After enduring a disappointing fourth quarter, the master limited partnership (MLP) space is leading the market so far this year. Indeed, on a price basis, the Alerian MLP Index is beating the S&P 500 by 5 percentage points year to date. And when you include the reinvestment of dividends for both indexes, that advantage widens to more than 6 percentage points.
As such, among the MLPs in our coverage universe that have buy targets–as opposed to “hold” or “sell” ratings–roughly half are trading above these recommended thresholds. That greatly narrows the number of MLPs that not only trade below our buy targets, but also have a Safety Rating of 3 or higher, as well as the prospect of ample distribution growth.
But first, a proprietary aside: Our MLP Profits Safety Rating System focuses on those factors that are indicative of both the safety of a distribution, as well as its potential for future growth. The highest possible Safety Rating is a 4.
One of the more intriguing names that satisfies the aforementioned criteria is Golar LNG Partners LP (NSDQ: GMLP). The limited partnership (LP) was created by its general partner Golar LNG Ltd (NSDQ: GLNG) to own and operate floating storage and regasification units (FSRU) as well as liquefied natural gas (LNG) carriers.
Both the LP and GP are owned by World Shipholding Ltd, an entity that’s indirectly controlled by Norwegian-born Cypriot shipping magnate John Fredriksen. The billionaire is perhaps best known among investors for his other ventures, including offshore driller Seadrill Ltd (NYSE: SDRL) and oil shipper Frontline Ltd (NYSE: FRO).
Although the market for LNG shipping is in relatively tight supply, Golar’s unit price has fallen just over 30 percent since hitting an all-time high of $39.05 last year on March 2. Of course, at a recent closing price of $30.01, Golar’s units are still up 33.4 percent since the LP’s April 2011 initial public offering (IPO). And when you include the reinvestment of distributions, the return is an even more attractive 47 percent, which compares quite favorably to the S&P 500’s 14.2 percent gain over that same period.
Given the relative strength of the niche in which it operates, it’s possible that Golar’s units have simply been beaten down in sympathy with other MLPs that specialize in seaborne transportation. But those shippers are operating in markets facing significant challenges, such as dry-bulk shipping, which is suffering slackening demand amid an oversupply of carriers, and crude carriers that are weathering OPEC’s production cut.
A Trio of Secondaries
A more likely explanation could be the MLP’s three secondary equity offerings over the past seven months. As Roger Conrad has previously written, investors typically see secondary offerings in a negative light because of concerns about dilution. And that almost always leads to a selloff. In fact, unit prices often fall below the secondary offering price.
Golar’s first follow-on offering was announced on July 10 in the wake of the previous day’s news that it would be acquiring an FSRU from its GP in a $385 million dropdown transaction. Investors must have anticipated that financing would entail a secondary offering because units began selling off with the announcement of the acquisition on July 9. Over the next several days, unit prices fell as much as 11.6 percent (to $30.80) before finally stabilizing. The MLP ultimately issued 6.32 million units at $30.95 each.
The same scenario occurred in early November. Golar announced a major acquisition on Nov. 1, followed by a press release the next day detailing another secondary offering. The MLP acquired the Golar Grand, a liquefied natural gas (LNG) carrier, in a $265 million dropdown transaction. However, the timing of the deal also coincided with a selloff in both the MLP space and the broad market. As a result, Golar’s units fell 20.5 percent (to $25.52) over the next two weeks before finally rebounding. The MLP ended up issuing 4.3 million units for $30.85 each.
And at the end of January, Golar’s third follow-on offering came in tandem with its acquisition of the LNG carrier Golar Maria in a $215 million dropdown deal. But this time the effect was somewhat muted since these moves transpired during a period when both the market and MLPs were advancing. Golar’s units declined by 5.5 percent (to $29.25) before heading slightly higher again. The MLP issued 3.9 million units at $30.00 each.
Dilution or Distribution Growth?
While worries about dilution are perfectly reasonable in other sectors of the stock market, MLPs regularly issue additional units to finance growth-oriented capital expenditures and acquisitions. In many cases, acquisitions can involve assets that are already under long-term contracts, so the MLP’s management team knows the return to expect from its investment well in advance of making it.
In Golar’s case, all three of these deals involved assets under long-term charters–the two LNG carriers are effectively under contract for about 5 years, while the FSRU is under contract through the end of 2022. And both of the LNG carrier deals were directly tied to bumps in the quarterly distribution of 3 percent to 5 percent.
So what is the potential for further distribution growth? Golar’s already boosted its payout by 25 percent since late 2011, and its next quarterly payout should rise at least 3 percent, thanks to its most recent acquisition. Thereafter, it depends on the rate at which its GP offers additional dropdowns. Though a third-party transaction is always possible, in a tight market it would be difficult to engineer such a deal at an attractive price.
Management had previously forecast two to three dropdowns in 2013, so that leaves another one to two dropdowns for the remainder of the year. The MLP currently has four FSRUs under contracts ranging from 10 years to 15 years, as well as five LNG carriers with charters ranging from 5 years to 20 years.
The GP currently has five LNG carriers, with another 11 newbuildings and two new FSRUs slated to join its fleet through 2015. In terms of contract duration, the GP’s vessels are under a variety of charters, but the LP is principally focused on long-term charters.
With the abundance of LNG expected to enter the global markets from the US, Canada and Australia over the next decade, the GP should be able to secure long-term charters for its future dropdowns. In fact, based on the industry order book as well as projected LNG supply, the shipping market is structurally short of vessels for long-term charters as well as the spot market. That’s expected to remain the case through 2020 in every year except 2015.
At the end of the third quarter, the LP had a revenue backlog of USD2.6 billion. Meanwhile, it held USD48 million in cash and cash equivalents on its balance sheet along with USD687 million in long-term debt, including a USD235 million senior unsecured bond due in 2017.
Golar’s latest quarterly payout is $0.50, which gives its units a current yield of 6.7 percent. Its coverage ratio for the third quarter was 1.12. The MLP is expected to report fourth-quarter earnings on Feb. 21, though that’s an estimate based on last year’s timing.
The bottom line is that as long as the underlying business remains sound, long-term investors can take advantage of such short-term selling to lock in cash flows at attractive rates. And as MLPs acquire productive assets and grow their distributions, unit prices will eventually head higher as well.
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