Knot Offshore Partners LP (KNOP) 2014 Q3 法說會逐字稿

Good day and welcome to the KNOT Offshore Partners third-quarter 2014 earnings release conference call. (Operator Instructions). Please note this event is being recorded. I would now like to turn the conference over to Mr. Arild Vik, CEO and CFO of KNOT Offshore Partners. Please go ahead.

Thank you very much. Good afternoon. Very much happy to welcome you to our third-quarter earnings conference call. And I will go through the presentation and we will take questions afterwards as they come. I think we should go straight to the presentation and after the notice to the recipients, we can go straight into page 3 for the highlights and recent events of the partnership during this period.

A major element is that we have added two vessels towards the end of the second quarter this year, so that has had a major effect on our income and operating income as well. Our net income ended up at $12.6 million and our operating income was $15.5 million. We generated adjusted EBITDA of $25.7 million and we generated distributable cash flow of $14.7 million. In addition to the acquisition effects from these two vessels, our result in third quarter was also positively affected by $1.8 million in unrealized derivative gains on interest swaps.

In third quarter, we declared a cash distribution of $0.49 per unit and this then leads us to having an annual distribution of $1.96 per unit, which is a 12.6% increase from the Q2 distribution. Also, during this quarter, the underwriters exercised their option to take their overall allotment option and the general partner followed on in order to maintain their 2% partner -- their ownership. So in total, the common unit offering and the overallotment option led to increase in our equity of $152 million.

Another notable event is that, during the quarter, our sponsor, Knutsen NYK Offshore Tankers, entered into long-term charters with BG group for vessels starting up in 2016 and 2017 and these contracts have been ordered at the Hyundai Heavy Industries in South Korea and this increases the partnership. The defined vessels were dropped down to six units.

Going to page 4 and looking at our P&L for this period, we have very good operations. We have 7.5 days off hire, which is more than we've had historically, but still it is well within what we expect to see over time and there will from time to time be such operational matters. Also, it's worth noting that, due to contract provisions, there is a noncash item of approximately $0.9 million for the third quarter and that was previously $0.5 million. So that's a change due to the new contracts that we entered into. And further, as mentioned, we had an unrealized gain of $1.8 million on interest rate swaps for this period.

Our balance sheet gives us -- of course, reflects the acquisition that we have made and we're sitting at the end of the quarter with $44 million as unrestricted cash, interest-bearing debt of about $540 million and our average credit margin is $2.4 million. We have, during the period, implemented part of the refinancing that we agreed, in total $380 million and we expect to complete the final amount of $140 million during the fourth quarter and we have then been able to, in this process, to extend the repayment profiles.

We have currently swapped $350 million of our total long-term debt interest risk so that we have then fixed that at levels with an average rate of 1.38% above in addition to the margins, which leads us to have a total interest cost well within our budgeted numbers and I think the 4% that we indicated at the IPO. So we've maintained a strong balance sheet in the Company.

On page 6, we show our distributable cash flow, which is in line with the effects that have been outlined in relation to the dropdown and on page 7, this gives us an adjusted EBITDA of $25.7 million, which also is in line with our expected numbers as advised at the IPO and in line with the increase in the effects that we have from the dropdowns that we have effected.

That takes us to page 8 where we then get an overview of our contract status. We currently have fixed contracts duration for our fleet of seven vessels of 5.1 years and accordingly, we do not see that we will be affected by short-term elements in the offshore-related industry. So this goes back to our basis being in the production chain of things and we expect to maintain stable cash flows.

On page 9, we highlight the fact that we have also, during this period, grown our inventory as Knutsen NYK Offshore Tankers entered into contracts for two new shuttle tankers with BG. These have been contracted at Hyundai in Korea and expected deliveries are the latter part of 2016 and first quarter of 2017 and these vessels will then in time be offered to the partnership and the contract could last up to 20 years. We will come back to BG's position in Brazil.

So that takes our -- on page 10, that takes our dropdown inventory up to in total six vessels. That is the Ingrid Knutsen and the Hull 574, which has been there from the IPO. It is the Dan Cisne and Dan Sabia, which were vessels acquired by our sponsor during this year and it is the two new contracts, which then will be delivered at the end of 2016 and beginning of 2017. All in all, these contracts have a fixed period of 7.6 years in average, 14.5 years, including options.

On page 11, we are highlighting the developments in Brazil. Although there have been delays in the Brazilian exploration and ability to execute on projects, we now see that there are clear signs of a positive development and with reference to BG, which we have contracted with, we see that they are on time and have quite an extensive program. And it's also important to note that they are operating with a breakeven level below $40 per barrel for these projects.

So on page 12, we have again referred to BG group's investor update where they have set out the specific fields and where we see the rampup of production that they have been experiencing during the period from fourth quarter 2012 to second quarter 2014 demonstrating that this activity is coming onstream.

On page 13, looking at the situation in Norway, it's also relevant to then look at how breakeven oil prices or requirement for the new field developments have developed and we see a rising trend, but we still see that, as far as these numbers go in 2013, we are still in many cases below $60 and on this basis, we expect to continue to see planned developments go ahead also in the North Sea and Norway. So all in all, on the basis that we are involved in the production part of the business where we are not cyclical in terms of our existing contracts and with the breakeven levels that we see the oil companies are referring to, we continue to believe in strong growth in this area.

Going to page 14 and our numbers, we are here listing the development of the quarter since we did the IPO. In our mind, the numbers are very much in line with what was outlined and the changes over the quarters is really reflected -- is really only reflecting the dropdowns that we have been doing. And we see in third quarter 2014 strong results in line with what we expect and it might be worth mentioning that the second quarter of this year, we had certain special effects due to cost of dropdowns being taken, but they did not go into the P&L for that period and that means that -- that was a special quarter, which cannot really be used for reference. We see that the coverage ratio is now in third quarter back in the levels that we have seen, actually slightly above the average levels that we have seen prior to this quarter.

So on page 15, we have set out the development in distributions and we have now reached a level of $1.96 per unit following the Hilda and Torill acquisition. So that is an increase by 12.6%. And that is, again, as I would say in line with what we have outlined. Since from the MQD, which we saw set out at the IPO, the increase is 31%.

So I would say that is the headlines. And we would then be happy to answer any questions. With me today is also Bjorn Bakkevig and Trygve Seglem, and I think then we will open up for any questions you might have.

(Operator Instructions). Derek Walker, Bank of America.

Good afternoon. I appreciate the color around the breakevens both in Brazil and North Sea. I guess in light of that information, do you still see any changes or behavior perhaps outside of those areas? I know there's other markets for shuttle tankers, but I'm not sure what the breakeven points are there and to some extent your appetite previously given just the commodity backdrop, but just what are you seeing outside of both of those markets for shuttle tankers and do you see the backdrop in commodity prices change the opportunity set there?

I think we continue to believe that Brazil and North Sea are main markets. I think we see development maybe off the Canadian coast potentially as they need maybe at one point to renew part of their fleet, but I mean we don't see West Africa and I don't think we see US Gulf quite yet. So I think that in terms of what's of practical importance for investors over the next three to five years, I think our picture is pretty much the same.

But also in the northern part of Norway and further north, there will be also some development and that will give longer distances for sailing, which also give a higher demand for vessels.

Got it. I appreciate it. And then, sorry, I hopped on the call late, but did you guys give a sense for just the overall tender activity for next year and how that's developed?

Well, I think we have indicated that there have been tendering activity and now we see that it's actually happening. There was also a tender awarded to a competitor the other day and I think we continue to believe that there are tenders out there, which would, for the next 12 months, be in the range of six to eight vessels. It's very difficult to give a fixed number, but I would -- we would definitely expect to see continued tender activity during that period.

And I very strongly believe that actually we should be able to take our share of that and be just as successful as we have been in 2014 and 2015.

Got it. And then just the last one from me. (multiple speakers).

So irrespective of the oil price, this will happen because these are fields, which are already decided to develop and they wouldn't be stopped.

Got it, got it. Just a last one from me, as you look at your portfolio and continue the path of just being a pure play shuttle tanker business, but are you evaluating other types of assets, either complementary or just additional platforms? Can you just provide some thoughts there?

I think we very much are following the main path of shuttle tankers for the time being. There could be FSU opportunities as they develop, but I think, again, we see strong growth potential in the shuttle tanker market and clearly, that is where we have our focus.

That's it for me. Thank you very much.

(Operator Instructions). T.J. Schultz, RBC Capital.

Hey, guys, just on the dropdowns, just looking for timing expectations for the next dropdowns, how we should think about those six contracts shifting into the MLP over the next couple of years. Is it something where you target a certain distribution growth and manage the drops into that timeframe? Just any color you can give would be great. Thanks.

I think we are maintaining our growth picture as we set out, so I would imagine that we would be looking to dropdown all these vessels over the next couple of years. We are not giving specific indications to when we will do it and the order of which we will do the dropdowns. But we do see that this gives us good basis for continuing the growth as we have laid out.

It will be pretty soon.

Okay. Can you just remind me what your growth expectations are over the next couple of years?

Well, I think we set out to say 10% to 15% growth over the first three-year period and that's pretty much where we are. Of course, we have delivered part of that growth already, but we see that as a reasonable expectation to model going forward.

Great, totally agree. I appreciate it. Thanks.

David Starkey, Morgan Stanley.

Yes, hi, guys. Can you give us an idea of what your interest rate exposure is? Say the short rates maybe in the next couple of years move up towards 3% or so, how that would affect your income? I know you're hedging, but how long are you fixed in and locked at current rates?

Well, currently, we are locked in about four years, which is $350 million out of a total of net $500 million in debt and we see that as a reasonable interest risk for us.

I mean that compares with the term of the fixed contracts of 5.1, and then you have some options in addition to that. So that should give you the picture.

So in the neighborhood of about four years based on the current hedging and current maturities?

Yes.

Okay. And what would happen if just for instance rates spiked up to 7% or 8% after that period with your income? How would that affect that?

Well, that would be reflected in the renewals of the contracts, but, of course, until then you would suffer.

But you do have these things locked in, so we don't really need to worry so much about what rates do over the next three or four years based on what you're saying?

Bjorn Bakkevig:

Yes.

I think that's right and then as Bjorn is saying here, I mean over time, we will be able to -- because the rate structure is, to a large extent, set by the capital costs involved, that's understood by both the charterers and the owners and that means that, over time, we will be able to get compensated, but there could, of course, be a lag in that process.

Great. Well, thanks for your help. I appreciate it.

[Andy Gupta], [Hite Hedge].

Hi, good afternoon, guys. My question was more around -- we've seen recently Statoil announce suspension of two rigs at least till the end of the year. I'm just wondering if this is reflective of activity in the North Sea and if it has an impact on tendering activity. Notwithstanding the comments you've already made on tendering activity.

We don't see that that will have any effect on tender activity for the next three to four years because the fields that we are tendering, they are already far matured and so much investment has been made in order to complete them. So when now Statoil and others are reducing the drilling activity that will have -- potentially that will have effects much further ahead. And again, if we look at our existing operation, we are protected from these developments because one thing is for sure and that is that the oil companies want to make sure that once they've made that much investment in specific fields, they want to get the oil out of there and sell it really at any price because they're still -- it's a big element of sunk cost there.

In short, I think it's quite natural that you see reductions in activity in the North Sea given the record high level it's been on the last year. In this presentation, we took in some slides from BG and wanted to show what's going on in Brazil. We feel that we have a very strong contract coverage currently with five years for the seven vessel fleet. We will double that fleet probably within the next couple of years and that dropdown inventory has even longer contracts averaging 7.6.

Beyond that, we see that we're pretty resilient on growth because as we tried to convey to you is that as long as oil prices are above $40, these fields that we're targeting for the shuttle are profitable. Of course, we have no expert views on what's going to happen with oil price and what's going to happen in financial markets, but that's what we see from our point of view.

Thank you. How do you see the M&A market evolve for you guys at the MLP level?

Well, it's a good question. We get more of that, but I think as far as we are concerned, we see excellent potential to continue to grow the business based on the backlog we have and based on the expectations we have for new business and then, of course, there are some other players that we could maybe try to consolidate, but, on the other hand, that's obviously something that doesn't come automatically. So we definitely see ourselves as growing and if there are M&A opportunities for us, we would look at them, but that's not something we have put in our assumptions that we will be able to do any acquisitions of other vessels.

But I would like to add to that that actually we have put out to our competitors in the market, both Lauritzen with their three vessels, they are totally now out of this market, and [Mongo and Kilby] bought their last vessel. So they are also away from the market. So these are the acquisitions we have made in KNOT, but, of course, actually depending on time charters and such, there will be candidates for both of them, all of them.

Thank you very much.

Matthew Phillips, Clarkson.

Hi, everybody. You touched on this in your last answer just now and I'm wondering -- I really appreciate the color on Brazil and North Sea breakevens and whatnot. I'm wondering if BG and Petrobras' outlook differs materially. I mean they each have their own funding issues and motivations and just BG, it seems clear, is still pushing ahead. Do you feel the same at Petrobras as well and clearly, you have a couple vessels with long-term contracts, as you just mentioned, that will be coming into the fleet, but I'm just wondering about how you see any difference in outlook in the two explorers?

I think actually that what we see is it's picking up again in (inaudible). And some of the projects, which previously was delayed, is now actually going ahead. So we see actually some kind of acceleration if we take the market as such out in Brazil. We see other companies than BG like, you have Repsol, Sinopec, the other (inaudible).

Petrobras and BG is pretty much 100% aligned. I mean BG has typical 35% share when Gulf has 10% and Petrobras 65% and if you look in their investor presentation, they have the same optimistic tone. There also is one more point with Brazil and that's that pre-salt wells have been better than anticipated, so they are producing more oil and that's a positive. That's been happening for the last half year.

Interesting, thanks. I appreciate the color.

William Adams, Advisory Research.

Yes, thanks for the discussion so far. I guess I wonder if you could give us a little color on what type of -- what were the economics or EBITDA multiple did you expect from those acquisitions of those charters by the parent for the two for Brazil?

You mean the last acquisitions we did in June?

The two with BG that will be a dropdown candidate. I was just curious what kind of economics it would be for the --.

We don't disclose that, but they are in line with previous contracts. So as we've earlier said, this market is pretty stable and you do not see big variations. And the variation is mostly connected to differences in interest rate level.

Can you give us a range of what historically the GP has been able to enter contracts for?

We have indicated that targeting unlevered IRR of around 10. You should have an idea.

Okay. And then on page or slide 21, you show this forecast that was given in November of 2013 and obviously then oil prices were significantly higher. And I was just curious, you talk about this source, [Hearnsley], whoever that is, talked about an additional need of 60 shuttle tankers by 2020. I just wonder how this oil price would impact that need by say 2020 because I would assume with the lower oil price and lower cash flows that maybe that would be deferred.

Yes, we haven't done any calculations on the effect of lower cash flows in the oil companies, but we know that we're late cycle. We know about all the fields that are going to be developed until 2020 and they are highly profitable at the current level. They should be highly profitable down to where we assume that US shale will shut down. As I said, I don't have any specific cash flow. You can do that as well as we can within oil companies. But I mean it's a completely different ballgame. Shale is short-term high production, you take out the big effect of volume.

These deepwater figures we are dealing with are very long term and as an example, in Brazil, the average production per well is around 30,000 barrels per day for the deepwater wells compared to, let's say, 15,000 barrels in the North Sea and 10,000 barrels in Gulf of Mexico.

But I think we can say because 2020 is not that many years ahead and the fields and developments that were supposed to happen during that period has come a long way. So we're not looking at any significant changes to that number.

We see actually that the tendering is actually picking up and has been doing that for the last 12 months and actually the result of that we will come forward and of course, it will take 2.5 years from when you get the contract until you have a new building into operation. So that pretty much takes us -- the contracts we are winning today, they will not start before 2017.

And for FPSOs, the leadtimes are even longer, up to three years plus.

Okay, great. Thanks so much.

(Operator Instructions). This concludes our question-and-answer session. I'd like to turn the conference back over to Mr. Arild Vik for any closing remarks.

Yes, thank you very much. We appreciate again having the opportunity to speak to you all and look forward to welcoming you to our next earnings conference in three months time. Thank you.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.