A High-Yield Stock to Think About
If you’ve been following this column, you’d know that I’m a big fan of pipeline stocks. These companies essentially operate the toll roads of the energy industry. As a result, they can run a relatively stable business despite commodity price volatility.
Better yet, a lot of pipeline businesses are structured as master limited partnerships (MLPs). These entities are required by law to distribute most of their available cash to investors. In return, they pay little to no income tax at the corporate level. The pass-through nature of MLPs have made them some of the highest yielders in the stock market.
Today’s featured stock is an MLP, but rather than being a pipeline operator, this company is in the “floating pipeline” business.
I’m talking about KNOT Offshore Partners LP (NYSE:KNOP), an MLP that operates and acquires shuttle tankers. Because these vessels transport oil from offshore installations to onshore facilities in a similar manner that a pipeline would transport oil along the ocean floor, they are often described as floating pipelines.
Right now, this MLP owns and operates a fleet of 16 offshore shuttle tankers, with an average age of 6.2 years.
The neat thing about the partnership’s business is that it is backed by long-term charters in the offshore oil production regions of the North Sea and Brazil.
As of September 30, KNOT Offshore Partners’ fleet had an average remaining fixed contract duration of 3.1 years, plus an additional 4.3 years on average in charterers’ option. (Source: “Third Quarter 2019 Results,” KNOT Offshore Partners LP, November 21, 2019.)
It helps that the counterparties of these contracts are established players in the energy industry, including Royal Dutch Shell plc (NYSE:RDS.A, RDS.B) and Exxon Mobil Corporation (NYSE:XOM).
Of course, the reason why investors like MLPs is that they offer some of the most generous cash distributions. And on that front, KNOT Offshore Partners stock does not disappoint.
KNOT Offshore Partners currently pays investors a cash distribution of $0.52 per unit on a quarterly basis. With KNOP stock trading at $19.26 per unit, that translates to an annual distribution yield of 10.8%.
Is the Distribution Safe at KNOT Offshore Partners LP?
In this day and age, an energy stock with a double-digit yield can seem a bit risky. So let’s take a look at KNOT’s financials to see if the partnership can actually afford its payout.
KNOT Offshore Partners’ recent earnings report showed that, in the third quarter of 2019, the partnership generated $28.0 million in distributable cash flow, up $1.9 million from the prior quarter. (Source: “KNOT Offshore Partners LP Earnings Release—Interim Results for the Period Ended September 30, 2019,” KNOT Offshore Partners LP, November 20, 2019.)
And since the MLP declared $18.0 million cash distributions during the quarter, it had a distribution coverage ratio of 1.6 times.
So, despite offering a jaw-dropping yield, KNOT earned 55% more cash than what was needed to cover its distributions in its most recent quarter. That’s a very wide margin of safety.
Remarking on third-quarter financials, chief executive officer and chief financial officer Gary Chapman said: “We continue to have a predictable cash flow and a healthy liquidity position, which gives KNOP flexibility to both continue to pay level of distributions, while also looking to future growth in the shuttle tanker market.” (Source: “KNOT Offshore Partners LP (KNOP) CEO Gary Chapman on Q3 2019 Results – Earnings Call Transcript,” Seeking Alpha, November 21, 2019.)
Things have been going quite well at this floating pipeline business. In the third quarter, KNOT Offshore Partners’ fleet of vessels operated with 99.7% utilization for scheduled operations.
As a matter of fact, fleet utilization has always been a strong suit for this MLP. Excluding scheduled maintenance and dockings, the partnership’s fleet has operated with an average utilization of 99.7% since its initial public offering (IPO) in 2013.
Going forward, the business looks solid, as there are no drydockings scheduled for any of KNOT’s vessels in the fourth quarter. In 2020, the partnership only has one vessel expected to undergo drydocking (for about 50 to 55 days).
At this point I would like to mention that, while the energy industry can be very volatile, KNOP stock has never cut its payout. In fact, despite the downturn in the oil industry a few years back, the partnership’s payout has only gone up.
After KNOT Offshore Partners stock went public, its first cash distribution was $0.3173 per unit—a prorated payment corresponding to a quarterly distribution rate of $0.375 per unit. The partnership’s current payout of $0.52 per unit represents a 38.7% increase from its IPO. (Source: “Distribution Policy & History,” KNOT Offshore Partners LP, last accessed November 28, 2019.)
As it stands, KNOP stock could be an opportunity for yield-seeking investors.