Shipping stocks have long been among the highest yielding securities available due to brutal market conditions over the last seven years.
During the peak of oil tanker rates in 2006, companies would charter the largest tankers for as much as $155,000/day. With credit cheap, the global economy booming, and oil prices on the rise, tanker companies massively overbuilt their fleets. The financial panic resulted in falling oil prices, slower economic growth, and a decline in credit availability that left many tanker companies struggling to survive as day rates began a six-year journey down to a low of $5,000.
Thanks to strengthening global economic growth, booming oil demand in China, and tanker companies cancelling new build orders in droves (as well as scrapping older tankers), it appears as if the oil tanker market has finally started to recover. This is a godsend to companies such as Nordic American Tankers -- who operates a fleet of 22 Suezmax tankers and offers a mouthwatering 9.8% yield. However, before you pile into Nordic American Tankers or its recently public offering, master limited partnership Nordic American Offshore, there are several facts you should be aware of.
Nordic American Tankers: the good, the bad, and the ugly
Nordic American Tankers focuses exclusively on Suezmax tankers, which hold 1 million barrels and cost the company $12,000/day to operate. By focusing on just one kind of ship, the company is able to minimize costs. This is a necessity because Nordic American operates purely through the spot market, meaning no long-term contracts, and little cash flow predictability.
Luckily for Nordic American Tankers, the Suezmax spot market soared to $40,000/day at the end of 2013. This helped lift Nordic American's quarterly average day rate 87% from $14,100 to $26,300. For its first quarter Nordic American Tankers recorded a 160% increase in revenues and posted a $4 million profit vs. a $32.4 million loss from last year.
The bad news is that the Suezmax spot market is highly volatile. For example, after peaking in December 2013, day rates plunged 62.5% to $15,000 by May before recovering to back to $43,700 on July 18. By July 25th the spot rate declined to $30,600.
Investors might be interested to know that in the last two weeks the suezmax spot rate jumped 51% before plunging 25%. This kind of severe volatility could spell long-term trouble because any company that wishes to consistently pay out high dividends requires predictable cash flows. A 100% dependence on a spot market that can fluctuate up or down 50% in a week means that Nordic American Tankers' dividend may never be safe.
Which brings me to the ugly side of Nordic American Tankers; its history of non-accretive shareholder dilution.
Nordic American Tankers hasn't been cash flow positive since 2010 and hasn't covered its dividend since 2004. In fact, from 2005 through 2013 Nordic American Tanker reported just $471 million in cash from operations, yet issued $1.178 billion in new stock. Nordic American has only been able to stay in business and pay its steadily decreasing dividend by continuously issuing shares and diluting existing shareholders.
Even a recovering Suezmax spot market may not guarantee an end to dilution, because Nordic American began selling shares back in 2004, long before the spot market tanked in 2008-2009.
However, hope for the company may come in the form of its recent IPO, Nordic American Offshore. This MLP yields 9% and owns six offshore rig supply vessels operating in the North Sea. Nordic American Offshore plans to use the proceeds from the offering to buy two more ships with an option for three more later.
This possibility of doubling its fleet means Nordic American Offshore's distribution could soar in years to come. With Nordic American Tankers owning 26% of Nordic American Offshore and its general partner and incentive distribution rights, the $2 million in dividends it received from Nordic American Offshore in Q1 could grow substantially. This might prevent the need for further dilution.
Foolish bottom line
Nordic American Tankers' exclusive use of the volatile suezmax spot market means its cash flows are not predictable enough to pay its generous, but insecure dividend. With a long-term day rate recovery yet to prove itself in a market that is wildly volatile, Nordic American Tankers remains a highly speculative investment. Nordic American Offshore represents a better potential investment but is too new to yet judge how sustainable its yield is.
Adam Galas has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.