Navios Maritime Partners (NMM) generated enough operating cash flow to cover their 2¢ per quarter distribution more than four times over last quarter. An 8.8% distribution yield covered more than 4x is extremely attractive (DCF yield = 36%). As are shares trading at less than 1/3 estimated NAV value (shares 90¢, NAV $2.91).
I only wish I could stop the story there; it would be a fairytale investment. Unfortunately, such things don’t exist in real life. Instead we need to ask ourselves just what kisses from Mrs. Frangou (CEO of Navios family), are necessary to turn Navios into a prince of an investment?
Navios Maritime Partners (NMM) had a weak Q4 with TCE and EBITDA down about 27%.
Source: NMM Presentation
Next quarter is likely to be even weaker.
Vale (VALE), an iron ore producer in Brazil had a dam break which killed at least 179 people and caused it to shut down production at mines with similar tailing dams. This in turn has caused a significant reduction in iron ore being shipped from Brazil to places like China (estimated are a 10% reduction in total production). Since the Brazil to China route is a long haul this reduces ton-mile demand for Capesize dry bulk even more significantly, and trickles down to smaller Panamax dry bulk ships as Capesize ships get repurposed. As a result, Capesize and Panamax Dry Bulk shipping rates are down about 60% and 40% respectively from this time last year with frankly no one really knowing when they might recover (data provided with our thanks by Value Investors Edge). The decrease in iron ore shipments from Brazil will likely be measured in years, rather than months. Legal ramifications and regulatory rule changes need to make their way through the system. Tailing dams need to get reinforced in an acceptable manner. (I don’t mean to be callous to the tragic loss of life here, my job however is to mainly focus on the financial ramifications.) For more on the macro situation in the dry bulk sector I suggest reading, “Drybulk Demand – Are Things Really That Bad?” by James Catlin.
Adding to a poor macro situation in the larger sized ships, the Navios family and its CEO, Angeliki Frangou, are currently not well thought of by individual investors. The parent company Navios Maritime (NM) has made some recent improvements, but continues to have negative equity value and remains in serious danger of bankruptcy. NM stopped paying its preferred shares distributions several years ago (NM.PH, NM.PG), underwent a 1:10 reverse split in order to remain listed (stock price above $1), and has seen debt on its Navios Maritime Acquisition (NNA) child downgraded by Moody’s. The fear is a relatively strong cash position at NMM will be used to support the parent, NM.
There is some precedence for this fear. At one-point Mrs. Frangou did try to orchestrate a loan from one of its children to NM. This loan however was canceled after significant shareholders protest (organized in part by J Mintzmyer of Value Investors Edge). NMM also prepaid a higher level of dry dock expenses to its parent in the past couple years, breaking from previous precedence of NMM reimbursing NM for the expenses shortly thereafter. Although the overall amount wasn’t massive, this move gave the equivalent of an interest-free credit facility to NM.
An obvious question is, why would anyone want to invest in such a troubled firm?
Well, as they say it’s always darkest before the dawn. This is a cyclical company and it’s clearly pretty dark out there. As indicated, Capesize and Panamax dry bulk rates are down significantly, and NMM stock itself has dropped about 95% in price over the last 5 years. Furthermore, if you read James article you will see there’s not a whole lot of positive indicators for ships which typically carry iron ore and coal like the Capesize ships. Ships that carry grains have a more positive potential outlook if a US – China trade deal spurs that long haul trade; however, NMM ships are significantly weighted towards Capesize.
Source: Navios Maritime Partners Website Data
The Hidden Charm:
The saving grace for NMM is its containerships. NMM is still generating a fair amount of cash thanks in large part to 5 container ships that it was supposed to transfer to sibling Navios Maritime Container (NMCI). NMCI has the right to purchase these ships for $36 million each but has yet to do so, instead choosing to use available cash to buy other containerships from third parties. Thus, the longer NMCI takes to exercise its right to purchase NMM containerships, the more cash these containerships generate for NMM. Furthermore, even assuming one day NMCI does buy the ships, NMM won’t be hurting for cash. Instead it will suddenly be flush with an estimated $100 million additional cash on hand (= $180 million from sale – $80 million mortgage payoff) on top of the $61 million it already had at the end of the year. To put some perspective on that, in combination it would represent over 96¢ per share in cash for a firm that is currently trading for less than that, 90¢ per share ($3.65 EV, $2.91 NAV). Anyway, you look at it, it’s a lot of cash and NMM is trading very cheaply. Furthermore, NMCI completing the purchase of these ships would likely concur with NMCI also declaring a dividend, 1/3rd of which gets returned back to NMM as additional cash flow (NMM owns 33.5% of NMCI’s outstanding shares). Which brings up our next topic.
Could NMCI trade Shares for Ships?
Again, NMM already owns 33.5% of NMCI. While it would probably want to stay under the 49% ownership level in order to keep NMCI results separate from NMM, it otherwise has been very willing to take ownership in its sibling, NMCI. Furthermore, I don’t see this 49% level as a significant limiting factor, because NMM can just choose to distribute NMCI units to NMM shareholders in order to stay under this level. It has already done this previously. There is even additional attraction to distributing NMCI shares to NMM shareholders as it allows NMCI to achieve greater liquidity on US markets.
What is a bigger problem is NMCI shares themselves are currently too cheap to fund accretive ship deals for its shareholders (NMCI trades at less than 50% of NAV). Don’t get me wrong, a ship for share deal at current prices would be a great deal for NMM shareholders, exchanging fairly priced ships for cheap NMCI shares just doesn’t work for NMCI. Thus, I don’t think a share for ship sale happens until after a US – China trade deal occurs, NMCI declares a meaningful distribution, and its share price rises. Only then does a ship for share deal become feasible. In the meantime, NMM has lots of lasting power.
As stated previously, NMM’s main dry bulk business is in the dumps, as is its stock, but if you look below the surface NMM’s cash situation is pretty decent. As is its debt profile. In fact Moody’s upgraded NMM’s debt rating to B2 last November.
As a result, NMM was able to obtain loans at an attractive LIBOR + 2.7% rate which will refinance 43% of the debt it has coming due in Q3 2020. The previous rate for this debt was LIBOR + 5.0%, so this is quite an improvement. One that recognizes NMM’s improved cash position. This refinance also both adds about 2.4¢ per share in cash flow to the bottom line thanks to the lower interest rate, and de-risks the debt schedule. Reminder, we are talking an extra 2.4¢ per share in annual cash flow for a stock that only trades at 90¢, it is pretty significant. Additionally, NMM did a sale leaseback transaction at roughly the same rate as current debt, but with a longer fixed term. This leaseback deal represented another 7% of total debt bringing the total amount refinanced recently to about half of all debt.
Source: NMM Presentation
The combination of the above financial moves reduces risk and allows for greater surety in utilizing cash for other purposes. While trading at less than $1.00, and in a sector that is in the dumps (dry bulk), NMM is nowhere near going bankrupt. In fact, the better question to ask is not if NMM has enough cash to survive, but rather, “what will our rich prince in hiding do with its excess treasure?”
Capital Allocation: What will NMM do with excess cash flow?
Although it could, in my opinion NMM is unlikely to up its distribution beyond a token amount any time soon. Rather, I think it is more likely to take a large portion of the excess cash from any containerships sales to NMCI and reinvest them in more dry bulk ships. Part of the reason for this is because Mrs. Frangou benefits from increased management fees the bigger the fleet gets, but it also just makes sense to buy ships while the sector is in trouble and they are cheap. Additionally, NMM has announced up to a $50 million dollar share buyback program. NMM shares, trading at only 1/3 rd of fair market NAV, are clearly an even better deal than buying ships. In theory NMM could potentially reduce share count by more than 30% while simultaneously purchasing a couple dry bulk ships at attractive prices, and still maintain a good overall debt to capitalization ratio.
Source: NMM Presentation
The reality of buybacks however is a bit more complex. There are daily SEC share buyback limitations (20-25% of average trading volume) and the use of a $50 million buyback program on such a cheap stock over a relatively short period of time would drive up the price. This makes buying back 30% of one’s float in a quarter or two nearly impossible. Buying back 1% – 3% of outstanding shares per month however is feasible, and would go a long way towards restoring shareholder confidence. In fact, some surmise that a $7 million-dollar transaction which occurred after hours on Friday, February 28th was NMM buying back 4% of its own shares from NM or some other large shareholder (at a very attractive sub-$1 price).
Source: Yahoo Finance
As they say, “in a land of paupers, Cash is King”.
To Be Continued:
While the US-China Trade War has produced significant negative sentiment and lower multiples across the shipping sector, I would remind readers sentiment can change rather quickly. Such a change might also enable the NMCI – NMM ship sale deal to complete, leaving NMM flush with cash. Even without consummation of this deal however, and despite significant ongoing challenges in the sector, NMM is doing fine. Certainly, better than a sub-$1.00 price would imply.
That being said, the price of NMM shares is clearly highly volatile and the near-term future in Capesize dry bulk carriers looks very weak. Thus, there’s no way you can consider the stock as anything but speculative. Speculative isn’t a euphemism for un-investable however. It just means you need to be careful with your position size in order to appropriately control overall portfolio risk, and consider stepping into any position over time as developments warrant. NMM tripling in price over the next couple years is quite possible. In fact, it would only bring the stock up to the firm’s current estimated NAV. This ugly frog could become a handsome prince.
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Disclosure: I am/we are long NMCI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: The article discusses speculative investments in the volatile shipping sector. I do not know your goals, risk tolerance, or particular situation; therefore, I cannot recommend any specific investment to you. Please do your own additional due diligence.
Editor’s Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.