|Shares Out. (in M):||107||P/E||0||2.8|
|Market Cap (in $M):||548||P/FCF||0||0|
|Net Debt (in $M):||3,579||EBIT||358||420|
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Teekay Offshore (TOO) is an MLP daughter company of Teekay Shipping (TK). Up until two days ago it paid an annual dividend of $2.24 per share or 43% at today’s stock price. TOO had plans to increase the dividend in 2016 and 2017 based on growth projects coming online. Last Thursday they announced a dividend cut to .11 cents quarterly an annual rate of 8.5% at the current price. The stock has declined from $36 eighteen months ago to $5 today.
So what happened? Well first the business is the same today as it was a few days ago, but like many other MLP’s TOO had counted on the equity market to finance growth. They would issue additional equity units to cover about 20% of the cost of new projects. As long as TOO’s equity was trading at a reasonable dividend level, this provided accretion to the existing equity holders. With the share price decline it became prohibitively expensive and dilutive to issue equity.
With the dividend change TOO’s risk relating to the equity component of its growth has lessened considerably. This move, in fact, will increase significantly the value of that growth to existing shareholders. The stock sold off 55% on the dividend change announcement, creating a great opportunity. To buy into the opportunity you need to be of the view that the world will continue to need offshore oil development to support world demand and that oil on average over the next 5 to 10 years will be higher than $35 a barrel.
TOO owns vessels called Floating Production Storage and Offloading units (FPSO’s) and shuttle tankers that service offshore oil fields. A FPSO vessel is designed to receive oil produced from a nearby field and then process and store it until it can be offloaded onto a tanker or transported through a pipeline. FPSOs are preferred in many offshore regions as they are easy to install and do not require a local pipeline infrastructure to export oil. Shuttle tankers shuttle oil from an offshore field to a terminal or larger tanker. TOO’s vessels are in long term contracts with major oil companies, such as Exxon, Statoil, Chevron and others with an average remaining contract length of five years. Typically new contracts are for initial terms anywhere from five to fifteen years and can include options. Offshore fields typically produce for long periods of time which benefits contract lengths.
This is a specialized niche in the oil services industry with the top five owners representing 62% of the market (65 units). Unlike the drill rig market there is nothing being built today that does not have a long term contract in place. Customer switching costs are high due to the customization of each vessel. TOO’s contracts do not have “outs” like some drilling rig contracts. The only typical “out” is if the oil price goes below lifting costs. In fields TOO operates in this cost varies from $3 to $12 per barrel. It is very unlikely that even in case of a major oil company bankruptcy that an existing contract would be terminated. Production and cash flow is of value in just about any oil price environment give low lifting costs associated with the projects TOO services.
TOO has four contracts coming online in 2016 and 2017. In total they represent about $1.8 billion in cost. TOO is financing these projects with debt (80%) and equity (retained cash flow from the dividend cut).
The new projects are:
1) Petrojarl FPSO - An older FSPO TOO owns that has been off contract after 12 deployments over the years. Recently they successfully signed a new agreement to operate the vessel offshore Brazil. The vessel is undergoing a $250 million upgrade that will extend its life by fifteen years. It will be placed back in service later in 2016 under an initial five year contract. The field in which it will be operating in is in its early stages of development, so the odds of the vessel working in that area under new contracts after the initial five year deal are very good. Financing is secured.
2) Libra FPSO Conversion (50% JV) – Will operate in Santos Basin offshore Brazil under a 12 year charter contract. Long term debt facility of $800 million is secured. Scheduled to commence operation in early 2017. Estimated 260 million BOE recoverable.
3) Gina Krog FSO Conversion – Operate in Gina Krog field in North Sea. Estimated 225 million BOE recoverable. Three year contact with 12 additional 1 year extensions. Long term debt facility of $230 million nearing completion. Expected to commence contract in second quarter of 2017.
4) ALP Towage Newbuilds – 4 state art towage vessels delivered throughout 2016. Building book of business now. Long term debt facility of $185 million secured.
The current low oil price environment has some benefits in the short run. For example re the Petrojarl….by using an existing vessel with modifications rather than a new-build, the oil company lowered their cost and also shortened the time to delivery. Similar opportunities may present in the future given the belt tightening by majors exploration budgets.
In the most recent quarterly earnings call, Peter Evensen, the CEO of TOO, commented on the inquiries and dialog they are having with customers about selling FPSO assets they own and operate to TOO. This could be a win/win for both. TOO’s specialization and operating expertise in this niche allows them to operate at a lower cost than the oil exploration companies. Therefore it may be a source of good business and growth for TOO, and another way for oil companies to reduce costs.
In early June 2015, TOO completed the acquisition of the Knarr unit from its parent company, Teekay. It has just been put on full contract in the North Sea with BG Nodge Limited, part of BG Group. TOO acquired the Knarr unit at a cost of $1.25 billion. The contract term with BG is six years with additional options for up to twenty years. The Knarr is the largest FSPO in the world and has the ability to process 65,000 barrels of oil per day and store 800,000 barrels.
Based on these additions above, TOO expects operating cash flow to grow 25% per year over the next two years. On a $500 million market cap after the current 8.5% dividend the company will generate from operations about $900 million over the next two years for equity investments in growth projects and debt reduction. The company has stated the dividend reduction will save $450 million over the next two years. Current projects outlined above require additional equity of about $200 million. This leaves $700 million for debt reduction, growth projects beyond 2017 and capx for redeployment of existing vessels (or $5.60 per share in cash which is higher than current trading price of the stock). TOO has about $60 million of bonds maturing in 2016, $70 million in 2017 and $90 million in early 2018. The new policy should provide ample room to retire maturing bonds.
In the most recent call announcing the dividend cut, TOO talked about a future dividend policy that left more room to pay down debt. Given the expected increase in cash flow over the next two years, TOO’s dividend capacity (assuming prior goal of 1.1 time coverage) ramps up to about $2.80 a share by end of 2017. Even paying out half of that gets the dividend to $1.40. I would expect in a more normalized environment for oil and with 2X coverage a yield of 7% would not be too aggressive. At that level the stock would be worth $20 or 4X today’s price. You would think that the reduced financial uncertainty created by the dividend cut would someday be recognized as good for shareholders and that the stock price would correct the mistake it made when it puked on the announcement.
|Teekay Offshore (TOO)|
|Vessle Operations||$ 1,019||$ 1,205||$ 1,575||$ 1,950|
|EBITDA||$ 467||$ 620||$ 760||$ 940|
|Interest||$ 70||$ 250||$ 290||$ 340|
|Preferred Dividend||$ 10||$ 18||$ 46||$ 46|
|Common Dividend||$ 184||$ 200||$ 47||$ 47|
|Net Cash Flow||$ 203||$ 152||$ 377||$ 507|
|Debt||$ 2,832||$ 3,833||$ 4,200||$ 4,850|
|Preferred Equity||$ 144||$ 144||$ 575||$ 575|
|Share Price||$ 5.13|
|EV||$ 3,524.91||$ 4,525.91||$ 5,323.91||$ 5,973.91|
|Cash Available for Growth Projects||$ 203||$ 152||$ 377||$ 507|
|and Debt Reduction|
|As a Percentage of Current Equity Value||37.0%||27.7%||68.7%||92.4%|
Market realizing TOO's business was not harmed by the dividend cut in fact it was strenghened.
Normalization of the oil market
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