Teekay Preferred Units: Attractive 10.1% Yield

Teekay Offshore Partners (TOO) is a marine energy transportation, storage and production company, and its preferred units currently offer an attractive 10.1% distribution yield. Teekay’s common units have declined over 70% in the last year, while the preferred units have declined around 12% during that same time period. The common units drastically cut their distribution payment earlier this year due to energy market and liquidity challenges, however we believe the cut is actually a good thing for the preferred units. Specifically, the common unit distribution cut frees up more cash to support the big preferred distribution payments which happen to be cumulative meaning Teekay must backpay unitholders if they ever skip or reduce a distribution payment (this is not the case for the common units). This week’s earnings announcement reinforces our view that Teekay management is taking the necessary steps to drive future success, the preferred units offer compelling income and price appreciation potential, and if you’re an income-focused investor, Teekay is worth a closer look.

Overview
As the following chart shows, Teekay has declined over 70% in the last year, compared to only a 2%, 15% and 12% decline for the S&P 500 market index (SPY), the overall energy sector ETF (XLE), and Teekay Series A preferred units (TOO), respectively. There’s obviously been a strong correlation between Teekay’s preferred and the energy sector, whereas Teekay’s common units faced steeper declines as the quarterly distribution payments were recently reduced to $0.11 per unit from $0.56 per unit.  

Data Source: Yahoo Finance

To add some color to the energy sector challenges Teekay faces, the company received a termination notice for a large charter contract from Repsol in November 2015. Repsol is a Spanish integrated energy company that has aggressively stepped up cost-cutting efforts as the price of oil has fallen and their profits went negative (EUR 2 billion in Q4). (http://www.marketwatch.com/story/repsol-profit-plunges-more-than-40-2016-05-05) Repsol is just one example of the types of challenges Teekay faces, and we’ll cover risk factors in further detail later in this report.

Teekay’s Cash Flows
Generating strong revenues hasn’t necessarily been the challenge for Teekay over the last several years as they have grown from $901 million in 2012, to $931 million in 2013, to $1 billion in 2014 and $1.2 billion in 2015 (and revenue was a healthy $307 million in Q1 2016 http://www.google.com/finance?q=NYSE%3ATOO&fstype=ii&ei=pjxCV8GFE5PAmAGouJywCA http://www.streetinsider.com/ec_earnings.php?q=too The challenge has been (and continues to be) balancing the cash inflows and outflows. Specifically, Teekay’s business requires heavy capital expenditures, and like other companies in the industry Teekay has used considerable amounts of debt to finance them. The following chart gives some perspective on the capital expenditure and debt balancing challenges Teekay faces in the coming years.