Capital Product Partners L.P.
Q2 2016 Earnings Call Transcript

Published: 29 Jul 2016

[Operator:]

Thank you for standing by, and welcome to the Capital Product Partners Second Quarter 2016 Financial Results Conference Call. We have with us today us, Mr. Jerry Kalogiratos, Chief Executive Officer and Chief Financial Officer of the company. At this time, all participants are in a listen-only mode. There will be a presentation followed by a question-and-answer session. [Operator Instructions] I must advise you that this conference is being recorded today 29th of July, 2016. The statements in today's conference call that are not historical facts, including our expectations regarding developments in the market, fleet developments, our ability to pursue growth opportunities, our expected charter coverage ratio for 2016 and 2017, and expectations or objectives regarding our quarterly distributions, cash reserves, and annual distribution guidance may be forward-looking statements as such as defined in Section 21E of the Securities Exchange Act of 1934 as amended. These forward-looking statements involve risks and uncertainties that could cause the stated or forecasted results to be materially different from those anticipated. Unless required by law, we expressly disclaim any obligation to update or revise any of the forward-looking statements, whether because of future events, new information, a change in our views or expectations to conform to actual results or otherwise. We assume no responsibility for the accuracy and completeness of the forward-looking statements. We make no prediction or statement about the performance of our common units. I would now like to hand the conference over to your speaker today, Mr. Kalogiratos. Please go ahead, sir.

[Jerry Kalogiratos:]

Thank you, Cass, and thank you all for joining us today. As a reminder, we'll be referring to the supporting slides available on the Web site as we go through today's presentation. On July 21, our Board of Directors declared the cash distribution of $0.075 per common unit, and $0.21375 per Class B unit for the second quarter of 2016. The second quarter common unit cash distribution will be paid on August 12 to unitholders of record on August 5. The second quarter Class B cash distribution will be paid on August 10 to Class B unitholders of record on August 3. Unit coverage for the quarter amounted to 2.1 times after accounting for the $14.6 million in capital reserves and Class B distributions. Partnership's net income for the second quarter stood at $14.9 million, a $0.8 million improvement on the $14.1 million net income recorded in the second quarter of '15. As previously announced, the Partnership has agreed with HMM, Hyundai Merchant Marine, a 20% reduction of the charter hire rate until the end of 2019 for the five vessels currently employed with HMM as part of its restructuring process. We will receive 4.4 million HMM common shares as compensation for the charter-hire loss. In addition, and during the quarter, two of our Suezmaxs, Miltiadis M II and the Amore Mio II, commenced their scheduled dry-docking upon completion of their respective time charters with CMTC and SAIL [ph]. The Miltiadis M II will complete the dry-docking at the end of July and the Amore Mio II is expected to complete its dry-docking in early-August. Both vessels have [indiscernible] good employment with Capital Maritime for 10 to 12 months. As a result of the new charters and as of the end of the second quarter 2016, the average remaining charter duration of our charters stood at 5.9 years, with approximate charter coverage of 94% for 2016 and 75% for 2017. Turning to slide three, revenues for the second quarter of 2016 were $60.9 million compared to $54.5 million in the second quarter of 2015. The increase is mainly a result of the increase in the size of the Partnership's fleet. Total expenses for the second quarter of 2016 were $40.3 million compared to $35.6 million in the second quarter of 2015. The total vessel operating expenses for the second quarter amounted to $18.7 million that is $1 million higher than the $17.7 million in the second quarter of 2015. The increase reflects primarily the increase of our fleet size. General and administrative expenses for the second quarter amounted to $1.5 million compared to $1.3 in the respective quarter in 2015, mainly due to expenses recognized in relation to the Partnership's omnibus incentive compensation plan. Total other expense net for the second quarter of 2016 amounted to $5.7 million, versus $4.8 million for the second quarter of 2015. The increase reflects the higher interest costs we incurred in the second quarter of '16 compared to the second quarter of 2015. The Partnership's net income for the second quarter of 2016 was $14.9 million compared to $14.1 million for the second quarter of 2015. Turning to slide four, you can see the details of our operating surplus calculations that determine the distributions to our unitholders compared to the previous quarter. Operating surplus is a non-GAAP financial measure which is defined fully in our press release. We have generated approximately $36.6 million in cash from operations before accounting for the Class B preferred unit distribution, and the capital reserve of $14.6 million. After adjusting for the reserve and the Class B unit distribution the adjusted operating surplus amounted to $19.2 million. Common unit coverage for the second quarter stood at 2.1 times. On slide five you can see the details of our balance sheet. As of the end of the second quarter, the Partners capital amounted to $921.2 million, corresponding to a decrease of $16.6 million from the total Partners capital as of year-end 2015, which amounted to $937.8 million. The decrease primarily reflects distributions declared and paid during the first-half of '16 partially offset by net income for the period. As of June 30, 2016, the Partnership's total debt increased by $26.3 million, to $597.9 million compared to total debt of $571.6 million as of year end 2015. The increase was due to the $35 million draw down under our senior secured credit facility with ING Bank to fund the acquisition of the CMA CGM Magdalena, which was delivered to us in February, 2016, but partially offset by $8.7 million of scheduled loan principal payments during the first-half of 2016 under the same credit facility. Overall, our balance sheet remains strong with a net-debt-to-cap of 34.6%, and with Partners' capital representing 59.2% of our total assets. Turning to slide six, we are pleased that HMM, the charter of five of the Partnership's container vessels, has successfully concluded and out-of-court restructuring agreement with its creditors as well as vessel owners, and signed an MOU to join from April, 2017 onwards the 2M Alliance, the world's largest container shipping alliance which comprises Maersk Line and MSC. As part of HMM's restructuring CPLP has agreed to a charter rate reduction of 20%, to $23,480 gross per day for its five containers chartered to HMM for the period between July 18 of this year to December 31, 2019. The charter rate will be restored thereafter to $29,350 gross per day until the respective earliest charter expirations in 2024 or 2025. The total charter rate reduction for the HMM vessels amounted to around $37 million. As compensation for the charter hire loss, the Partnership will receive approximately 4.4 million HMM shares, which will be freely tradable on the stock market division of the Korean Exchange from August 5 onwards. At this point I would like to highlight that while the impact of the HMM vessel's charter reduction will adversely affect our cash flows until the end of 2019, when the charter rate under respective charter parties is expected to be restored to the original rate. We believe that the reduced charter rate and the charter reduction compensation that we expect to receive represents relatively favorable outcome given the alternative employment opportunities in the current weak container charter market. Turning to slide seven, we are pleased to have secured new time charter employment for two of our Suezmax tankers. The Miltiadis M II has been fixed to Capital Maritime for 10 to 12 months at $25,000 gross per day. We have also fixed the Amore Mio II to Capital Maritime at $21,000 gross per day for the same charter term of 10 to 12 months. Both charters are expected to begin in August. We are pleased to see our sponsor, Capital Maritime, step in and offer attractive employment for two of our vessels at the point in time that the weakness in the spot market, namely spot crude tanker market has negatively affected demand for period employment. In addition to the new time charter employment secured for the Miltiadis M II and the Amore Mio II, the Partnership has agreed with Flopec that the Agisilaos will replace the Arionas, a sister vessel, under a three-year charter at $19,000 per day gross, as the Arionas will undergo its scheduled special survey over the next few months. In the meantime, the vessel is employed on voyage charters. Agisilaos was previously employed with CMTC at 14,500 gross per day for a year with earliest charter exploration in August 2016. Moving to slide eight, and taking to account new charters, the other remaining charter duration is 5.9 years. We have seven product tankers, one Suezmax tanker, and two containers that we will need to fix over the next 12 months assuming that the respective charters do not exercise optional periods. While rates in the tanker sector had been under pressure in the second quarter, partly due to a seasonal low demand and increased supply of vessels, we believe that the limit in new tanker ordering observed year-to-date and rationalization effect to capacity combined with solid industry fundamentals for product and crude tankers remain positive trends for tanker markets in medium to long run. Turning to slide nine, we reviewed the product tanker market developments in the second quarter of 2016. MR product tankers spot rates remained under pressure during the quarter as high inventories across all major refine products had a negative impact on demand for product tankers. According to VIA, OECD commercial inventories stood at a record 3.1 million barrels in May, while floating [indiscernible] has reached its highest levels since 2009. On top of this, arbitrage opportunities were scarce while a growing supply of low cost LPG from North America used instead of naphthalene petrochemical plants further reviews demand for product tankers. Also contributing the negative sentiment, the MR product tanker fleet has expanded at a relatively high pace with net fleet growth at 6.1% year on year as of the end of the quarter. On the bright side, high U.S. product exports and firm Latin American product demand supported the market and partially offset weakness in other regions. The product tanker period market was active during the second quarter but rates decline considerably in the face of the softer spot rate environment. Despite the current weakness in the market, demand and supply dynamics are expected to improve going forward. New contracting activity has been very limited with only 5 new MR orders placed year to date. This is partially due to the negative sentiment prevailing another 16 sectors such as in the drive bulk and offshore markets at a time of limited access to capital for the industry as a whole. Concurrently, the MR order book has now decreased to 11.2% as a percentage of the fleeting terms of deadweight capacity, the lowest since 2000. At the same time, the MR product tanker order book continue to experience slippage during the first half of 2016 as approximately 26% of the expected new buildings were not delivered on schedule. On the demand side, structural reforms in China's refining sector and refinery capacity expansion East of Suez are expected to positively affect the product rate. China's total export of refine fuels dumped by almost 40% year-on-year, with much of the surge being attributable to a leap in China's shipments of diesel. Overall, product tanker deadweight demand for full year 2016 is projected to grow by approximately 4%. Turning to slide 10, the Suezmax crude tanker market was weaker in the second quarter of 2016. The decline was partly attributed to seasonally weaker demand for crude oil. In China, in particular, crude imports decreased over the course of the quarter with imports dropping to a five month low in June, as a result of refinery maintenance. Adding pressure to the markets; oil disruptions in Nigeria result in a steep decline of crude exports from the country, reducing employment opportunities for Suezmax. In addition to the weaker demand, increased crude tanker deliveries have brought in higher competition among owners and executed downward pressure in rates during the quarter as 56 crude vessels were delivered in the first half of 2016 against 36 in the first half of 2015. The Suezmax market was on the other hand supported by increased crude flows from Iran, while delays resulting from refineries strikes in France in the second half of the quarter helped to reduce the supply. In the peer markets, we saw limited demand for Suezmax tankers during this period, while period rates retreated with line with a softer spot market. According to VIA, world oil demand is expected to increase by 1.4 million barrels in 2016, following growth of 1.8 million barrels in 2015. Overall, industry analysts expect Suezmax tanker deadweight demand to expand by 1% for 2016. This is largely on the back of firm growth of Chinese crude imports and due to the emergence of Iranian crude exports exports to Europe and the Mid, following the removal of nuclear-related sanctions in January. Looking to supply side, the Suezmax tanker order book through 2019 corresponds to approximately 21.6% of the current fleet. Nevertheless, contractual activity has declined sharply with six Suezmax orders year-to-date, a sharp contrast to the 23 vessels ordered in the same time period last year. Moreover, slippage for the first half of the year amounted to 37% of the expected deliveries for the same time period. Moving to slide 11, the capital reserve of 14.6 million was established by our Board in the previous quarter to provide for all the anticipated debt repayments between 2016 and 2018, and we expect to maintain this amount of capital reserves through the end of 2018. Our debt outstanding at the end of 2018 based on our current fleet is expected to circa 430 million, which would imply a pro forma net debt to cap of 26.5%. We continue to work towards finding refinancing solution which depending on its terms could increase our distributable cash flow and allow us to increase distribution from current levels. Importantly, following the successful outcome of the HMM restructuring, I would like to highlight that we intend to use any potential cash windfall from the sale of the HMM compensation to pursue accretive transactions and expand our asset base. As you can see from the next slide, slide 12, CPLP has access to a number of assets that could be dropdown candidates including eight MRs, for which we have the right of first refusal, and for some of which have already finance in place provided the vessels have two-year employment. In addition, our sponsor controls a number of other assets some with long term charters already in place that could also find their way into the partnership. With this, I would like to reiterate that we intend to revisit our annual distribution guidance from time to time as we pursue accretive transactions and expand our asset base and are successfully refinancing our debt under favorable terms thus increasing the long term distributable cash flow of the partnership. And with this, I am happy to answer any questions you may have.

[Operator:]

Thank you. [Operator Instructions] Your first question comes from line of Jon Chappell from Evercore ISI. Please ask you question.

[Jon Chappell:]

Thanks. Good afternoon, Jerry.

[Jerry Kalogiratos:]

Hi, Jon.

[Jon Chappell:]

Just a couple of quick ones as we think about the covered ratio going forward and your ability to potentially expand the distribution at some point. The capital reserve consistent over the last two quarters makes 100% sense as you lay out the debt amortization over the next couple of years. Just wondering about the increasing recommended reserves that jumped pretty meaningfully from the first quarter to the second quarter, is that the type of run rate you are thinking about for capital requirements going forward, is that's what you think about the covered ratio?

[Jerry Kalogiratos:]

Jon, the cash reserves are built as we have previously announced to repay the amortization of external borrowing for the next two years, which is a capital reserve, as well as for other operational contingencies and CapEx requirements. As we build these reserves, we will aim for two things. Firstly, complete accretive transactions that will help us revisit [ph] the distribution networks. And to this respect, I would like to remind you the last slide on the deck where you can see the potential dropdown opportunities. And secondly, we can use cash to pay down debt in order to secure financing over debt under favorable terms. That should allow us to reduce our capital reserves and decrease our common unit distribution.

[Jon Chappell:]

And the third, I guess the third area you contentiously used that you mentioned at the very end of your comments was the HMM share. So, first of all, little bit surprised there is no lockup there, but that's great, freely traded in a week or so. You did mention in the press release that you received the share at a discount. Can you just, number one, explain exactly what that means? And then, two, just talk about maybe your strategy with those shares. Is it something you would like to unlock liquidity as soon as possible, or do you kind of view them as optionality and hold on them [ph] until you needed it?

[Jerry Kalogiratos:]

We received approximately 4.4 million shares, which represents our loss of charter revenue for approximately 3.5 years, amounting to 37 million at a price of KRW 9,530 per share. Today's HMM share closing price is KRW 10,600, because we received those shares at a discount. With regard to their use as discussed, we will opportunistically try to liquidate the shares over time. And potential cash windfall from the sale of the shares we could put to work immediately by completed accretive transactions that could help us revisit the distribution guidance upwards, so even in the short-term.

[Jon Chappell:]

That's helpful. Then the final thing is, obviously a lot of the overhang has been duress now with HMM behind you. And even the other two containerships that were redelivered last year but on short-term charters. As you look across your fleet list there's still four ships that standout as being way above market with still pretty significant duration of about four years, in average, left. They seem to be better counterparties, but just as we think about the risk reward here, has there been any conversations there about potential renegotiations or do you feel comfortable with those charters until expiration?

[Jerry Kalogiratos:]

No, there have been no discussion whatsoever. CMA CGM I presume is one of the counterparties you are referring to has been always punctual with payments. And actually, we have never had any issues whatsoever. If anything, they are in expansion mode. The other counterparty being COSCO I'm guessing, having merged COSCO now -- COSCO having merged now with China Shipping. This is really the national carrier of China Inc. And really this is, I guess in the end, the Chinese sovereign risk. And if you recall, we also have a charter insurance there in place so that if COSCO fails to honor the charter party then the insurance will pay us up to $25,000 per day for the next four years, plus market up to a maximum amount of the charter party hire. But in any case, we're not very much concerned with COSCO. We weren't in the first place, even lesser now that they have merged with China Shipping.

[Jon Chappell:]

Great, that's what I wanted to hear. Thanks a lot, Jerry.

[Jerry Kalogiratos:]

Thank you, Jon.

[Operator:]

Thank you. The next question comes from the line of Spiro Dounis from UBS Securities. Please ask your question.

[Spiro Dounis:]

Hi, Jerry, how are you?

[Jerry Kalogiratos:]

Hi, Spiro, I'm very well. Yourself?

[Spiro Dounis:]

Good. Not bad. Just wanted to maybe get some color around I guess the timing and magnitude of how you're thinking about a dropdown. And just to make it clear that -- it sounds like you don't intend to issue any equity to make this dropdown happen. It's going to be basically done with cash and debt, and just, once again, circling back toward the magnitude. I guess, how many of those vessels, some are on the water now, how many of those vessels are actually chartered and meet that specification?

[Jerry Kalogiratos:]

Well, I think the first important step is to understand how and when we will liquidate the HMM shares. I mean, while this could be potential liquidity that we can use to acquire new assets, we will be opportunistic about the liquidation. So then we can think about the next acquisition. But in the end, shares that are freely tradable are liquid assets. So assuming that we have a windfall from the shares then we will think about what will be the next acquisition. Now, with regard to the charters of CMTC -- sorry, with regard to the vessels that CMTC controls, on the one hand, we have a number of MRs that have finance in place but do not necessarily have charter coverage. One of them has for I think a bit less than a year. But there are also other assets. For example, there are two Aframaxes new builds with five-year charters. In the end, the decision will be what is more accretive to our distributable cash flow, as well as what provides cash flow visibility. So no decisions have been made yet.

[Spiro Dounis:]

Got it. Okay, that's helpful. And then just second one, trying to maybe get a sense for when you do eventually increase distribution. And correct me if I'm wrong, it sounds like what you're trying to do is to increase the asset base before doing that I guess [technical difficulty] bring the situation back to where it was before, which I guess might be harder right now just given obviously the HMM charters are lower, plus you rolled over some charters into lower charters, is that the right way to think about what you are doing with the asset base, or is there a potential that maybe once the distribution is lifted it could be lower than it was before?

[Jerry Kalogiratos:]

There are two things that will lead us to a distribution increase. As you have already pointed out the first one is the expansion of our asset base. And this could be achieved by, for example, using part of the proceeds from the liquidation of the HMM shares. And the second thing, it would be the refinancing. As we have discussed in the past, while we have now been reserving for -- while we have capital reserve in place which should if it continues accumulate so that we lower our outstanding debt to very low levels by the end of 2008, what we will try to do is find a way to refinance earlier than that. And any accretion from this refinancing should find its way back to unitholders in the form of a distribution increase.

[Spiro Dounis:]

Okay. I guess but in terms of what that number is maybe something everything is on the table at this point? Would be you expectation that it gets restored to the prior level, or I mean it could be any other number?

[Jerry Kalogiratos:]

Well, two things. First of all, there is the HMM effect as you correctly pointed out that would make it difficult for the distribution to go back to the original level. And secondly, there is I think a refinancing would potentially involve a level of amortization that we did not have before. The fleet is not getting younger. We have to make sure that there is at least an element of amortization in let's say in the new regime when it comes to our debt.

[Spiro Dounis:]

Got it. That's clear. Thanks, Jerry.

[Operator:]

Thank you. Next question comes from the line of Amit Mehrotra from Deutsche Bank. Please ask your question.

[Jason:]

Hey, guys. It's actually Jason in for Amit. I know you touched on this a little, but any guidance on the targeted leverage level?

[Jerry Kalogiratos:]

Well, we have always aimed for -- in the past for 50/50 debt equity mix, but especially now that our debt -- our leverage has been decreasing, we could potentially look at transactions with slightly higher leverage where especially there is also an amortization element as I just discussed. So you shouldn't expect us to deviate much from this the 50/50 debt equity, but it does in the end also depend on the overall leverage of the balance sheet and what level of amortization the new indebtedness will have.

[Jason:]

Very good, and if I could actually follow-up, how important is non-amortizing debt going forward?

[Jerry Kalogiratos:]

Well, as discussed, I think it would be prudent for us to have an element of amortization especially for ships that are not new builds or not very modern. So I think we would be pursuing at least some element of amortization going forward.

[Jason:]

Okay. Very good. And another one, what is the max LTV going forward? Any guidance on that would be great.

[Jerry Kalogiratos:]

Well, we don't necessarily think like that. But as I said, we have been aiming on a 50/50 debt equity or we were very close to that in the past. There is in any case an LTV covenant is that's what you have in mind at 72.5%, but this we haven't -- we are not anywhere near to that in terms of net debt to fair market values.

[Jason:]

Very good. Thank you. And one last one just what's the drydock in special survey cash cost you expect for remainder of this year and next?

[Jerry Kalogiratos:]

Well, there is only one vessel that is coming up for dry-dock over the next 12 months. That's a 37,000 deadweight tanker that's the one that was employed previously with Flopec. The cost of the cash expense for the dry-docking of a vessel like that would be between $0.50 million to $0.75 million.

[Jason:]

All right. That's it for me, appreciate the time guys.

[Operator:]

Thank you. And our next question comes from the line of Mike Gyure from Janney Montgomery. Please ask your question.

[Mike Gyure:]

Yes, good morning. It looks like you had a great quarter on the operating expense side for the vessel fleet. Can you tell me if there's kind of anything in there that was may be one time versus the first quarter or what your expectation is for those expenses going forward?

[Jerry Kalogiratos:]

There is one of award of acclaim that emerged from an incident back in 2013 of 1.1 million, and this was accredited to operating expenses as back then they repaired that, these vessel had to incur where fully expensed.

[Mike Gyure:]

Thank you very much.

[Jerry Kalogiratos:]

Thank you.

[Operator:]

Thank you. [Operator Instructions] Next question comes from the line of Ben Brownlow from Raymond James. Please ask your question.

[Ben Brownlow:]

Good morning. Thanks for taking the question. On the swap and product tankers for the Flopec charter, the Arionas, can you just touch on the voyage employment rate there? And do you anticipate that vessel being dry-docked at any point before it begins its special survey in November?

[Jerry Kalogiratos:]

Well, then the reason that this vessel was replaced is that the Agisilaos was in near proximity. So Capital Maritime offered to terminate the charter early so that we really minimize the ballast of the potential substitute. So from that perspective, it was a positive, because there is the obligation under the charter party to Flopec to have the vessel replaced. Now the vessel will need to dry-dock and pass special survey by November and in the meantime, we will be performing voyages effectively to reposition to, let's say, a region where it can get a proper and cheaper dry-dock. While the deadline, if I'm not mistaken, is in November, if we find the right the combination of voyages, the vessel might end up dry-docked and pass special survey earlier than that.

[Ben Brownlow:]

Okay. So it's right now receiving no revenue?

[Jerry Kalogiratos:]

No. Actually the vessel is performing voyages that do generate revenue, but what we are trying to find is a proper voyage so that we will reposition the ship closer to a dry-docking -- to a region that we are dry-docking, and special survey can be passed at decent cost. The problem with South America is that there is very limited capacity, and it's also a quite expensive one when it comes dry-docking.

[Ben Brownlow:]

Okay. And do you anticipate one of those tankers going back to sponsor Capital Maritime after the special dry-docking?

[Jerry Kalogiratos:]

Well, it will depend on what other opportunities are on offer. Capital Maritime is one source but also other parties as well.

[Ben Brownlow:]

Great. Thank you, Jerry.

[Jerry Kalogiratos:]

Thank you, Ben.

[Operator:]

Thank you. There are no further questions at this time. Mr. Kalogiratos, please carry on.

[Jerry Kalogiratos:]

Thank you, Cass, and I'd like to thank you all for once again for listening in today.

[Operator:]

Thank you. That does conclude our conference for today. Thank you for participating. You may now all disconnect.