Lock in this shipping fund's 9% yield

It’s not often that you can lock in a 9 per cent dividend yield from a company that has delivered a 100 per cent net asset value (NAV) total return over the past five years. It is even more unusual that the company is trading on a 26 per cent discount to book value even though it is selling off 10 per cent of its assets at a premium to NAV and plans to return the cash to shareholders. However, this is the offering from ship leasing fund Tufton Oceanic Assets (SHIP:109¢).

In the latest six-month period, Tufton’s gross operating profit increased by 8 per cent to $33.4mn, generating a 14.3 per cent return on the time-weighted capital employed in the $428mn fund, a reflection of buoyant charter rates across Tufton’s six medium-range product tankers and two chemical tankers.

Furthermore, the net yield on the fleet of nine bulkers (36.6 per cent of NAV), which carry unpackaged bulk cargo increased sharply, mainly due to improving demand growth for major bulk and the impact of reduced transit through the Panama Canal. Supported by strong supply-side fundamentals – grain and minor bulk trade demand are forecast to improve this year – and with spot day hire rates well above existing charter rates, net yields on bulkers are set to rise even higher on new long-term charters as ships are redeployed.

At the same time, tightening environmental regulations and low shipyard capacity is keeping new-build prices high and supporting second-hand valuations across Tufton’s entire fleet. The company’s investment manager is taking advantage of these dynamics.

Set sail for a profitable voyage

In mid-January 2024, Tufton’s investment manager demonstrated the company's ability to divest portfolio vessels at or above NAV by announcing the disposal of two handysize product tankers (smaller bulk carriers) for $41.75mn, representing a 3.1 per cent premium to their carrying valuation. The transaction is a forward sale and should close in the second quarter of 2024 after the vessels complete their current charters.

This explains why the board plans to recycle a portion of the proceeds back to shareholders through a capital distribution equating to between 5-10 per cent of NAV of 145.2¢, implying a return of 7.25-14.5¢ per share. In addition, the improving dynamics in the shipping market has enabled the board to hike the annual dividend per share by 17 per cent to 10¢, paid in quarterly instalments, to underpin a 9.2 per cent dividend yield.

The disposal crystallises a net internal rate of return (IRR) of 25 per cent on the vessels, or double Tufton’s published 12 per cent target, and generates a net multiple on invested capital (MOIC) of two times, including earnings.

Tanker market well underpinned

Importantly, the dynamics in the tanker market remain robust. Limited fleet growth, coupled with a hike in tanker demand due to the Ukraine conflict and increasing European imports from non-Russia suppliers, sent charter rates for medium-range product tankers (43.5 per cent of NAV) to an 18-year high in 2023. Furthermore, refinery expansions in the Middle East and Asia suggest the product tanker market will remain strong for the next couple of years at least.

Interestingly, between 25-30 per cent of medium-range product tankers can engage in the chemicals/vegetable oils trade. This means that the chemical tanker market (8.9 per cent of NAV) benefits as more medium-range product tankers shift towards the tightening product tanker market. This is supportive of the outlook for freight rates on Tufton’s product tankers, all of which are on fixed-rate charters (average charter length of two years).

It's worth noting that Tufton has no exposure to container ships, having correctly anticipated a weaker market after freight rates and ship valuations spiralled during Covid-19. The investment manager realised a net IRR of 27 per cent from its containerships between 2018 and 2023.

Upside potential

It’s not difficult to envisage a scenario where you could make a 16-22 per cent total return within the next 12 months after factoring in four quarterly dividends of 2.5¢ a share and a 7.25-14.5¢-a-share capital distribution. At the mid point of that range, the distribution would be 10.9¢ a share, which would reduce the NAV per share from 145.2¢ to 134¢. So, if the shares continue to trade on a 26 per cent discount to NAV, the share price will adjust to 99¢.

However, NAV per share is clearly on an upwards trajectory, as seen in the final quarter of 2023 when it rose by 5.1 per cent (after payment of the quarterly dividend). A continuation of this trend is highly supportive of the share price, as are ongoing NAV per share enhancing share buybacks. In fact, I would be surprised if Tufton’s share price is lower than it is now by the year-end, and that’s after paying out cash distributions of 17.25¢ to 24.5¢. The fact that the investment managers and principals acquired almost 0.5mn shares at the start of the year to lift their combined stakes to 4.2 per cent is telling. Buy.

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