also increase it going forward.
Preferred Shares Have Benefits Versus Common Units
TGP has issued two classes of Preferred shares so far – 9.00% Series A, and 8.50% Series B. Both the classes were issued with liquidation preference of $25.00 per unit, at a price to the public of $25.00 per preference unit. These units are senior to the common units and, as such, receive priority over the common units in distributions and liquidation.
The Preference Units are listed on the New York Stock Exchange under the symbol “TGP PA”, and “TGP PB”. TGP.PA is currently trading at a slight discount (0.32%) to its liquidation preference and is callable in October 2021. TGP.PB is currently trading at a relatively higher discount (9.52%) to its liquidation preference and is callable in October 2027. When the preferred stock is callable, it means that the issuer (in this case TGP) has the right to call in or redeem the stock at a pre-set price (liquidation preference) after a defined period (callable date).
Of the two preferred stocks, we like Series B (TGP.PB) given great price appreciation potential and higher yield. When looking at historical prices, we see that the Series B preferred was trading above $25 range pre-COVID. We expect it to go back to those levels again as normalcy returns and this will imply decent price appreciation for investors. While the Series B preferred shares have a slightly lower dividend yield when compared to the common units, the preferred units exhibit much lower price volatility compared to common units. Thus, they are particularly attractive for investors seeking steady income with low volatility.
(source: Yahoo finance)
However, with volatility in mind, investors with a stronger tolerance for ups and downs (hopefully, a lot more up for Teekay), the common units are worth considering too. In fact, the distribution will likely continue to increase considering Teekay’s younger fleet and improved financials. The concern, however, is spot rates. Specifically, as 6% of the ships roll off contracts in 2021 (and more in the years ahead), the company will again be at increasing mercy of market rates. There are reasons to believe rates will improve (as the world moves beyond the Covid slowdown), but the preferreds continue to provide a safer bet (albeit with a slightly lower yield and only a small fraction of the price appreciation potential). Every investor has to decide what makes the most sense for their personal situation.
From a valuation standpoint, TGP appears reasonably valued compared to other LNG shipping MLPs, but this doesn’t take into account the improving fundamentals and advantages of the business. For example, TGP could have significant upside as it pays down its debt and as LNG market conditions improve. For example, on most measures (such as EV to EBITDA, Price to Distributable Cash Flow and Dividend Yield), TGP appears valued competitively considering its relatively higher leverage. Nonetheless, we believe there is scope for the common units to appreciate significantly, but the share price path could be volatile and it is less certain than the preferred units.
(source: Thomson Reuters)
High leverage: TGP noted that its current adjusted net debt is ~$4.5 billion (including its portion of JV debt). The leverage at the end of Q220 was 5.9x. This could be a cause of concern if there are any disruptions to its expected cash flows. We believe TGP has its debt and liquidity under control, especially considering there are no near-term debt maturities and TGP is well positioned to refinance its debt payments due in 2021.
Industry risk: The LNG sector is a cyclical industry that has historically been volatile. This impacts all shipping companies. Additional risks to the LNG sector include commodity prices, global GDP growth, natural gas demand, weather and environmental regulations.
Teekay LNG Partner’s financial position continues to improve, and, in our view, those improvements are not fully reflected in the market price of the common or the preferred units. Spot rates are less of an issue for the company in the near term (the fleet is fully-fixed for the remainder of 2020 and 94% fixed for 2021), but they will increasingly matter over the long term. The LNG industry is cyclical and can be volatile, but there are reasons to believe conditions will improve from where they are currently. If you are willing to pay closer attention to market conditions and you are more interested in dramatic upside potential than simply steady income distributions – the common units are worth considering. However, the preferred units have some upside too, and the price and income payments of the preferred units are safer. We are currently long the series-B preferreds, but always encourage investors to know themselves and to consider the investments that make most sense for their individual situation.
Top 7 Preferred Stocks: 7.0% Yields and Up
We have ranked the preferred units of Teekay LNG Partners #5 on our new report, Top 7 Preferred Stocks: 7% Yields and Up. We appreciate the improving quality of the company’s balance sheet, and believe improving market conditions could also add further strength to the business. The full report is available to members of our Marketplace service, Big Dividends PLUS by Blue Harbinger. We are currently offering free 2-week trials to the service and a discounted membership rate through Tuesday, October 6th. Learn more.
Disclosure: I am/we are long TGP.PB. 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.