Nordic American Tankers (NAT) is the most popular tanker stock, commanding superior stock valuations because of its long dividend history. But its capacity to declare generous dividends has been curtailed by debt covenants from its February 2019 Credit Facility with Beal Bank.
This may be a blessing in disguise, because it allows NAT to execute a clear and sustainable capital allocation strategy, including payment of dividends.
NAT, an owner of 23 Suezmax-type crude oil carriers, is led by colorful if not venerable CEO Herbjorn Hansson. It is one of the oldest publicly traded shipping stocks on NYSE. It is mostly shunned by institutional investors, but it is a darling of retail investors who seek high dividend yields.
NAT typically commands stock valuations at a substantial premium to its net asset value, a rarity among shipping stocks that tend to trade at a discount to NAV.
Its secret sauce has historically been high dividend payments (92 consecutive payments – an eternity for shipping stocks), supported partly by free cash flows and partly by timely equity raises.
Raising cash to support dividends is no longer a viable option. NAT has an ageing fleet and any future equity raises will likely pay for new ship acquisitions to replace older tonnage.
The only way to pay dividends in the future will be to earn them. And even then, NAT will have to split its free cash between dividends and extra debt repayments. You can blame the debt covenants on how free cash is now allocated.
There are three restrictions stemming from the 2019 Credit Facility:
- NAT must maintain a minimum liquidity of $30m,
- NAT must “prepay” for drydock costs, i.e. capital expenditures for its existing fleet, by setting money aside in a restricted cash account,
- NAT must apply 50% of net earnings (from the 20 tankers pledged as collateral to Beal Bank) to pay down debt, in addition to scheduled debt repayments.
Compliance with these covenants explains the company’s dividend policy for the past three quarters. It can also be used as a guide for future dividend declarations.
The table above illustrates how free cash is allocated at the end of each quarter between dividends and extra debt repayments. Each extra debt repayment is due in the following quarter. NAT is projected to have a proforma debt of $338.5m, after its extra debt repayment of $31.9m in the third quarter of 2020. Its debt stood at $410.5m a year ago.
Now, these restrictions can be viewed as a bad thing for NAT shareholders, because future dividend yields will be lower. I believe the opposite is true. By prioritizing prepayment for dry-dock costs and accelerated debt repayments, NAT is rationalizing its capital allocation and dividend policy. Free cash is now split between capital expenditures, extra debt payments and dividends.
Sooner or later NAT will have to upgrade its fleet. Having low levels of debt will allow it to acquire new vessels without major equity raises, thus lowering (if not eliminating) the risk of dilution. For example, selling an older vessel (debt-free) for scrap could provide $8m as equity towards the purchase of a new vessel.
Whether by accident or design, the debt covenants have allowed NAT to formulate a clear and sustainable capital allocation policy. In an industry known for opaque decision-making and “surprise” equity offerings, this should be applauded.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.