Hoegh LNG Partners: Speculative Preferred Shares Offer Appealing Yield

Introduction

When Höegh LNG Partners was still trading, I decided against buying the common units, but instead initiated a long position in the preferred shares. Other authors here on Seeking Alpha provided excellent coverage of how the Höegh LNG delisting story. At the end of 2022, the new owners of Höegh LNG Partners decided to delist the preferred shares from a main exchange. These securities are still trading, now with (OTC:HMLPF) as the ticker symbol, but the recent share price represents just half of the principal value of $25 per share.

I still own the preferred shares, and although I am very unhappy with the delisting, I also don’t want to sell at the current share price either. Fortunately, Höegh LNG Partners continues to publish its quarterly financial results, so I can at least keep track of the financial health of the company.

The underlying company continues to perform well

During the third quarter, Höegh LNG Partners reported a total revenue of approximately $39M which is a small increase compared to the $37M it generated in the third quarter of last year. Additionally, the total amount of operating expenses decreased pretty sharply due to the lower G&A expenses after the delisting of the company. This resulted in a 50% increase in the operating income which jumped from $18.2M to $27.7M, although this increase also included an additional $2.4M in earnings of joint ventures which benefited from a higher charter revenue and lower finance expenses.

While HMLP still has to deal with increasing interest expenses, the recent increases were pretty benign as the company’s focus on debt repayment does pay off. The pre-tax income was $18.3M, resulting in a net profit of $18.3M of which $3.9M was attributable to the owners of the preferred shares. The remainder of the profit, $14.4M, was attributable to the owners of the common equity.

The income statement indicates the preferred dividend payments are still very well covered, and the cash flow statement further confirms this.

As you can see in the image below, the reported operating cash flow was $24.7M and after taking the changes in the working capital position into consideration, the adjusted operating cash flow was $23.8M. As there was no capex incurred during the quarter, this also was the net free cash flow result.

The company spent $18.9M on making dividend payments, of which $15M was distributed to the limited partners. This was the first cash distribution to the limited partners this year, and this actually strengthens the case for the preferred shares (see later). The partnership also dipped in its cash reserves to repay debt, and it ended the third quarter with $34M in cash, $19M in restricted cash, a current debt of $44M and a long-term debt of $258M. Excluding the restricted cash, the total net debt was approximately $268M, a $36M decrease compared to the total net debt as of the end of FY 2022. By the end of this year, the net debt level will drop to approximately two times the EBITDA (including JV earnings), which is a pretty comfortable position.

Good financial performance also makes the balance sheet safer. At the end of September, the total amount of assets on the balance sheet was $1.01B, of which just $350M were liabilities. As the image below shows, the total amount of equity on the balance sheet jumped from $626M to $661M.

For the preferred shareholders, it is important to see there are still just 7.09M preferred shares outstanding with a total principal value of $177M. This means that there is almost $500M in equity ranked junior to the preferred shares, which provides a pretty good asset coverage level ratio.

A brief recap of the preferred shares

The terms of the preferred shares are actually very straightforward. There currently are 7.1M 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 off an annualized distribution of$2.1875 per share, payable in four equal quarterly tranches of just under $0.55 per quarter).

Importantly, the preferred shares are cumulative in nature so as long as the owners of Höegh are taking cash out of the company, they simply have to pay the preferred dividends as well. And that’s why I was pretty ‘happy’ to see the partnership made a distribution to the common units held by Höegh LNG. This means it is now less likely the preferred shareholders will be ‘starved’ by suspending the preferred dividend payments while no cash is being streamed up to the parent. And in the ‘subsequent events’ section of the quarterly results, you can see the partnership made another $5M distribution to Höegh LNG, the parent, which seems to indicate the distributions will just continue, which reduces the risk of the preferred dividends getting suspended.

Investment thesis

Höegh LNG was able to take Höegh LNG Partners private due to the uncertainty surrounding the arbitration on the FSRU Lampung as the Indonesian charterer wanted to declare the lease and maintenance contract null and void. This case is now in arbitration and Höegh LNG Partners is still collecting the monthly fees from the charterer. The charterer is claiming $472M plus interest and costs. Should Höegh lose the arbitration, this would have a profound negative impact on its financial situation.

While I don’t expect Höegh LNG Partners to lose the arbitration proceedings, I hope an amicable solution between both parties can be reached, as that would be in the best interest of everyone involved.

In any case, the preferred dividends are still well-covered and there is plenty of equity ranking junior to the preferred equity, so I am still holding my preferred shares for now. I may even add a little bit to my current position but I will of course keep my position size reasonable.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.