Hoegh LNG Partners 15.6% Yielding Preferred Shares: A High Risk/High Reward Trade-Off

seekingalpha04-22

Hoegh LNG Partners reported strong cash flow and financial results in its full-year report.The company's preferred dividends are fully covered and it has recently started paying distributions on its ...

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ClaudineVM Introduction I have a long position in Hoegh LNG Partners’s preferred shares, which are trading with OTC:HMLPF as its ticker symbol. As the common units of Hoegh were delisted after a go-private transaction, information is scarce, and the quarterly reports issued by Hoegh are pretty much the only easily accessible data to keep an eye on the health of the company. As Hoegh recently reported its full-year financial results, and as I consider this to be a high-risk security, I try to keep an eye on the financial performance of the company on a quarterly basis to immediately take action if/when needed. In an important update on the FSRU Lampung arbitration, Hoegh LNG confirmed all arbitration proceedings have been halted and an amicable solution has been reached. This removes an important risk from the equation. Seeking Alpha The cash flow remains strong As all of Hoegh’s five FSRUs are chartered under long-term agreements, there are virtually no surprises in the partnership’s financial results. Looking at the full-year results, Hoegh reported a total revenue of just under $150M, and after deducting the almost $62M in operating expenses and adding the $18.2M in equity earnings in joint ventures, the operating income was approximately $106M. HMLPF Investor Relations As you can see above, the company was able to keep its financial situation under control and the total net finance expense decreased slightly. This resulted in a pre-tax income of $83.4M and a net profit of just under $76M. As I’ll explain later in this article, the total amount of preferred dividends payable during the year was $15.5M, which means the net income attributable to the common unitholders was just under $60.5M. The contribution from joint ventures is related to the 50% ownership in the Neptune and Cape Ann vessels. As shown below, the total net income of those two assets was almost $36M, and about half of that was attributable to Hoegh LNG Partners. HMLPF Investor Relations Unfortunately, this generates just an accounting gain, and as you can see in the cash flow statement below, there’s only about $2.3M that got ‘upstreamed’ from the joint venture to Hoegh LNG Partners as part of a principal repayment. The other earnings are accumulated on Hoegh’s balance sheet. The reported operating cash flow was approximately $87.1M, and after adding back the net changes in the working capital and after adding the $2.3M in cash flow from the joint venture related assets, the adjusted operating cash flow was approximately $94.9M. HMLPF Investor Relations As there was no capex to speak of, that also immediately was the net free cash flow, and after deducting the preferred dividend payments, the net free cash flow attributable to the common unitholders was approximately $79.5M. And as shown above, the majority was used to repay in excess of $50M in debt, while it also distributed about $20M to its common unitholders (see later). At the end of December, Hoegh LNG’s total cash and restricted cash position was approximately $52M while the company had about $44M in short-term debt and $243M in long-term debt for a total net debt of $235M and just under $260M if you would exclude the restricted cash. HMLPF Investor Relations Also important from the perspective of a preferred shareholder is the $664M in total equity, of which approximately $177M would be required to settle the preferred shares. This means there is approximately $490M in common equity, which ranks junior to the preferred shares. As the company is very profitable and not all profits are used to pay dividends, the total amount of equity just continues to increase. That means the preferred dividends are still more than fully covered As mentioned in the previous article, the terms of the preferred shares are actually very straightforward. There currently are 7.09M preferred shares series A outstanding which can be called by the company at any moment (that is not a likely scenario and I rather expect a tender offer below the $25 principal value). These preferred shares offer an annualized distribution of $2.1875 per share, payable in four equal quarterly tranches of just under $0.55 per quarter. So far, the company has continued to pay the preferred dividends. Seeking Alpha While it always is important to remain careful when the underlying company’s shares have been delisted as the new owner of Hoegh may simply not care about the wellbeing of the preferred shareholders, it is encouraging to see the company has recently started to pay distributions on its common units. HMLPF Investor Relations That’s clearly visible in the cash flow statement (shown again above). We see the company paid a total of $35.5M in distributions to limited partners and preferred unitholders. We know there are 7.09 million preferred shares outstanding and 7.09M * $2.1875 = $15.5M. That’s what’s required in annual preferred dividends. We also know the partnership only paid a total of $26.6M in preferred and common distributions in the first nine months of 2023 which means a total of $8.9M was distributed in the final quarter of the year. We know the preferred dividends only require just under $3.9M in quarterly payments, which means there was a distribution of approximately $5M to the common unitholders of Hoegh LNG Partners. That’s positive news for the preferred shareholders, as the cumulative nature of the preferred shares prohibits the partnership from making payments on the common equity as long as there is a preferred dividend outstanding. This is confirmed in the statement of changes of capital. As you can see below, the partnership paid about $20M in distributions to the common equity. This represents about a third of the attributable net income. HMLPF Investor Relations As long as the partnership pays a distribution on the common units, it simply has to make sure the preferred dividends are paid on time and in full. There obviously are some risks to the thesis. Hoegh LNG could decide at any given moment it will stop the common and preferred dividend payments, and it would be allowed to do so. Secondly, as explained in the previous article as well, the arbitration against its Indonesian charterer of the FSRU Lampung was weighing on the perception of the company. However, a footnote on page 44 of the annual report indicates the entire matter has been settled (the emphasis is mine). On February 5, 2024, the parties entered into an amicable settlement by which the parties have agreed to settle all of the disputes, claims and counterclaims between the parties that gave rise to the said arbitration proceedings and agreed to terminate the arbitrations with immediate effect finally and irrevocably. The charter contract for PGN FSRU Lampung remains in full force and effect and each party will cover its own costs in relation to the terminated arbitrations. Investment thesis Given the almost $80M in free cash flow, it is clear the partnership was taken private at a bargain valuation, as the $9.25 delisting price represented a market capitalization of just $310M for the common equity. There have recently been rumors about Hoegh LNG Holdings looking to monetize the FSRU division (paywalled), and with a book value of close to $0.5B, it could be in a position to make a nice profit on a potential sale (note: the article does not specify if Hoegh LNG Partners would be sold, as the potential sale could be related to other assets. That being said, resolving the FSRU Lampung arbitration was likely required before putting FSRU assets up for sale). In any case, this is not playing any role in my investment thesis.  I have a long position in Hoegh LNG Partners and I continue to hold that position while trying to buy more shares. That hasn’t been easy as A) not all brokers allow buy trades in HMLPF (selling is always possible) and B) the low liquidity levels means an order can remain open for a while. I do have a buy order in the market to add to my position, but I’m bidding in the $11.5-12.00 region. The preferred shares of Hoegh LNG Partners are currently yielding approximately 15.6%, and with a payout ratio of 20% of the earnings and with almost $0.5B in common equity ranked junior to the preferred capital, I’m not worried about Hoegh’s ability to pay. The ‘willingness’ to pay is always questionable after the delisting of the preferred shares, but Hoegh LNG has made all preferred payments correctly and has recently started to pay distributions on the common equity.  Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. 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