Ocean Yield – Possible Reversion After Q3 2020 (OTCMKTS:OYIEF)

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Ocean Yield is a company I try to keep track of – given my 1% portfolio stake in the company. Sadly, due to COVID-19 and the company’s issues with its FPSO, and the pandemic-resulting finance troubles, the company has been pressured from multiple sides for months now, leading to capital destruction on a scale of only 2-3 positions in my portfolio rival.

However, the latest quarterly reports start to show a bit more promise – and it’s time to look it over.

The purpose of this article is to report on Ocean Yield and to decipher the company’s results a little. We’ll talk about dividend sustainability and what we can expect from the company’s operations going forward. We’ll conclude with the crucial answer to the question “When could you invest in Ocean Yield?”.

Let’s see where we stand.

Ocean Yield – How has the company been doing?

The picture the company is presenting, and one I agree with, is that things are improving slowly. I’ve been fairly clear in my previous articles – all articles on the company – that Ocean Yield, thanks to its capital structure, the network of creditors, and assets, has a fairly stable fundamental base – with the exception of one or two of those assets that continue to hamper things.

This is the story of 3Q20 – at least in part.

Looking at profit metrics and cash-flow-equivalents, the company finds itself in a stable and somewhat improved position going into 4Q20. Over the past few months, Ocean Yield has been busy addressing its capital structure, improving debt and credit ratios through a variety of means (most of them fairly accounting-related), but the company has also been leveraging its credit advantage and size to continue buying and leasing vessels.

On a quarterly basis, the results included:

  • Improved adj. net profit from continuing operations, up to $22.0M from $21.3 sequentially, and up from $16.8 YoY. On a YoY basis, we can see a clear improvement in the company’s net profit thanks to some of these improvements.
  • EBITDA of $52.2M, Adj. EBITDA of $75.8M, the latter being adjusted for ship leases.
  • Continued EBITDA backlog of nearly $3B over 10.1 years of average charter length.
  • Over $163M in cash/equivalents, with a total of $200M in available liquidity.
  • The company has received shares in Solstad offshore, equal to about 3.8% of the company. As of now, the company has no plans to divest these shares (Source: 3Q20 Earnings Call, Lars Solbakken)

Additionally, the company elected to increase the dividend, albeit by 0.1 cents per share. That turns the current yield into around 9%.

Results also included some one-offs which need be considered. If you recall, the company had a total loss due to a fire of a Höegh vessel, and $26M worth of insurance payment has been received by the company. Ocean Yield also sold a chemical tanker, and an oil-service vessel, while acquiring two Suezmax vessels, essentially keeping the fleet at the current size.

I personally believe anything that reduces the company exposure to upstream, midstream, or downstream, particularly in the service or drilling sectors, to be positive and consider the sales excellent.

Ocean Yield has also continued to show its financial strength, prepaying a 300M NOK bond (OCY04), and buying back 20M NOK of bonds early. Results were overall in line with last quarter results, but there are some positive points to be held up overall. The company has reduced its overall average interest rate, meaning financial leases are down slightly. The company also received income from a new JV’s, which Ocean Yield now has with both Aker as well as Quantum pacific.

Overall, looking at unadjusted profit numbers, they are heavily negative due to impairments taken by Ocean Yield not only for the FPSO but for the vessel Connector. There are also some costs for the establishment of the JV with Aker, which drove financial expenses up to $17M for the quarter, still down sequentially from $25M in 2Q20.

The main points that we revisit during every quarterly presentation with Ocean Yield are:

  • The FPSO Dhirubhai-1.
  • The Connector/FAR Senator and Statesman.

There’s no real visibility for a conclusion for the FPSO chapter in this quarter. The company states that it’s in the process of selling the vessel, and hopes to get at least equal to or above book value for it, but we have no timing guidance. So while discussions are apparently progressing, there’s no expectation for when things will improve. The company also took a nearly $100M impairment for the vessel in 3Q20, which was part of what drove the net profit down, together with impairments for the Connector. The FPSO will likely be an anchor dragging the company results down for some time yet.

Thankfully, the Connector will be providing the company with income starting December of 2020 thanks to a short-term charter in a challenging market, but there’s still a period of dry-dock for the vessel, and an impairment of $36.4M has been recorded.

The good news this quarter is the progress made in FAR Senator and Statesman, which are included in the restructuring agreement with Solstad offshore. Both vessels now have 4-year bareboat charters with variable rates, and the company has also received 3.8% of SO in Solstad Offshore. At market value, the company’s 2.8M shares are worth around ~8-9M NOK, though the company currently has no intention of divesting them, and expects positive EBITDA from the vessels and investment going forward.

(Source: Ocean Yield)

I think we now know enough of the quarter to start wrapping up a bit.

In my 2Q20 report, I pointed quite a bit to the counterparty risk that the company held in assets, or vessels. The short-term recovery that began in 2Q20 has, in some ways, continued during this quarter. What’s significantly more important as I see it is, however:

  • The company has continued to reduce counterparty risk, and trends in bulkers and other segments are improving.
  • The stated priority, according to IR and management, of fortifying the balance sheet and making things significantly safer, has been continuing during this quarter.
  • During 2Q20 we had really no indications as to the FPSO. The current indication, that sales talks are ongoing, but we don’t have a time frame is still a significantly improved statement from what was given the last quarter.
  • The counterparty/vessel risk with FAR Senator/Statesman has essentially been eliminated under the new structure.
  • The Connector will be delivering EBITDA starting December of 2020.

In my last article, I mentioned:

First, company EBITDA as well as profit/adj. net profit is already materially improved from a YoY comparison. Given that things are likely to improve in 3Q20 and 4Q20 rather than decline (an educated guess based on trends and forecasts, not a guarantee), it’s to be expected that FY20 EBITDA/earnings will be improved compared to FY19. Based on the 175M number of outstanding shares, the current dividend level of $0.05/share, coming to an annual dividend of $0.2, would eat up around ~$35M worth of profit, excluding dividends on hybrid capital and controlling interests.

(Source: Ocean Yield – Painful Road to Recovery)

This has not changed. While this quarter hasn’t been a material, sequential improvement, it’s a fundamental improvement on a YoY basis. Even with the very slight dividend increase, the company won’t be endangering anything, based on either TTM or NTM numbers.

So, Ocean Yield is still very much in recovery/crisis management mode, though the crisis that needs to be addressed has certainly been reduced in scope. I argue that with the new JV’s and the FAR Senator/Statesmen deals, only the FPSO really remains as the one significant, forward risk for the company. Once this risk has been solved – either way – We’re looking at a pathway of recovery for the company.

Ocean Yield has also continued with its historical trends of acquiring and leasing new vessels, even during today’s market, and continues to find leasing customers with good credit rating to add to its significant portfolio and EBITDA Backlog.

(Source: Ocean Yield 3Q20 Presentation)

With most of its vessels on long-term charters and with a well-diversified contract spread, the company continues to show long-term visibility for its profits, even if current company dynamics with the FPSO and macro drag things down. The company’s financial situation, while improved, continues to be stressed, and gearing continues to be extremely high, with an equity ratio still under 30%. The credit market continues to be the real only available source of capital for this company.

Issuing new equity at the current market cap/share price would be foolish, to put it mildly, given the actual book value of the company’s current asset base.

I expect the company to continue trading at pressured valuations and with uncertainty until the FPSO dilemma is fully resolved (and possibly the Connector as well).

Interestingly enough, the company provided some positive dividend guidance this quarter.

I think that our plan is to gradually increase the dividend going forward. We have a conservative dividend level at the moment compared to the expected dividend capacity. But we — due to the lower share price, we do not have any intention of raising new equity for growth. So therefore, we will maintain a more conservative dividend payout ratio than we have historically have, but the plan is absolutely to gradually increase it.

(Source: 3Q20 Earnings Call, Lars Solbakken)

If you recall my last article, the company’s comments regarding the dividends at that point were far more unclear. With one dividend raise already done, and the company intending to gradually elevate the dividend back towards more normal levels, the catalyst for recovery at that point will be the solving of the current issues and a continued improvement in the company’s equity ratio.

With trends as they currently are, I don’t see any substantial risk that could lead to a complete failure in this respect. The combination of the low share price together with macro requires the company to raise its equity ratio and improve its credit rating to continue to have access to the credit market that enables its purchases of vessels. Increasing the dividend would currently endanger this – but the catalysts for a reversion are, as I see it, slowly becoming clearer.

Let’s look at valuation.

Ocean Yield – what is the valuation?

Very little has changed with regard to company valuation from my last article. The company continues to be undervalued on a historical basis in terms of its earnings (normalized), its FCF, and its operating cash flow per share. In terms of the book value and tangible book value for its assets, the company currently trades at 0.5X of that book value. Going by pure book value, fair 1X valuation, which has been historically more true, would indicate a nearly double level in share price from current pricing.

None of this is news, and it’s what we’ve been saying for the past few articles. Ocean Yield has dropped from a share price of above 40 NOK/share to current levels, and book value alone certainly isn’t, and never should be enough to convince anyone that a company is undervalued.

The headwinds faced by Ocean Yield are known and well-established at this point. Both from articles like this one and by the company itself. Elevated amounts of counterparty risk, credit risk, and sub-par capital structure with elevated gearing ratios have pushed the company to where it stands today.

However, in order for there to be an actual risk of default if you will, or destruction of capital, the company’s assets or contracts would have to be declared worth much less or higher risk than they currently are. Given the improvements in counterparty risks, new JV’s, better equity ratios, and a light at the end of the tunnel for the FPSO, it’s my argument that we’re starting to see positives here. The increase in company dividend confirms this further, in my opinion. You need to recall the ownership structure of the company, with essentially a very motivated majority owner having the stake in Ocean Yield.

(Source: TIKR.com)

In my last article, I said that:

Ocean Yield’s valuation and prospects should be viewed in a potentially positive light not only because of these insider interests, but because the company’s financial plan going forward makes sense. The company continues to have all of the advantages that I’ve previously pointed out, but now trades at a barely-above bottom-feeding sort of valuation.

All of the relevant multiples, including earnings, revenues, EBITDA point toward the fact that the company is currently being traded at a much lower multiple than historically seen – but there are, of course, reasons for this. Investors must decide whether they believe this market price reflects the realistic future potential of the company, or whether the market is mispricing the long-term value of Ocean Yield here, as well as the associated risk.

(Source: Ocean Yield – Painful Road to Recovery)

I believe that we now have improved visibility to justify a slightly more positive stance on the company. The JV, the continued YoY beats, the dividend raise, the progress with the FPSO, new contracts for Connector, and JV with the two FAR Vessels, Ocean Yield is progressing toward a point where results will no longer be impaired by things like the Dhirubhai-1. An Ocean Yield that reports for the most part unimpaired EBITDA is a company that generates significant amounts of cash simply based on the ongoing contracts it currently owns. With improved market conditions for many of the company’s sub-segments, I feel comfortable raising the company a notch or two in terms of regard and target.

While saying this, I also want to point out that by investing in Ocean Yield, you’re investing in a higher-risk company, and I believe that a 9% yield isn’t necessarily appealing enough to warrant a buy for you specifically.

There are companies that are several hundred times the size of this one, with nearly equal yield, in far more conservative sectors. This investment appeals to a very specific group of investors – and it certainly isn’t one I recommend for everyone.

Current street targets for the company range between 20-45 NOK/share, with an average of about 29.75 NOK/share, marking the company at a street undervaluation of around 37% at the current market price. That valuation is equal to a 2021E estimate of around 8X P/E, and 5-year normalized EPS of around 6X P/E – fairly low in my book, but understandable when we consider the risks. We also know that in terms of book value, relevant for an asset-heavy company like Ocean Yield, the undervaluation indicates more than 50% undervaluation to historical multiples.

To remain conservative, I give Ocean Yield a price target in this article, but one below the current street means, and one that takes this historical normalized P/E multiple targets over 5-years, and applies it to forecasted earnings for 2021. That means a 6X earnings price target comes to a price target of around 23 NOK/share, which makes the undervaluation to my conservative estimate around 10% at the time of writing this article.

Granted, it needs to be said that at these estimates, the company’s dividend payout ratio is less than 55%, and the potential upside in terms of book value is still massive. But I don’t feel comfortable, given the risks still involved, to give the company any sort of higher target here until we have more visibility.

Thesis

Ocean Yield comes with a “BUY” rating, but one that requires careful consideration. The low appeal here is based in large part on comparative appeal in other, much safer companies with near-equal dividend yields but safeties that eclipse Ocean Yield’s by far.

To the question of whether I consider the company’s dividend safe – I do, under current circumstances. But other companies, of course, offer far safer yields. To the question of whether the company will recover, my answer is that I believe that Ocean Yield will recover.

But for the conservative dividend investor, with alternatives including companies that don’t have any crisis to recover from, it’s hard to justify a “BUY” on this company when considering available alternatives. Only when other positions are filled and your risk tolerance is high can you consider the company – that’s how I see it.

The potential here is not only a 100%+ capital appreciation when things normalize, it’s a dividend that starts at 9% currently and is set to grow significantly over time, as the company has the capacity to under normal operations pay out nearly twice as much. Ocean Yield is a dividend company – that is its sole reason for existing and owning the assets it does. So the potential here is incredible, there’s no doubt about it.

The flip side is however that it may take years, or it may never happen. A souring in the credit market or a shift in interest rates – remember, many of the company’s lease agreements have LIBOR-related adjustment clauses – can go both ways. The same trends that have improved the company’s leasing costs can reverse, and make it essentially unprofitable to do so if things get bad enough.

This is why the company, for me, is a clear Class 4 stock with a high-risk rating. It’s as “speculative” as I’m comfortable getting into – and remember, I then consider the company long-term “safe” enough for me.

Still, looking at Ocean Yield exclusively, I consider the company at this time to be a 9-10% undervalued “BUY”, with a price target of 23 NOK/share.

Thank you for reading.

Disclosure: I am/we are long OYIEF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: While this article may sound like financial advice, please observe that the author is not a CFA or in any way licensed to give financial advice. It may be structured as such, but it is not financial advice. Investors are required and expected to do their own due diligence and research prior to any investment.

I own the European/Scandinavian tickers (not the ADRs) of all European/Scandinavian companies listed in my articles.

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