Description

NuStar Energy L.P. is an energy infrastructure MLP focused on pipeline and storage of crude oil and refined products.  The company operates approximately 9,000 miles of product pipelines, owns 84 terminal and storage facilities,  and serves primarily the mid-west and gulf coast markets.  It has a significant market presence transporting crude oil out of the Eagle Ford shale and well as substantial dock capacity in Corpus Christi for the storage and export of oil and derivative products.   The equity currently trades at ~7.0% distribution yield, largely due to its historical cash flow volatility, below peer group coverage ratio, and a distribution that has not grown in several years. 

The market currently views NS through a lens distorted by its historical issues, largely ignoring the dramatic improvements to the business that have taken place.  In the past several years, the company transitioned the portfolio to a stable fee-based business, thereby reducing volatility and significantly growing profitability.  The company divested its Asphalt business (completed in Q1 2014), stabilized the storage business, and added a number of extremely high ROIC growth projects utilizing existing portfolio infrastructure.  These projects, which include two Eagle Ford crude pipelines and a restart of an idled line to carry NGLs for export to the global market, should add $90mm of incremental EBITDA for a small capital outlay of $335mm (3.75x EBITDA build).  These projects provide visibility through 2016 and should allow the company to achieve its targeted 1.0x coverage ratio for the year.  Look into the future, management has highlighted a backlog of over $1B of attractive projects that should provide visibility and confidence to increase the distribution for the first time in years. 

It is reasonable to value the stock at $90/share based on a 5.5% yield and a L-T growth rate in the 6-8% range.  This is a strategic midstream asset for those focused on continued growth in the Eagle Ford shale and/or the potential for crude exports.  The MLP space is an interesting animal.  There are very comparable assets to NS today, trading at 2-3% yields solely because the visibility for growth is there in the short term.  As the organic growth diminishes for these companies over time, there is a high level of motivation to utilize low cost equity via accretive acquisitions (i.e. major drivers for the KMI transaction this past summer).  While it seems the company is well on its way to drive the stock higher via execution, the stock’s strategic assets and discounted valuation presents itself as a potential target.  Overall, the team’s ability to execute coupled with highly visible growth projects and an attractive valuation suggests NuStar is likely to outperform over the next several years.

2014-2016 Bridge:

Unlike many other companies with a high level of ambiguity as to the specific drivers of growth, NuStar outlines the key projects that drive the YoY EBITDA improvement going forward in the business.  These projects, as noted above, are extremely attractive IRRs and have been structured as L-T take/pay contacts with their customers. 

-        12 Inch Line:  The company currently has an idled 200 mile 12-inch pipeline that runs from Mont Belvieu to Corpus Christi.  NuStar is converting this to a NGL line to ship propane & butane to the gulf coast for export.  NS has contracted 2/3rds of the capacity with Occidental Petroleum on a L-T contract, thereby locking in $23mm of EBITDA on an annual basis.  The line costs $160mm of cap ex and if fully contracted, should generate $40mm of EBITDA.  The pipeline is expected to be in full service by the second quarter of 2015. 

-        South Texas Phase #1:  The company has a strong Eagle Ford shale presence due to its acquisition into the space in December 2012.  Management completed an Eagle Ford crude line to carry 35k bpd for $45mm of cap ex (~45% IRR), which contributes $20mm of EBITDA contribution annually via L-T contracts.  This line is fully contracted and just started up mid-year.     

-        South Texas Phase #2:  Due to the strong demand for the first phase, management is also spending ~$130mm for 65k bpd of additional capacity.  They are tied into the large oil producers should experience a substantial uplift of $40mm of EBITDA as it is fully contracted.  The line comes online in Q1 2015.

-        Tariffs: The oil pipeline space is regulated under the FERC and has embedded inflation protection ( http://www.ferc.gov/industries/oil/gen-info/pipeline-index.asp ).  This adds ~$12.5 to EBITDA on an annual basis, reset every July 1^st. 

Net net, these drivers should add 20% to EBITDA in 2015 & 2016 assuming no incremental benefit from additional projects.  Worth noting growth cap ex is expected to be $330-$350mm this year, which suggests incremental projects not accounted for in the above bridge.

Future Growth Opportunities:

The company has noted in its most recent investor presentation that it has $1.0-$1.$B of potential growth projects.  The projects do not include those outlined above and likely fall in the 4-8x EBITDA builds referenced by the company historically. When asked in the last conference call on its future opportunities, management responded with the following.  “We’re looking at over $1B set of opportunities, and that’s higher than it’s been in our history and were going to continue adding to that pipeline and evaluating opportunities at an increasing pace.”  In fact, just this week, the company issued a press release disclosing a JV to jointly develop infrastructure to transport LPGs and refined product to Mexico.  This is likely a significant project and a good example that attractive organic investments are moving towards FID.  Announcements and commentary such as this should provide comfort that organic growth can be sustained for many years.

Coverage Ratio:  One of the reasons NS historically traded at a severe discount to the MLP group was its coverage ratio, defined as FCF/Distributions.  In other words, a company with a 1.0 coverage ratio pays out exactly 100% of free cash flow, while a 2.0 coverage ratio pays out 50% of what it earns.  While most companies in the MLP space trade on yield + growth, a coverage ratio >1.0 may indicate a company that 1) has the ability to cover its distribution and 2) and has “cushion” to potentially grow its distribution down the road.  Due to NuStar’s asphalt losses, its coverage ratio declined materially to .65x in 2012, leading the market to conclude its dividend was at risk of a severe cut.  Rather than cutting its distribution, NuStar opted to organically grow its way out of it.  Through numerous highly attractive growth projects and the elimination of losses through the divestiture of the asphalt business, NS managed to increase its ratio to .8x in 2013 and is well on its way to hitting the 1.0x target for 2014.  As EBITDA improves into 2015 & 2016, management will be in a position to utilize its >1.0 coverage ratio to grow the distribution for the first time in four years.

Overall, NuStar’s attractive yield and defensive characteristics provides strong fundamental support.  In a period in which concerns over US oil production has increased due to pricing compression in crude, NS’s earnings are extremely resilient and the stock is not being ascribed any value to the future growth in the business.  The recent sell off in the stock appears to be largely a function of panic related selling in the MLP space, which has failed to differentiate relative cash flow yields and the dramatic improvement in the business over the past several years. 

Catalyst