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Sunday, February 20, 2011

DHT Maritime: A Value Play on Rising Rates

DHT Maritime (DHT) operates in the highly competitive crude oil shipping market. Their fleet consists of 3 very large crude carriers (VLCCs), 2 suezmax tankers, and 4 aframax tankers. In addition, the company recently bought a fourth VLCC (built in 1999) for $55mm.

I first became attracted to the company through this activist filing. Normally, I try to stay away from industries like this one; there is no competitive advantage or moat possible, rates are notoriously volatile, leverage ratios are high, etc. However, the filing laid out a great case for the stock to appreciate, noting it was materially undervalued compared to its peers. What really attracted to me to this, though, were the contracts they had signed for all of their ships, which had been locked into at or near the top of the market. These call for a mimimum base charter, and allow for DHT to capture around 1/3 of the prices above this base charter rate. With charter rates currently depressed, these contracts have proved to be a godsend for DHT, as they have enabled them to collect much more than they would if their ships were on the spot market.

What created the opportunity in this stock was historic mismanagement during the economic downturn. The company paid out all of their free cash flow (FCF) as a dividend until the beginning of 2008, when they set their dividend to a fixed rate of 25 cents per share. They continued to pay this dividend even as the stock market and economy cratered throughout 2008. They could do this because of the stability of cash flow from their chartered contracts. Then, in March 2009, the company raised equity for, in my mind, no good reason (the stated reason was to pay down debt, but the company wasn’t in violation of their covenants). The price they raised equity at implied a dividend yield of almost 25%, so why they raised equity instead of cutting the dividend and using those funds to pay debt I’ll never understand. Anyway, the new equity made the dividend unsustainable, and the company eventually had to cut their dividend due, in large part, to all of the new equity they raised (aren’t CEOs great?).

Flash forward to today. The company now has installed a new and seemingly talented management team. The company still has over a year left on all of their charter contracts (the first of the contracts don’t expire until April 2012, and could be renewed until as late as 2019). These contracts GUARANTEE the company will earn at least $40mm in FCF per year, which easily covers their new dividend payments of ~20mm annually.

The company trades for an EV of ~450mm and market cap of ~225mm. So an investor today gets a company with huge leverage and stable cash flows PLUS a call option on potentially rising tanker rates in the form of the profit sharing from the contracts and the newly purchased VLCC (which will go on the spot market).

The company also is kind enough to announce the appraised value of their fleet on their conference calls. With the recent purchase of the VLCC, the appraised value of the ships is just over $415mm. With EV at ~$440m, the investor is paying a premium of ~25m (around 5% of the value of their ships) as a premium for the cash flow guarantees and an option on rising tanker rates and prices.
So I think DHT is slightly undervalued at today’s prices. I can think of three types of people who would benefit from taking a harder look at DHT.

First, investors looking for a high dividend yield - DHT yields in excess of 8%, and the payout is well covered by the cash flows from the contracts. Second, investors who are looking for a way to pay a potential rise in tanker prices. DHT won’t benefit as much as its competitors who have their entire fleet completely on the spot market in such an environment, but they will benefit, and an investor doesn’t have to worry as much about the downside its competitors have in case rates collapse. Rising oil = Rising rates = rising tanker prices. The stressed capital markets + low rates have resulted in extremely depressed tanker prices, and as the global economy continues to recover tanker prices should continue to rise.

However, the main reason I wrote about this stock is for value investors. In the event that the market pulls back and takes DHT along with it, it could create an excellent value buying opportunity to pick the company up for below the value of their ships and earn the the contractually guaranteed cash flows for free.

Disclosure: I do not OWN DHT shares.

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