What’s gotten into small caps lately? They had been taking it on the chin in August, but in the last two weeks they’ve caught a bid from the market:
We found two small caps with very attractive yields. One is new to us – Fortress Transportation & Infrastructure Investors (FTAI), and the other is a familiar holding – KNOT Offshore Partners LP (KNOP).
Both KNOP and FTAI have gotten the cold shoulder from Mr. Market in 2019 and over the past year. Even though it has a very steady, resilient business model, KNOP got caught up in the negative market sentiment toward many of the higher yielding shipping stocks.
FTAI acquires high-quality infrastructure and equipment that’s essential for the transportation of goods and people globally. FTAI currently invests across four market sectors: Aviation, energy, intermodal transport and rail. FTAI targets assets that, on a combined basis, generate strong and stable cash flows with the potential for earnings growth and asset appreciation. The company’s existing mix of assets provides significant cash flows as well as organic growth potential through identified projects.
The company is externally managed by an affiliate of Fortress Investment Group LLC, which has a dedicated team of professionals who collectively have acquired more than $17 billion in transportation-related assets since 2002. As of June 30, 2019, FTAI had total consolidated assets of $3.1 billion and total equity capital of $1.04 billion.
Its FTAI’s aviation leasing segment that pays for the dividends – it’s ~65% of total book equity, with infrastructure assets being the remaining 35%.
FTAI owns Jefferson terminal, in Beaumont, TX, on the Gulf Coast, which handles crude, ethanol, and refined products on their way to Mexico. The company also owns a short line railroad – CMQR, that runs from Montral to Maine:
FTAI has 2 development projects: The Repauno port hub, on the Delaware River near Philly, which liquid storage and warehousing facilities. It also owns Long Ridge terminal, located in the Marcellus and Utica shale plays.
In Feb. 15, 2019, FTAI’s subsidiary, Long Ridge Energy Generation LLC (“LREG”), entered into an engineering, procurement and construction agreement with Kiewit Power Constructors Co. to construct a 485 megawatt natural gas fired, combined cycle power plant at Long Ridge Energy Terminal.
LREG also entered into an agreement for the purchase of power generation equipment and related services (the “PIE Agreement”) with General Electric (NYSE:GE) to acquire equipment and related services to be utilized at the power plant, including one combustion turbine, one condensing steam turbine, one hydrogen-cooled generator, one heat-recovery steam generator and related items.
The aggregate value of the EPC Agreement and the PIE Agreement is approximately $430 million.
KNOP is a leader in the niche shuttle tanker industry, which is less than 1% of the world’s shipping fleet.
Like many other high yield vehicles we follow, KNOP’s business model is based mainly upon long term contracts – its fleet has an average contract duration balance of ~3.2 years, with an additional 4.4 years of charterers’ options on top of that.
These are specialized vessels take 2.5-3 years to build, which helps support KNOP’s recontracting efforts, as its customers typically utilize the extension options on these vessels. The vessels have a lifespan of ~20 – 25 years. Fleet utilization also has been steady and strong, with an average of ~99.6% since KNOP’s IPO. This is a niche industry, with not a lot of speculative building – the shuttle tanker fleet is only ~1% of the world shipping fleet.
FTAI had very strong earnings growth in the first half of 2019, with EBITDA rising by ~60% to a company record, and Funds Available for Distribution – FAD, growing by ~98%, which shot its coverage up to 2.77X, a company record.
KNOP had much stronger growth in 2018, with EBITDA up more than 20% and DCF rising over 9%, as new dropdown assets kicked in.
The next dropdown probably won’t happen until sometime in mid 2020, when Hull 3113 begins a long-term charter. There are two other potential dropdowns available from KNOP’s sponsor.
Neither of these stocks are dividend growth plays – management has kept KNOP’s quarterly payout flat, at $.52 since Q4 2015 – they maintained it right through the crude crash though since their business model insulates them from commodity pricing.
FTAI also has held its quarterly distribution flat since Q4 2015. FTAI pays $.33/quarter – at $16.02, it yields 8.24%, while KNOP has a much higher yield, of 11.15%.
FTAI goes ex-dividend in a March/May/Aug./nov. cycle, while KNOP’s schedule is more typical of LP’s – Feb-May-Aug-Nov.
FTAI also just issued a preferred stock, the 8.25% Fixed-to-Floating Rate Series A Cumulative Perpetual Redeemable Preferred Shares, currently trading at ~$25.87, under the ticker FRTRP. From 9/15/2024 dividends will be paid at a floating rate of the Three-Month LIBOR plus 688.6 basis points per annum.
The current three-month LIBOR rate is 2.11%, so FRTRP’s floating rate would be ~8.99% if we were currently in the September 2024 time period, five years down the pike.
Although KNOP is an LP, it issues a 1099 at tax time. FTAI does issue a K-1 however.
If you’re lukewarm bullish, FTAI has an interesting put strike which expires in February 2020. It pays $.50, and gives you a $14.50 breakeven, which is 12.9% above FTAI’s 52-week low.
Analysts’ Price Targets:
At $16.02, FTAI is ~30% below analysts’ $20.86 average price target, while KNOP is ~7% below its $19.95 price target.
Both of these small caps look cheap, on a price to distribution funding basis. FTAI’s mgt. uses FAD – Funds Available For Distribution, and is currently selling at a P/FAD of 5.21X.
KNOP uses distributable cash flow and is selling at a price/DCF of 6.13X, which, although it’s merely in line with other high yield shipping forms that we cover, is reasonable for a stable niche leader like KNOP.
FTAI looks cheap vs. its sector on a price/book basis, while KNOP is selling below book value.
FTAI’s ROA and ROE are much lower than its sector averages, while its debt/equity leverage is more conservative and its EBITDA margin is much higher.
KOP’s ROA and ROE are in line, while its debt leverage also is lower than the sector median. Its EBITDA margin is over twice that of the sector median.
FTAI had $115.6M in cash and a debt/capital ratio of 61.1%, as of 6/30/19. During the six months ended June 30, 2019, additional borrowings were obtained in connection with the 2025 Notes of $148.7 million, 2022 Notes of $147.8 million, revolving credit facility of $105.0 million, LREG Credit Agreement of $71.5 million, Jefferson Revolver of $23.2 million, DRP Revolver of $21.6 million, and CMQR Credit Agreement of $11.7 million. FTAI made total principal repayments of $128.8 million, primarily relating to the Revolving Credit Facility of $115.0 million and CMQR Credit Agreement of $10.7 million.
KNOP: As of June 30, 2019, KNOP had $71.1 million in available liquidity, which consisted of cash and cash equivalents of $42.4 million and $28.7 million of capacity under its revolving credit facilities. The revolving credit facilities mature in August 2021 and September 2023.
KNOP’s won’t have its first balloon repayment on its debt until 2021.
Disclaimer: This article was written for informational purposes only, and is not intended as personal investment advice. Please practice due diligence before investing in any investment vehicle mentioned in this article.
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Disclosure: I am/we are long KNOP, FTAI. 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.