This post first appeared in our new The Alpha Community, which is currently free for all premium subscribers.
Summary
- KNOT Offshore Partners (NYSE:KNOP) is a leading player in the shuttle tanker market, offering long-term contracts with oil majors.
- The stock has suffered from a sharp dividend cut, but contract stability suggests a potential rebound.
- Valuation remains depressed, presenting a compelling opportunity for income and value investors.
- Recent transactions and fleet repositioning set the stage for improved financial flexibility and distribution growth.
Introduction
KNOT Offshore Partners (KNOP) has been a long-time favorite among income investors, thanks to its historically high dividend yield and niche shuttle tanker operations. However, macroeconomic headwinds and delays in North Sea projects led to a severe dividend cut in late 2022. Despite these challenges, KNOP is making strategic moves that could position it for a recovery in both distributions and share prices.
Shuttle Tankers: A Niche but Essential Market
Unlike conventional tankers that transport oil between terminals, shuttle tankers serve as a critical link between offshore production units and onshore refineries. These vessels operate under long-term contracts (typically 5-15 years), ensuring revenue visibility.
KNOP’s fleet comprises 18 shuttle tankers, including 12 Suezmax, 5 Aframax, and 1 Panamax vessel. Major clients include Equinor, Shell, Petrobras, and TotalEnergies, reinforcing the stability of its cash flows.
The fleet is operating at 98.8% utilization. The Contractual backlog expanded (as at September 30, 2024) to $980m of fixed contracts averaging 2.8 years. The Charterers’ options average a further 2.4 years. The fleet has a contractual backlog of 5.2 years if all options are exercised.
Dividend Cut and Path to Recovery
In response to the delays in North Sea projects, KNOP reduced its quarterly dividend from $0.52/unit to $0.026/unit in late 2022. That drove the share price down by 70%. However, the company has since restructured contracts and secured new agreements that improve fleet utilization and double the contractual backlog. When the management announced the dividend cut, it clearly stated the conditions under which the dividends would increase again. Those conditions have been broadly achieved by now. The next step is for the management to deliver under its undertaking.
Fearnley Securities are bullish on dividend restart
According to Fearnley Securities, KNOP’s current backlog supports a dividend payout of approximately $0.30/unit per quarter. If the company follows through with its vessel optimization strategy, a distribution increase could be seen by mid-2025.
Valuation: Deep Discount to NAV
KNOP is currently trading at a significant discount on its net asset value (NAV). Based on fleet valuations and contracted revenue, Fearnley estimates a NAV per unit of $13.8. With the stock trading below $6, the price-to-NAV ratio sits at just 0.43x, indicating substantial upside potential.
The key driver for rerating will be improved investor confidence in the dividend reinstatement and the company’s ability to refinance upcoming debt maturities without excessive equity dilution.
Recent Transactions Bolster Financial Stability
KNOP recently executed vessel swaps and contract restructurings to optimize cash flow and reduce near-term capital expenditures. The Tuva Knutsen transaction, for example, provided a net positive cash inflow, improving the company’s financial position.
Additionally, the replacement of the open Panamax vessel (Dan Sabia) with a more strategic asset could provide further visibility for dividend increases in 2025.
Risks to Consider
While the investment case for KNOP is compelling, risks remain:
- Debt Refinancing: Upcoming maturities in 2025-2026 will require refinancing at potentially higher interest rates.
- Market Volatility: Crude tanker rates are cyclical, and any weakness in offshore production projects could impact demand.
- Sponsor Support: The role of Knutsen NYK in managing fleet dropdowns and financial backing remains a critical factor.
Conclusion
KNOT Offshore Partners is at a pivotal moment. The stock trades at a deep discount to NAV, while contract stability and fleet repositioning suggest a pathway for dividend recovery. If management successfully executes its refinancing strategy and optimizes vessel utilization, KNOP could see significant appreciation from current levels. When dividends were paid, KNOP traded at three times higher than today.
KNOP presents an attractive value and income opportunity in the specialized shuttle tanker market.
