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When we last covered NuStar Energy L.P. (NS) we had a bullish outlook on all aspects of its capital structure, though we definitely had one we favored above the others. A lot has happened since then, and we decided to provide an update on our “buy thesis” in light of these new facts.
A Quick Recap On The Company
NuStar is a Master Limited Partnership or MLP that operates in three segments: Pipelines, storage, and fuel marketing. Its primary focus is in the Permian Basin. It has approximately 10,000 miles of pipeline and a total storage capacity of 74 MMbbls.
Source: NuStar Presentation
The company has one of the best assets in the business and it also has kept its leverage under control over the years. It started off 2020 by delivering rather superlative results in 2019, but things have taken a turn for the deep south since then.
Source: NuStar Presentation
The results were solid and in line with expectations. That was of course because the pandemic impact was felt later in the quarter and most firms barely had time to even react by March 31, 2020. NuStar did however, make some key updates around the time the results were released.
- 2020 Adjusted EBITDA guidance was lowered to $665 – $735 million, a decrease of about 5.5% compared to their previous 2020 guidance.
- A big reduction in capital expenditures wherein 2020 capital spending estimates were moved to a range of $165 – $195 million. This was a 45% reduction from previous guidance. Maintenance capex spending was unchanged.
- A distribution cut to $0.40/quarter. This would save the company $88 million in cash through 2020.
- A reduction of $45 million in operating expenses.
- Finally, it announced a three-year, $750 million unsecured term loan agreement with Oaktree Capital Management (OAK) to increase liquidity and to address near-term debt maturities. They used $500 million of the proceeds to pay down the revolving credit line. This loan was done at an incredibly expensive 12% rate.
The company expects to have a distribution coverage ratio of about 1.7X.
Source: NuStar 1Q2020 Earnings Results
NuStar’s EBITDA decrease is rather substantial when you take into account the $45 million in operating expense reductions. In the absence of those reductions EBITDA would have dropped more than 10%. The company also is likely going to have to reduce EBITDA again and we think by another 5% at least. Two factors are at play here that were not in motion when Q1-2020 results were released. The first is that storage was in exceptional demand as the “super contango” (where future prices are much higher than spot prices) was in play. That has eased off and contango has normalized. NuStar’s storage assets while still in strong demand are likely to not be firing on the same afterburners as in April and early May. The second aspect is the continued declines in production across all the basins.
While production is scheduled for a brief bounce, as uneconomical production is brought back on line, we believe that NuStar is massively overestimating average and exit 2020 production from US shale. Investors should recall that while NuStar has a big base of investment grade producers, the capital expenditures have been across the board. The over expenditures (and resulting oil price crash) will impact all producers, even investment grade ones.
Source: NuStar Presentation
NuStar also was expecting Permian to be kept afloat at $40/barrel but the reality on the ground is that $40 is unlikely to work today as balance sheets are highly distressed.
Source: NuStar Presentation
That brings us to our adjusted EBITDA estimates which are about 4% below the low end of the company’s numbers.
Source: Author’s Calculations
NuStar has some of the best assets in the midstream space and we expect them to command a premium. At the same time, in almost every existing pipeline, we think capacity will exceed flow-through barrels. Pricing will be difficult for NuStar in 2021 and it might have to make concessions for some customers. The storage assets should be steady but we would not expect them to drive the EBITDA higher.
Income investors looking to buy NuStar should invest in the preferred stocks instead of the common units.
NuStar offers three publicly-traded preferred stocks. All are par $25, cumulative, fixed-to-floating rate securities. They pay dividends four times a year and go ex-dividend at the end of February, May, August, and November.
NuStar Energy L.P., 8.50% Series A Fixed to Float Cumulative Redeemable Perpetual Preferred Units (NS.PA)
- Fixed coupon is $2.125 or 8.5%
- Current Price as of writing this is $16.99
- Current Stripped Yield is 12.2%
- Callable on 12/15/2021
- After 12/15/2021, yield floats at LIBOR plus 6.766%
NuStar Energy L.P., 7.625% Series B Fixed to Float Cumulative Redeemable Perpetual Preferred Units (NS.PB)
- Fixed coupon is $1.91 or 7.625%
- Current Price as of writing this is $15.47
- Current Stripped Yield is 11.9%
- Callable on 6/15/2022
- After 6/15/2022, yield floats at LIBOR plus 5.643%
NuStar Energy L.P., 9.00% Series C Fixed to Float Cumulative Redeemable Perpetual Preferred Units (NS.PC)
- Fixed coupon is $2.25 or 9.0%
- Current Price is $18.17
- Current Stripped Yield is 12.0%
- Callable on 12/15/2022
- After 12/15/2022, yield floats at LIBOR plus 6.88%
Note: LIBOR will be phased out by the end of 2021 and replaced by a similar benchmark.
They have risen off the lows from when we last recommended them, and though they’re still well under $20, we see them more as yield plays here rather than big capital appreciation stories. Given that the yields at the current prices are very generous, investors are getting huge income.
All three preferreds are so far below “par value” that any of them being called will be a massive windfall to investors. While you do pay more upfront today for NS-C, you are compensated by a larger floating yield down the line. This also increases the odds of it being called. NS-A has a higher YTC because it is callable the earliest, in 17 months. With the three-month LIBOR rate in the 0.3% neighborhood and expected to remain low, we can anticipate floating rates that are 1.5–2.0% lower than the current fixed rate (if not redeemed on the call date).
When we last covered this company we were cognizant of the risks of refinancing the debt maturity of $450 million in September of 2020.
Source: NS Presentation
The new credit line with OAK has put to rest that danger but NuStar paid a ridiculous rate for that financing. That damages equity prospects to some extent. NuStar also would have to think about where they see oil production in the Permian going over the next three years and invest accordingly. We believe low production from US shale plays will eventually force a recovery in prices and ultimately incentivize production.
NuStar assets are vital for the Permian producers and Permian assets are likely to be the first place growth resumes when prices improve. The common units though come after over $3.3 billion of debt and $785 million in preferred ownership. So while there are reasons to be a bit bullish, we don’t see an extremely compelling case on them. NuStar’s rush to the capital markets at a time when they were most distressed also weakens the case for the common.
For the preferred units to be impaired we have to assume that EBITDA keeps dropping into 2021-2022 and the company is worth less than a 7X EBITDA multiple. We see that as extremely unlikely and believe the preferred units are safe and will maintain close to a 3X distribution coverage (or 300% coverage for the preferred dividends). This provides a higher safety level than other preferred stocks.
There’s a fair amount of subjectivity here on which preferred units can be bought and redemption of a preferred might happen depending on the market climate around the callable date. We like all three of these preferreds, but investors should note different float rates and the call dates. We would reiterate that all three are still undervalued and represent excellent yields in today’s low-yield world. While the upside is limited, we are recommending these preferred stocks for their high dividends as part of a highly diversified income portfolio.
Note: K-1s are issued for NuStar’s preferred dividends.
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Disclosure: I am/we are long NS.PA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.