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Teekay Corporation: An Ingenious Model in a Tough Business
Over the past decade, Teekay has transformed itself from being primarily an owner of ships in the cyclical spot tanker market to being a broad-based asset manager with a greater emphasis on fixed-rate, long-term contracts. Time-charters, with a guaranteed base rate, may include performance clauses, profit-sharing agreements and inflation adjustments, but they won’t capture the potential upside, or feel the pain on the way down, when the spot market swings.
Teekay has expanded into the liquefied natural gas (LNG) and liquefied petroleum gas (LPG) shipping sectors, which often involve contracts up to 25 years, or essentially the full life of the vessel. The LNG market is expected to grow significantly over the next 20 years, but the pace of near-term development has been somewhat disappointing due to delays in onshore infrastructure projects.
More recently, Teekay has focused on expanding its presence in the offshore market, including shuttle tankers, floating production storage and offloading (FPSO) units, and floating storage and off-take (FSO) units. The company believes this business will provide, over time, better rates of return than conventional tanker operations. The market for offshore crude oil and gas has grown very rapidly over the past five years, and the rate of development spending is expected to be 20% higher over the next five years. Teekay has long had a presence in the North Sea offshore business, which is maturing, but still offers opportunities. Lately, it has been bidding for business (and has won more than its share) in the Brazilian market, the fastest-growing offshore arena. Teekay has no operations in the Gulf of Mexico, where the April explosion of the Deepwater Horizon rig and subsequent oil spill has put developments on hold and will very likely result in costly regulation. Teekay could still be affected by the tragedy if Gulf assets move into its markets and competition increases, but it may also benefit if the oil companies turn to higher quality contractors and vessels.
Though Teekay has shifted its weight toward time-charter business, it is still very much at the mercy of the spot market. Only about 45% of the company’s operating revenue days are fixed for 2011. Too, prevailing spot rates help determine time-charter terms as contracts are negotiated. And the spot market is notoriously volatile, cyclical, and seasonal. For instance, spot rates for Very Large Crude Carriers were well over $100,000 a day in July of 2008, compared to an average of $20,000 and as low as $5,000 this August . (For a more detailed discussion of the current state of and outlook for the Maritime Industry and Teekay’s recent contract wins see those respective reports in the September 3rd Issue of the Value Line Investment Survey.)
When the markets are down as they are now, financing for new ships dries up, which eventually helps bring about a positive correction, but can also result in severe near-term penalties for construction cancelations and hurt a vessel owner’s long-term growth plans. Teekay has gone a long way toward alleviating that problem through the formation of publicly traded “daughter” companies, as follows.
In 2005, TK added, through an initial public offering of common units, Teekay LNG Partners L.P. (TGP) as part of the strategy to expand operations in the LNG shipping sector. TGP provides LNG, LPG, and crude oil transportation under long-term, fixed-rate contracts with major energy and utility companies. TK currently owns 49% of TGP, including a 2% general partner interest.
In late 2006, an initial public offering of common units for Teekay Offshore Partners L.P. (TOO) was completed. This subsidiary owns and operates conventional crude and derivative product tankers, shuttle tankers, FSOs, and FPSOs. The idea is that investors, who want to limit their exposure to the spot tanker market, but participate in offshore expansion, can buy units of TOO, rather than shares of TK. TOO has raised capital through several follow-on public offerings, most recently for 5.25 million units (For $115 million)in August. At last count, TK retained a 36% interest in TOO, including the 2% general partner interest.
Teekay Tankers (TNK) was added in late 2007 with an initial public offering of common stock. This subsidiary of which (TK currently owns 37%) has the most exposure to the spot tanker market, which can be preferable to more adventurous investors. The most recent follow-on offering was completed in April.
Some may wonder why the parent structure is maintained at all. Part of the answer is that the parent has certain marketing and asset purchasing advantages. TK purchases the vessels, finds them employment, and then drops them down to the daughter companies at cost, receiving the capital they previously raised through debt and equity offerings. The company has a goal of being net debt-free at the parent level by 2012, and TK does not guarantee any of the obligations of the subsidiaries. Also, TK has enhanced its returns through fee-based (management) revenue and ownership of the general partnership’s incentive distribution rights, which entitle it to disproportionate amounts of available cash as distribution levels to unit holders increase. And the daughters distribute all cash (or pay dividends in the case of TNK) beyond what is needed for operating expenses and capital expenditures.
This organizational structure may or may not make it easier to value TK, depending on methodology. When shipping profits are at a low point, or in negative territory, as they have been lately, the preferred method to value a company is to compare the share price to Net Asset Value (NAV). NAV is basically the market value of the company’s assets, minus net debt (usually total debt minus cash and cash equivalents), plus equity interest. Since TGP, TOO, and TNK are publically traded, it’s simply a matter of summing up TK’s ownership interest to arrive at the value of the equity. However, when one maritime segment is down, most are, so one would have to calculate the NAV’s of each of the daughter companies to arrive at a truer valuation. The problem is is that ship values can fluctuate nearly as much and as fast as spot tanker rates.
Looking at the big picture, TK is well positioned for the long run. It has limited its exposure to the spot market, while retaining some of the upside for when rates improve. Meanwhile, it has a growing footprint in the most promising industry sectors.