Teekay Corporation: Discounted Bet On Teekay Tankers – Buy (NYSE:TK)

Note:

I have covered Teekay Corporation (NYSE:TK) previously, so investors should view this as an update to my earlier articles on the company.

Last week, shares of Teekay Corporation sold off after its main consolidated asset Teekay Tankers Ltd. (TNK) reported weaker-than-expected fourth quarter results.

Adding insult to injury, Teekay Tankers management refused to return additional capital to shareholders despite the company’s strong cash flow generation and best-in-class balance sheet (emphasis added by author).

Our spot market exposure and fleet of mid-size tankers position Teekay Tankers to continue generating strong cash flow, particularly as tonne-mile demand growth is forecasted to outpace fleet supply growth in the coming years. We intend to maintain our discipline and long-term orientation in capital allocation, prioritizing the retention of capital for future fleet reinvestment while also continuing to return capital to shareholders

At prevailing charter rates, Teekay Tankers’ annualized free cash flow yield would be north of 30%:

In 2023, Teekay Tankers generated a whopping $575 million in free cash flow, thus resulting in the company moving from a $345 million net debt position at the end of 2022 to a $226 million net cash position at the end of Q4. Management expects Teekay Tankers to be completely debt free with 23 unencumbered vessels by the end of the first quarter.

On the Teekay Tankers conference call, analysts more or less openly expressed their displeasure with the company’s approach to capital allocation. Kudos to Pareto Securities’ analyst Eirik Haavaldsen for asking the right questions despite being largely rebuffed my management (emphasis added by author):

Eirik Haavaldsen

(…) I was just curious because did I understand you correctly when you said that you don’t really have a limit as to how big your cash per share could really grow here because, of course, you’re already at very decent levels and at current markets, that’s growing rapidly. So, you don’t see swollen cash coffers as and there’s no limit basically to where we can be.

Stewart Andrade

So, we don’t have a number in mind that says once we reach this number that we would feel compelled to do something with that capital. Again, it’s looking at the opportunities in the market, the need for fleet reinvestment, our view on when those opportunities might arise, how much capital we would need to take advantage of those, and then making a decision around our overall capital allocation.

So, where we stand today, we think that we will continue to build balance sheet strength, and we will balance that off against returning capital to shareholders via our capital allocation policy that we’ve outlined. And we can’t really look into the crystal ball and say, well, in 12 months from now, what will our decision be around capital allocation. But where we are today is that we’re in the same place roughly that we when we announced our capital allocation nine months ago, which is our primary focus will continue to be on building financial strength, so we can make reinvestments in the fleet, balance that off against returning capital directly to shareholders.

And when we if and when we get to a stage that we think that’s not the appropriate capital allocation policy and we should do something different, which could be investing that capital, it could be returning it to shareholders, whatever it is. Then if we get to that stage, we will definitely communicate that to the market and we’ll go from there.

(…)

Not surprisingly, in his subsequent research note titled “Corporate Governonsense,” he called out management on its capital allocation decisions.

However, while management’s approach to shareholder capital returns remains disappointing, investors would be well-served to focus on ongoing strong industry fundamentals with a second consecutive year of massive free cash flow generation looking very likely at this point.

In addition, given the company’s mounting cash hoard and increased pressure from analysts and investors, I would expect management to change course and declare at least one special dividend (in addition to Teekay Tankers’ regular $0.25 quarterly cash dividend) over the course of 2024.

Following last week’s sell-off, Teekay Corporation’s discount to net asset value (“NAV”) has increased from 12% to approximately 18%:

With approximately 95% of Teekay Corporation’s revenues derived from the consolidation of Teekay Tankers, the company’s small marine services operations can be considered immaterial.

As of the end of Q4, Teekay Corporation owned 5,168,785 Class A common shares and 4,625,997 Class B common shares of Teekay Tankers, representing a 28.8% economic interest and the majority of voting power.

Over the past 18 months, Teekay Corporation has repurchased more than 10% of outstanding shares. However, the increase in the company’s stock price has resulted in slower buyback activity as of late.

Teekay Corporation ended the year with $287.4 million in cash, cash equivalents and short-term investments, which are comprised of bank deposits and short-term debt securities issued by the United States government.

At least in my opinion, there’s little sense in Teekay Corporation remaining a public company, as basically the entire value of the business is derived from the stake in Teekay Tankers and a massive amount of cash on the balance sheet.

Given this issue, management could consider selling or outright ceasing the company’s marine services operations and dissolve the company while distributing all cash and Teekay Tankers shares to common shareholders.

Alternatively, Teekay Corporation could merge into Teekay Tankers in order to eliminate the unnecessary and costly dual listing structure and reduce corporate overhead. In addition, the move would strengthen Teekay Tankers financial position even further, thus potentially enabling a very large special dividend payment of up to $8 per share.

However, following the sale of Teekay LNG Partners to Stonepeak more than two years ago and the subsequent wind-down of its FPSO operations, Teekay Corporation has been sitting on its cash pile without making major efforts to put its capital work or considering a potential merger with Teekay Tankers.

Given this issue, investors should not expect Teekay Corporation’s management to change course anytime soon.

Bottom Line

Following last week’s selloff, Teekay Corporation’s discount to NAV has increased to the upper end of its usual 10% to 20% range, which at least in my opinion provides for another chance to gain exposure to persistently strong crude tanker markets at a decent price tag.

In addition, I would expect Teekay Tankers management to reconsider its capital allocation approach over the balance of the year, thus hopefully resulting in the declaration of a meaningful special dividend.

Consequently, I am raising my rating on Teekay Corporation’s shares from “Hold” to “Buy.“