Wall Street Is Dead Wrong About KNOT Offshore Partners

Source: Knot Offshore Partners.

KNOT Offshore's cash flow is highly secure, backed by long-term fixed rate contracts with some of the largest oil companies in the world, such as ExxonMobil, Statoil , and BG Group , which will soon be owned by Royal Dutch Shell . The same holds true for the future dropdown pipeline of tankers, which provide the opportunity to grow its fleet 50%.

Despite the worst oil crash in a generation, big oil companies continue to invest in the most attractive offshore opportunities, and that means continued strong demand for this niche midstream sector. For example, BG group is currently investing heavily in offshore Brazilian oil production, where breakeven prices remain below $40 per barrel.

Similarly, Statoil continues to see potential in North sea oil production. In fact, Statoil recently decided to invest over $7 billion in the Mariner oil field and is thinking about investing in the Bressay field as well. Combined, these two projects would likely result in 195,000 barrels per day of production and generate demand for five shuttle tankers.

Risks to be aware of

Should oil prices remain low for several years, then shuttle tanker charter rates will continue to decline, as they are slowly doing now. For example, Repsol Brasil , a subsidiary of Sinopec , recently extended its contract for one of Knot's tankers by five years to 2023 in exchange for a 6.2% reduction in charter rate.

Meanwhile, KNOT Offshore's current unit price is potentially too low to raise equity growth capital to buy the five dropdown tankers from its sponsor without excess dilution that could slow future distribution growth.

Debt financing could also prove a challenge, given KNOT Offshore's existing $611 million total debt load and current liquidity of $87.2 million. Given KNOT's 6.6 debt-to-EBITDA ratio, lenders might only be willing to extend additional loans to perhaps buy one additional tanker.

Bottom line: Wall Street has KNOT Offshore Partners' business model all wrong

There doesn't seem to be any justifiable reasons why KNOT Offshore Partners should be trading at a 15% yield. Yes, plunging oil prices have had a small negative effect on shuttle tanker charter rates. However, based on the small magnitude of these declines thus far, KNOT Offshore's long-term contracted, fixed-fee midstream business model, and its sustainable coverage ratio, I think the probability of a distribution cut over the next few years is far lower than what Wall Street is currently pricing into the MLP.

What's more, its sponsor's dropdown pipeline means that KNOT Offshore Partners has a very clear growth catalyst should either oil prices recover or Wall Street realize its mistake and price this MLP's units correctly.

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The article Wall Street Is Dead Wrong About KNOT Offshore Partners originally appeared on

Adam Galas has no position in any stocks mentioned. The Motley Fool owns shares of ExxonMobil. The Motley Fool recommends Statoil (ADR). 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 .

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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