Description

Navios Short Write-Up

Navios Maritime Partners ("NMM" or "Navios Partners") is the dry-bulk and container shipping MLP subsidiary of Navios Holdings ("NM"). At current valuation, NMM is a compelling short.

• NMM's primary assets are dry-bulk ships, which are highly commoditized assets that have a transparent and liquid sale & purchase market. One can use data from recent transactions or from one of several internationally recognized third party brokers, to see that at current valuation NMM is trading for almost 2x the value of its ships and time-charter contracts.

• NNM's valuation is supported by a dividend, which currently implies a 11% yield. NMM's dividend is unsustainable and the Company is already paying out more than it generates in cash flow. Going forward this problem will only compound as NMM has a number of ships on long-term time charters that will see their contracts expire in the next 12 to 36 months.

• NMM has a significant amount of debt, which currently carries very generous amortization terms and thus further amplifies current cash flow. When a big chunk of its debt comes due in 2018, NMM may have to sell assets, further reducing its dividend paying capacity.

• NMM's dividend yield is unattractive and should re-price to a higher yield even after the dividend is cut. NMM's assets have a finite life and will only be worth scrap in about 15 years. At the end of their useful life, proceeds from scrapping these ships will be used to payback debt, thus there will be no residual value to the equity. NMM's dividend should be treated as a return of capital, not a return on capital. The IRR of NMM's dividend stream is far below the headline yield number.

• In an attempt to support its dividend, NMM has turned its focus towards the container sector, where it is buying older, second hand ships with above market time-charter contracts attached. The economics of these deals are questionable, as they are paying premium prices for ships with above market contracts. These deals look accretive on year one cash flow, but are potentially dilutive when considering the economics of these deals after time-charter contracts expire. Furthermore, NMM does not have enough liquidity to materially increase its container fleet while preserving its dividend, thus limiting the impact even if it found accretive container deals.

• NMM will not be bailed out by improvements in the dry-bulk market. Over the last 10 years a massive boom in shipbuilding capacity has ensured that almost any demand growth scenario can be met by newbuild supply. As we saw in 2013, any uptick in freight rates will lead to a surge in ordering activity, which will help keep the market balanced and help keep a lid on freight rates.

• There is no reason for NMM to trade at a premium to NAV. NMM has around 43% downside from current price as a dividend cut in the next 12-24 months should catalyze the stock to fall closer to NAV.

NMM assets are liquid and highly commoditized, yet trades at 2x NAV

Calculation of NMM's NAV is fairly straightforward. Unlike for other types of traditional MLP assets (pipelines, terminals, storage assets) and even shipping MLP assets (LNG carriers, FPSOs, drill ships) the market for dry-bulk ships is highly commoditized with an active and transparent sale and purchase market. These attributes make the value of NMM's shipping fleet visible to anyone that has access to Clarksons, Vessel Value or any of the other reputable shipping valuation service providers. Using figures from Clarksons for dry-bulk and Vessel Value for container ships, I calculate NMM's fleet value today in the table below.

Source: Current market value based on data from Clarksons and Vessel Value.

The other important component of NMM's NAV are above-market, long-term time charter contracts that the Company has attached to a number of its vessels. Since the value of these time-charter contracts are not included in the NAV of the ships, we need to give NMM credit for these contracts separately. Note that I assume all of these contracts are "money good", but in reality there is credit risk to many of these contracts as evidenced by the fact that a number of them have not performed (NMM's cash flows were protected by insurance, something it doesn't have as much of going forward). By subtracting the above market time-charter rate from the current market rate for each of these contracts and then applying a discount rate (a generous 5%-10% rate) I estimate a NPV for these above market time-charter contracts. I will discuss my assumptions for future market rates in a later section.

Putting these figures together, plus cash and less debt, I get the valuation below. As the figures show, NMM NAV is $8.75 per share, which is about 43% below current price. Given the commoditized nature of this business, I see no reason for NMM to trade at a premium to net asset value. Another important consideration is how NMM's NAV changes as its above market time-charter contracts roll off and its ships age. The table below also shows NMM's estimate NAV at the end of 2015, 2016 and 2017. As NMM's ships age and its long-term time-charters roll off, I would expect NMM's net asset value to also fall.

(1) Pro forma for the acquisition of YM Unit post-panamax containership.

NMM's share price is being held up by a dividend which it cannot afford

NMM has been paying out a dividend that is larger than its normalized quarterly operating cash flow for at least the past 4 quarters. This gap has been masked by a number of one-items, particularly the cancelation of a time-charter insurance policy which resulted in several non-recurring cash payments.

Note: Adjusted coverage ratio removed the effect of one-time items such as insurance settlements and working capital swings.

These items rolled off in Q2 2014 and in Q3 2014 NMM reported a clean quarter which showed its distribution coverage ratio at 0.87x assuming no capex reserve and 0.70x with the modest capex reserve that NMM includes in its operating surplus figure. Thus, even NMM's own figures show the Company is not generating enough cash to meet its dividend payment.

NMM Q3 2014 Investor Presentation

Going forward, I estimate that NMM's distribution coverage will remain below 1x (despite what they claim in their "pro forma" metric) as more of the Company's ships roll off of long-term time charters that are significantly above the current market. In a series of tables below I highlight expected cash flow per share for a low case, base case and upside case freight rate environment. I also illustrate where an investor can "buy" freight rates currently as shown by the forward freight agreement market ("FFA"), which is the forward market for dry-bulk freight rates. The FFA market is relevant because it is a tradable market that should roughly represent the markets future expectation for freight rates. The current FFA market is closest to my low case, giving me comfort that my assumptions are conservative.

For each case I project out operating surplus per share, assume nothing is set aside for a capex reserve. Thus, I look at NMM on a liquidation basis, which I think is appropriate given the Company has limited room to fund its dividend, let alone grow its fleet. My model assumes NMM amortizes its debt by about 1.5% per year and scraps ships when they reach 25 years of age. Scrap proceeds are used to pay down excess debt, thus there is no residual value left for the equity. For each case I look at cumulative dividends over the next 15 years, the average dividend payment that can be afforded per year, the NPV of the dividend stream assuming a 10% discount rate, and the IRR of the dividend stream given the current stock price.

The table below highlights the downside case, which is not far off from current FFA rates. Dividend cuts in this scenario might be more dramatic than represented as NMM might have more difficult refinancing its debt (big bullet maturity in 2018) with freight rates this low.

The upside case is more than 100% above current long-term FFA rates. If one were to believe freight rates would be this strong simply buying the FFA would be a better risk-reward than investing in NMM. For reasons discussed below, I think its highly unlikely this case is realized.

In all three cases presented above, NMM's current dividend is unaffordable. I believe that running a dividend discount model is the most appropriate approach to valuing the company on a dividend basis given that its dividends are falling and there will be no residual value to the equity holders once these ships are scrapped. As illustrated in the tables, I believe that the future dividend stream of NMM warrants a $7.75 stock price. While this price target would imply a 18% "headline" yield (assuming dividend is cut near term to about $1.40), it represents only a 10% IRR over the life of these assets.

Container ship deals have questionable economics and NMM does not have enough cash flow to materially increase its container exposure, while funding the current dividend

Over the past year NMM has been shifting its focus out of dry-bulk and into the container shipping space. The Company has executed on two transactions, both of which have similar characteristics. In both cases NMM bought older containerships (2006 build) with above market long-term time charter contracts attached to them. The unlevered, first year cash yield of these transactions was in excess of 15%, thus making them look accretive (NMM used a mix of equity and debt to fund these deals). However, in both cases, the tenor of the contract is about 5 years, thus leaving the vessel spot exposed after the above market contract rolls off. The spot market for post-panamax containerships remains very weak, and when these ships roll off of charter they will likely earn rates below where they are currently time-chartered. There are a few recent data-points that suggest the time-charter market for a modern 6,000 TEU container vessel is below $20,000 per day (vs. the $30k-$35k that these ships are earning on current time-charter contracts). Furthermore, supply growth in the container sector has been large (8% per year over the past few years) and the order-book is still big (particularly for post-panamax and larger). As an example, if the spot rate for a larger post-panamax vessel remains around $20,000 per day when the time-charter contract for NMM's most recent containership deal expires, the IRR on the investment will be about 7% on an unlevered basis and 10% on a levered basis, which is much lower than the year one cash flow yield of 15%.

Note: Assumes 20 year useful life and $17 million of scrap value.

Even if NMM could find accretive containership deals, the Company has limited ability to fund these transactions given declining cash flow and its commitment to payout current level of dividend through 2015. Pro-forma for the most recent containership deal NMM executed, I estimate NMM's cash balance will be just under $110 million. In my base case, I estimate NMM will need to draw on $30 million of this cash to continue to fund its dividend in 2015, thus leaving $80 million of cash for acquisitions. Even if NMM were to use this cash, plus 50% LTV financing, I estimate that it could execute only 2 additional container ship transactions. NMM's most recent containership deals added about $0.09 in cash flow per share per ship (post financing costs and debt amortization), thus the magnitude of this impact is about $0.18 per share. Given the magnitude of NMM's dividend underfunding a couple of containership deals will not be enough to materially improve its coverage ratio.

The dry-bulk market won't bail out NMM

Over the past 10 years global shipbuilding capacity for dry-bulk ships has increased dramatically. In the early to mid-2000s, a rapid increase in trade for dry-bulk cargo lead to a surge in demand for dry-bulk ships. This increase in demand sparked a rise in freight rates which in turn sparked a massive increase in ship ordering. The ship ordering activity caused an increase in newbuild ship prices, which in turn caused many to expand and open new shipbuilding capacity. Given the lag time in setting up a new ship yard (or expanding an existing one) and then building a new ship, much of this new capacity did not begin to hit the market until after 2011. As this new shipbuilding capacity hit the market, the commodity boom that sparked the demand in the first place began to slow down.

The increase in shipbuilding capacity has been dramatic. This can be best illustrated by annual new ship deliveries, which we can use as a rough proxy for ship building capacity. Between 2000 and 2006, new build deliveries totaled about 20 million deadweight tonnes (dwt) per year. In 2012, as a result of a large order-book and new shipyard capacity, the industry delivered over 100 million dwt in new dry-bulk ships or more than 5x the average less than 10 years earlier. Though new deliveries have fallen to about 50 million dwt (last 12 months), significant shipbuilding capacity still exists in the market. This slack capacity is important because it should prevent the tight market conditions that caused the dramatic rise in freight rates prior to the financial crisis. In the current environment, I would expect an uptick in freight rates to be accompanied by a surge in ordering activity and shipbuilding, as there is plenty of excess shipbuilding capacity to absorb new orders. This dynamic is exactly what was witnessed by the market in 2013 when an uptick in freights caused a surge in ordering activity. In 2013 there were 100 million dwt of ships ordered versus 25 million dwt in 2012, or a 4x increase in a single year.

To put these figures into context, the current dry-bulk fleet is about 750 million deadweight tonnes. Thus a delivery schedule of 50 million dwt (as we will see in 2014) represents about 6.5% fleet growth, whereas 100 million dwt would represent 13% fleet growth. Between 2004-2014 dry-bulk trade grew by about 6.8% per annum and is expected to growth 4%-5% per year over the next couple of years. Thus looking at current deliveries, the current order-book (5% fleet growth next year, net of scrapping) and shipyard capacity we believe the data suggests a balanced market with potential for downside in a weakening demand environment.

Conclusion and Catalyst

Seeing the importance of its dividend to its stock price, NMM's management team has committed to paying its current level of dividend through 2015. While its possible that NMM will live up to this commitment, I believe its commitment beyond 2015 will come into greater focus as the market sees successive quarters of less than 1x dividend coverage and a draw down on the Company's cash. Thus, I expect the market to become increasingly focused on the Company's dividend commitment beyond 2015. As outlined throughout this write-up, I don't think the Company has the ability to maintain this dividend level and ultimately a cut (or expectation of a cut) should cause the stock to re-rate to levels that are closer to NAV or $8 per share.

Catalyst

Conclusion and Catalyst

Seeing the importance of its dividend to its stock price, NMM's management team has committed to paying its current level of dividend through 2015. While its possible that NMM will live up to this commitment, I believe its commitment beyond 2015 will come into greater focus as the market sees successive quarters of less than 1x dividend coverage and a draw down on the Company's cash. Thus, I expect the market to become increasingly focused on the Company's dividend commitment beyond 2015. As outlined throughout this write-up, I don't think the Company has the ability to maintain this dividend level and ultimately a cut (or expectation of a cut) should cause the stock to re-rate to levels that are closer to NAV or $8 per share.