A Double-Digit Yielder You Likely Haven’t Considered
It’s no secret that beaten-down stocks can offer some of the highest yields. The only problem is that quite often, stocks are down for a good reason. If a company’s share price tumbles because its dividend is no longer safe, you should probably stay away from it, regardless of how high the yield has become.
The good news is, there are also companies that are down simply because they operate in an out-of-favor industry. And if they have enough resources to maintain their dividends, their elevated yields could be worth considering.
KNOT Offshore Partners LP (NYSE:KNOP) is a good example of this.
Structured as a master limited partnership (MLP), KNOT Offshore Partners owns, operates, and acquires shuttle tankers. These tankers are usually under long-term charters in the offshore oil production regions of the North Sea and Brazil.
If you’ve been following the markets, you’d know that oil prices just had another round of downturn. WTI crude plunged 21% in November 2018, marking its worst monthly performance in a decade.
Therefore, it shouldn’t come as a surprise that companies in the oil industry have taken a hit as well. In the case of KNOT Offshore Partners, the partnership’s unit price has tumbled more than 10% since its high this summer.
And because distribution yield moves inversely to a partnership’s unit price, the pullback in KNOP stock has made it one of the highest yielders in today’s market.
Trading at around $20.18 per unit, KNOT Offshore Partners LP offers a staggering annual yield of 10.3%.
High Distribution Yield Backed by a Solid Business
Sure, with commodity prices being volatile, high-yield energy stocks don’t really look like the safest bets. However, keep in mind that while KNOP operates in the energy industry, it does not have any exploration or production business. Instead, the partnership, along with its sponsor Knutsen NYK, has a sizable fleet of shuttle tankers.
Because shuttle tankers are somewhat of a niche in the energy business, KNOP, despite not being a well-known name to most people, has already established a solid position in its operating market.
As of September 30, 2018, the partnership had a fleet of 16 shuttle tankers, serving a high-profile customer base that includes Exxon Mobil Corporation (NYSE:XOM) and Royal Dutch Shell plc (NYSE:RDS.A, RDS.B). (Source: “Third Quarter 2018 Results,” KNOT Offshore Partners LP, last accessed November 27, 2018.)
The business is also recurring. At the end of the third quarter, KNOP’s fleet of vessels had an average remaining fixed contract duration of 3.9 years and an additional 4.4 years on average in Charterer’s Option. Therefore, the partnership can generate stable cash flows despite the ups and downs in oil prices.
Maintaining a Safe Payout
For those concerned about this ultra-high yielder’s distribution safety, a look at its latest earnings report should be reassuring.
In the third quarter of 2018, the partnership’s fleet achieved an impressive utilization rate of 99.9% for scheduled operations. (Source: “KNOT Offshore Partners LP: Earnings Release—Interim Results for the Period Ended September 30, 2018,” KNOT Offshore Partners LP, November 26, 2018.)
Of course, because KNOT Offshore Partners is an MLP, its key financial performance metric is distributable cash flow. By comparing this metric to the partnership’s actual cash distributions, we can see whether the payout is safe in a given reporting period.
In the third quarter, KNOT Offshore Partners LP generated $26.3 million in distributable cash flow. Considering that the partnership declared total distributions of $18.0 million during the quarter, its distribution coverage ratio came out to 1.46 times. (Source: KNOT Offshore Partners LP, op cit.)
In other words, the partnership generated 46% more cash than what was needed to meet its distribution obligations. And if you look at bit further back, you’d see that in the second quarter of this year, KNOP’s distribution coverage ratio stood at an equally impressive 1.50 times.
Therefore, the payout was safe.
Bottom Line on KNOT Offshore Partners LP
Ultimately, I wouldn’t call KNOP stock a slam dunk. As an income investor with a long-term horizon, I prefer companies that can grow their payout to shareholders over time.
KNOT Offshore Partners completed its initial public offering (IPO) in 2013 and was paying increasing distributions up until 2015. Since then, the partnership’s per-unit payout has stayed constant.
Going forward, KNOP will likely keep following the current distribution policy. During the latest earnings conference call, the partnership’s Chief Executive Officer and Chief Financial Officer John Costain said:
Given the quality and the market position of the sponsor, together with the shuttle tanker outlook, the yield has elevated under very attractive value proposition. There is, therefore, little benefit to the MLP in the short term to increase distribution when the yield is around 10%.
(Source: “KNOT Offshore Partners (KNOP) Q3 2018 Earnings Conference Call Transcript,” The Motley Fool, November 28, 2018.)
Still, keep in mind that since the oil price downturn started in the summer of 2014, dividend cuts were not uncommon in the energy sector. By offering a safe yield of over 10%, KNOT Offshore Partners LP is already a rare find.