BW LPG Q2 Earnings: Product Services Division Confuses Markets

Investment thesis

I covered BW LPG (OTCPK:BWLLF) in a recent article, "BW LPG: Still an Attractive Choice for the Income-Oriented Investor," outlining its strong balance sheet, attractive pricing, a large share of dual fuel ships in its fleet, and predictable dividend history as the main factors underlying a buy recommendation.

Its recently published Q2 earnings report supports this thesis. However, its stock price has risen significantly since then, and its relatively new reporting segment, Product Services, introduced some complexity. I still rate the stock a buy, with an unchanged target price of NOK 150 (USD 14.01). However, it is closer to being rated as a "hold" due to being relatively more expensive and has thus already taken out some of its potential.

Q2 resulted in a $0.81 dividend per share being declared (equivalent to 28% annualized yield) wholly covered by its free cash flow. It reiterates its positive market outlook and says it will continue paying high dividends if strong rates continue. BW LPG has also decided to pursue a dual US listing, estimated to be finalized in early 2024. This move will improve access to the stock for US investors and increase available trading hours.

The company reported Net Profit After Tax of $78.2 million for Q2, way below expectations and initially sending the stock down 9% from its August 28 closing price of NOK 126.10 (USD 11.79). However, as the market digested its Q2 report, the stock eventually closed on August 29 at NOK 127.40 (USD 11.81), a 1.03% increase.

In any case, BW LPG closed the books in Q2 with free cash flow of $194.9 million - more than enough to cover dividends - a record low net leverage ratio of 19%, and $330.9 million in cash and cash equivalents. Compared to its main peers, Avance Gas (OTCPK:AVACF) and Dorian LPG (LPG), it continues to be an attractive option for income-oriented investors.

Strong Fundamentals Continue in Q2

As its two main peers, Avance Gas and Dorian LPG, have reported their Q2 earnings, we can compare performance over time for all three. In this section, I will discuss recent developments in three key metrics: Dividend yield, EV/EBITDA, and Net Debt to EBITDA. I will explain how these figures were calculated towards the end of this section.

Let's begin by reviewing the dividend yield (trailing twelve months):

The graph shows that all three have experienced declining or stagnating yields over the past few quarters. Albeit at high levels. This is entirely predictable, given that freight rates have remained high, but not continued into the sky. Furthermore, as the graph above shows, BW LPG has been able to grow its yield (increase its dividend faster than its stock price has increased) more than its peers.

All three companies have had a large positive stock price development YTD:

BW LPG declared a $0.81/share dividend on a reported EPS of $0.53 this quarter. While this may seem as a departure from its straightforward, rule-based dividend policy, it is actually not. For reasons elaborated on below, in the chapter "Events in Products Services...", the dividend payout is no longer based on net profit after tax, but trading-adjusted-profit. This non-GAAP measure equated to $0.81 for the quarter, which means that the dividend payout of 100% of EPS is exactly in line with BW LPG's policy of paying out 100% of earnings when net leverage ratio is below 20% (Q2 ended with a ratio of 19%).

Turning our attention to the EV/EBITDA ratio, we see that BW LPG remains relatively cheap compared to its peers as measured by this ratio:

Avance Gas and Dorian LPG are more or less similar, but BW LPG is consistently cheaper in terms of this metric.

Finally, we will consider the net debt to EBITDA ratio. BW LPG has deleveraged consistently over the past few quarters, reaching a record 19% net leverage. According to its dividend policy, a net leverage below 20 percent means that it will pay out 100 percent of earnings as dividends.

Its peer Dorian LPG has also taken the opportunity to deleverage, but at a slower pace, and is still at higher level. Avance Gas, on the other hand, has increased leverage.

This development is reflective of where each company is, in terms of new build programs:

• BW LPG finished its LPG dual fuel conversion program during 2021-2022. Out of its 16 LPG dual fuel vessels, 15 are owned and one is chartered.
• Dorian LPG has 1 dual fuel vessel in its fleet, and has chartered 3 more (fiscal 2024 Q1 report, p. 19).
• Avance Gas has 4, with an additional 4 on order (medium gas carriers, estimated delivery during Q1 2024 onwards) (its Fleet list also contains its fleet orders).

In other words, BW LPG has both the most LPG dual fuel vessels in its fleet, and the lowest leverage.

Neither BW LPG nor Dorian are, according to their latest earnings presentations, looking to add more vessels to their fleets.

"[T]here are no talks of newbuildings at the moment," BW LPG CEO Kristian Sorensen said in its latest earnings call, responding to a question from a caller.

Dorian CEO John Hadjipateras had this to say about fleet renewal in Dorian's latest earnings call:

Regarding fleet renewal, 25 ships with a useful life of approximately 25 years implies replacing one ship per year. We capitalized on a good set of market dynamics to build one ship and to charter in three more on initial seven year terms with options. These fleet renewal deals were economically attractive. As the chartered in ships give us market exposure, optionality on length and the potential upside of the purchase options while not requiring a large upfront investment. We price optionality in our investment decisions as we continue to evaluate fleet renewal and other opportunities.

In other words, both are put off by high newbuild prices.

Avance Gas took delivery of 2 LPG dual fuel vessels during this quarter, causing additional drawndowns on its $555 million sustainability-linked debt facility.

With its record low leverage, BW LPG is in a great position to weather any storm coming in the future.

Why is having LPG dual fuel vessels in your fleet an asset? BW LPG offers this compelling slide in its latest presentation:

With the VLSFO/LPG spread averaging $200 in 2023, BW LPG has a payback time of about 4 years - and an internal rate of return of about 25% (!) on its investment in LPG propulsion.

To calculate the metrics used in this section, I collected figures from each company's quarterly reports over time. The figures were put into this table, which also contains the calculations necessary to create the graphs shown above:

Dark blue columns are input columns (data fetched from quarterly reports), while light blue column headers are calculated columns.

• EBITDA (4 quarters): Rolling sum of four quarters' EBITDA.
• Market cap: Shares outstanding multiplied by share price end of quarter.
• Enterprise value: Market cap + total debt - cash and cash equivalents.
• Dividend per share (last four quarters): Rolling sum.
• Earnings per share (last four quarters): Rolling sum.
• EV/EBITDA: Enterprise value divided by EBITDA (4 quarters).
• Dividend yield: DPS 4 quarters divided by EPS 4 quarters.
• Net debt to EBITDA: (total debt - cash and cash equivalents) / (EBITDA 4 quarters)

Events in Product Services Division Warrants an Update to BW LPG's Dividend Policy

Following its Vilma LPG acquisition, BW LPG introduced Product Services as a separate reporting segment, starting in Q4 2022. From its website,

(..) the team provides customers with reliable, integrated LPG delivery services, by purchasing LPG and offering it delivered directly to buyers and receivers.

Product Services was created in February 2019 but has not been reported separately in the income statement previously.

On July 18, 2023, BW LPG published a non-regulatory press release innocently titled, "Update on BW LPG’s Product Services Q2 2023 Segment Performance". Within the press release, the following passage was buried:

BW Product Services will report a net loss of approximately USD 32 million because of a timing effect.

This "timing effect" was due to "[t]he benefit from the hedged freight costs via physical shipping positions will enter the net profit over time, while the M-t-M valuation of the cargo operations and derivatives are entered into the accounts immediately." This would lead to the board considering a new, non-GAAP measure named "trading profit," rather than the division's net profit/loss, as the basis for dividend payouts.

In its Q2 presentation, BW LPG confirmed that the dividend policy now considers trading profit rather than the previous NPAT - net profit after tax - measure.

Considering that the company reported an NPAT of $78.2 million and a trading-profit-adjusted result of $112.2, the "timing effect" amounts to NPAT being revised by 43% to reach the "trading-profit-adjusted result." I speculate that this difference was the cause of the opening low on August 29, as investors probably missed this July 18 message and looked at the NPAT only.

In any case, I don't particularly like that a reporting segment accounting for about 36% of revenues (as of Q2 2023) has created the need to use a metric with an awkward name. I will be following the developments in this division closely.

Conclusion

In its Q2 report (p. 5), BW LPG reiterated its positive market outlook:

For the remainder of 2023, we foresee sustained high spot rates, driven by robust LPG exports from both North America and the Middle East. (..) We remain optimistic about the long-term prospects of natural gas and LPG, as gas continues to serve as the most promising transitional fuel towards a cleaner future.

In addition, siginifcant factors continue to buoy freight rates by restricting supply in the marketplace:

• Newbuilding activity remains subdued. Yards are not able to deliver new ships until H1 2027, according to the Q2 report.
• The Panama Canal drought drives ton-mile demand by creating an incentive for LPG carriers to take the long route around the Cape of Good Hope or the Suez canal. Container vessels, cruise ships and others are given priority in the clogged canal. An article on FreightWaves explains this issue further, adding a telling quote from Oystein Kalleklev, CEO of Avance Gas: “We usually see congestion more or less every year in the fourth quarter. Now we’re already seeing it in August"

The sum of these effects is that, in my view, the market outlook is still positive for the VLGC freight market. In the time since the last article on BW LPG, its stock price has increased 13% (August 14 - September 6 closing). The upsde in the stock price is thus narrower, but its dividend outlook is still strong. Finally, its pending 2024 U.S. dual listing can be expected to increase liquidity and make the stock much more attractive to U.S. investors.

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.