With the market betting that Fed rate hikes may end in the second half of 2023, many preferreds and bonds have been selling at higher prices. The idea is that, when rates stop rising, those income vehicles will look more attractive.
Of course, nobody, including the Fed, knows when the rate hikes will stop. So, we went hunting for overlooked, high-yield, discounted preferreds, which can give us a price cushion.
We found the Imperial Petroleum Inc. 8.75% Series A Cumulative Preferred Shares (NASDAQ:IMPPP). Both IMPP common and IMPPP preferreds began trading on Monday, Dec. 6, 2021, as a result of a spin-off from StealthGas (GASS).
Imperial Petroleum (NASDAQ:IMPP) owns only product and crude oil tankers. It provides international seaborne transportation services to oil producers, refineries, and commodities traders. It carries refined petroleum products, such as gasoline, diesel, fuel oil, and jet fuel, as well as edible oils and chemicals, and crude oils.
IMPP is a micro-cap stock, with a $36M market cap. In order to quickly grow its fleet, management has rapidly diluted the common shares, which, in turn, fell from over $9.00 down to $.18. Management intends to keep utilizing the ATM program in order to raise more cash for expansion of the fleet – they may need to do a reverse split, in order to be in compliance with NASDAQ rules. However, preferred shareholders benefit from common share dilution.
“For the time being, we will continue with the ATMs until we have enough cash or a fleet large enough to be competing with the global players.” (Q4 earnings call)
The IMPPP preferred shares have a number of supportive features, including:
-They’re cumulative, so IMPP must pay preferred shareholders any skipped dividends before paying a common dividend.
-If a “Change of Control” occurs, IMPP shall have the right to redeem the Series A Preferred Shares, in whole but not in part, within 90 days of the occurrence of the Change of Control, at a price, prior to December 31, 2023, equal to $26.50 per Series A Preferred Share, plus accrued but unpaid dividends, whether or not declared. On or after December 31, 2023, the redemption price with respect to a Change of Control Redemption will be the same as for an optional redemption. (The values of the redemptions will conform to the annual call date table listed further on in this article.)
-IMPP must maintain at the end of each quarter a free cash balance of $0.5M per vessel for the first 24 months of the company’s operation. It ended 2022 with $119M in cash, and $40M in operating cash flow.
The IMPPP preferred shares have a series of call dates, which determine how much the issuer, Imperial Petroleum, must pay to redeem these shares. At their 2/21/23 closing price, the IMPPP shares are ~20% below their June 2023 $26.00 call/redemption value.
After 6/20/23, the redemption call price decreases by $0.25/year, to $25.75 prior to 6/30/24, to $25.50 before 6/30/25, to $25.25 before 6/30/26, and finally, to $25.00 before 6/30/27. There were ~795,878 IMPPP preferred shares outstanding, as of 12/31/22.
Most likely, management won’t redeem these shares before sometime in 2025 as they intend to use cash to increase the fleet size to ~20 vessels, so that they can compete for oil majors’ shipping business. CEO Vafias: “I would say a proper fleet size will be in the region of 20, 25 ships.” (Q4 earnings call)
This table shows you the potential capital gains and ~total profits that would occur at each call cutoff date, with ongoing distributions outweighing cap gains from 2025 onwards.
For example, the potential capital gain if these shares are called on 6/29/25 would be $6.09/share, whereas the distributions would be $4.92/share, for a total net profit of $11.01, a ~56.73% total return in ~2.25 years, or ~25% annualized:
At its 3/30/23 $19.41 price, IMPPP yields 11.27%. It should go ex-dividend next on ~6/23/23, with a ~6/30/23 pay date.
Coverage for preferred dividends from net income was a whopping 34.5X in Q4 ’22, and 16.96X in full year 2022.
Net income does include non-cash depreciation, so if you add that back to net income, the earnings before depreciation & amortization, EBDA, coverage is higher. EBDA coverage was 44.45X in Q4 ’22, and 23.97X in full year 2022:
The useful lives of these vessels are estimated to be 25 years from date of initial delivery from the shipyard. IMPP’s nine vessels were built from 2008 to 2011.
Management grew the fleet from just four vessels to nine vessels in 2022, which was an opportune time to do so, as shipping rates remained high. The fleet’s operational utilization was ~79% in Q4 2022 due to two vessels being in drydock. Voyage days grew from 1428 in 2021 to 2464, amping up earnings exponentially.
In February, management announced that it had “entered into agreements to acquire two handysize drybulk carriers, built in Japan at Naikai Zosen in 2012 and at Shin Kurushima Onishi in 2013, respectively, from CEO Vafias-owned entities, which brings IMPP’s total fleet size up to 11 vessels.
IMPPP has four vessels on short term charters expiring in the first half of 2023, with the balance being in the spot rate market, as spot rates continue to be very attractive.
“We have strategically dedicated the majority of our spot market, as demand is strong, with high charter rates.
All demand is estimated to grow by 1.8% in 2023, despite the global economic slowdown, due to the energy crisis and high interest rates.
However, a strong rebound in oil demand is expected as China slowly fully reopens. And we expect this will necessitate the reversal of the OPEC cuts.” (Q4 earnings call)
With the big increase in rates and its fleet size, IMPP’s earnings exploded in full-year 2022, three-digit growth. In Q4 ’22, even with two vessels drydocking, IMPP had three-digit revenue growth and four-digit growth in net income and EBITDA. Interest expense also grew rapidly, due to higher rates and more debt to finance the growing fleet.
Profitability and Leverage:
You may be surprised to learn that the marine shipping industry has relatively conservative debt leverage. IMPP’s management is following that policy, with its very strong balance sheet. As of 12/31/22, it had ~$70M in debt, but ~$119M in cash and time deposits:
IMPP’s Loan payments are only $10M/year, vs. Q4 annualized EBITDA of ~$71M, and Operating Cash Flow of $40M in full year 2022.
Its EBITDA/Interest coverage was a robust 26X in 2022, higher than the 23X industry average, while its net debt/EBITDA and debt/equity leverage ratios were both much more conservative than industry averages. ROA and ROE trail the industry average, but they should improve with IMPP’s bigger earnings base.
Debt and Liquidity:
IMPP initially incurred ~$28M of indebtedness under its New Senior Secured Credit Facility, which it entered into in conjunction with the Spin-Off Distribution, to refinance outstanding indebtedness of StealthGas secured by the four vessels that it contributed to IMPP in the spinoff.
Borrowings under the New Senior Secured Credit Facility bear interest at an annual interest rate of LIBOR plus a margin of 1.95% and will mature in 2027.
Leverage, which is defined as total debt net of cash/total market adjusted assets, must not at any time exceed 70%. EBITDA to interest expense over the preceding 12 months must at all times be more than 2.5X. For the year 2022, EBITDA to interest expense was over 26X.
IMPP is allowed to declare and pay dividends in amounts up to 50% of its free cash flow in any rolling 12-month period so long as we are not in default thereunder nor would be in default as a result of such dividend payment.
In September 2022, IMPP got a $17M term loan facility, for financing the dry bulk carrier Eco Bushfire, and also entered into a commitment letter for a senior secured credit facility in an amount of up to $30.8 million related to the financing of the two crude tanker vessels, the Suez Protopia and the Suez Enchanted.” (SA)
The company is on an upward growth trajectory, with a conservative balance sheet, and the IMPPP shares have very strong net income/dividend coverage of 17X and 24X EBDA/dividend coverage. We rate the IMPPP preferred shares a buy, up to $25.00.
Editor’s Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.