In Vogue: NuStar Energy L. P. And The Permian (NYSE:NS)

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The effect of crude production at the Permian Basin trumps all other U. S. regions with respect to energy investments. Being involved with that source offers NuStar Energy L.P. (NYSE:NS) a unique opportunity even with its draconian preferred stock position. With almost half of the nation’s crude oil coming from the Permian, having a presence in that field is paramount. With the results from the last quarter and other information in view, our investor’s vision of NuStar is sharpened. Let’s open the cover and view the table of contents.

NuStar’s Properties & Business Climate

NuStar Energy transports both crude and finished products mostly within the Mid-West and Southwest. NuStar describes its pipelines thus:

“NuStar owns 3,205 miles of refined product pipelines and 2,245 miles of crude oil pipelines, as well as 5.6 million barrels of crude oil storage capacity, which comprise our Central West System. In addition, we own 2,500 miles of refined product pipelines, consisting of the East and North Pipelines, and a 2,000-mile ammonia pipeline, which comprise our Central East System.”

The following presentation slide further details its pristine product transportation system, most of it in the Central and South Texas regions.

Citi Presentation

NuStar Presentation

The company also operates a premium ammonia line within the central portion of the U. S.. Of note: ammonia is being considered as a viable means to transport hydrogen within the renewable implementation plan.

The company obtained premium Permian Basin assets in 2017 through purchasing Navigator. Many outsiders, including us, question the purchase costs, which saddled NuStar with four preferred shares offerings, now coming due. But, what can’t be questioned is the premier nature of these assets. The company once referred to these thusly:

“Thanks once again to our Permian Crude Systems core premier location, lowest producer cost and highest product quality, we have seen strong volume improvement there.”

A second presentation slide summarizes NuStar’s performance, comparison and projection.

Citi Presentation

NuStar

Outputs into NuStar’s transportation assets continue to outperform others in the same region. The company expects to exit 2022 at rates 10% higher than in 2023. By 2025, outputs might reach at 9 million barrels per day or almost double of 2022. In July, the company processed north of 560,000 barrels per day while expecting north of 570,000 at the end of the year.

The next slide shows the steady rate for volume increases by quarter since 2017.

Citi Presentation

NuStar

But, we must remember that in the process of purchasing Navigator, the company issued four different preferred shares, A, B, C & D. Beginning in 2023, D share interest rates go ballistic with rates climbing above 13%, a total yearly interest cost of $80 million. The company may repurchase D preferred after June of 2023 at a price of approximately $31. With an approximate 23.25 million shares, the cost of repurchasing equals $700 million roughly 2022s EBITDA. (We note that in a previous article that we stated the repurchase cost at $600 million. Our further research slightly increased the repurchasing cost.)

It is important to note that management understands and has been preparing for extinguishing these preferred shares for a few years, including operating such that all dividends, capital expenses are paid from operations. To further help, the company began a 2022 optimization initiative to reduce spending between 2022 and 2023.

Citi Conference Presentation

NuStar Presentation

Thus far, a $60 million reduction is forthcoming. More is on the way. From our view, it seems that this won’t exceed $100 million. It still helps.

Continuing with slides, this next one communicates the significance of the Corpus Christi assets moving into the future.

Citi Presentation

NuStar

Again, NuStar possess premium assets at Corpus, another plus.

On the last conference call, questions from analysts focused significantly on future demand with a recession looming and about managing increased cost from high inflation. Theresa Chen of Barclays asked:

“First, I wanted to ask you about your outlook for demand across your product system. Since there seems to be an overwhelmingly — overwhelming amount of concern related to recession risk, and how the consumer is potentially resisting these higher prices?”

Regarding the first issue, Brad Barron, company CEO, answered:

“I can tell you, our big customers are not seeing it [reductions in demand] either. . . . And then just anecdotally, several of us have made long driving trips across the state of Texas, and I can promise you there is no cutback in traffic on our interstates.”

With regards to the second issue, management discussed that indexation was in place with all but a few contracts. FERC assets, which make up 95% of the pipelines, may take full advantage for inflation cost adders. James Carreker of US Capital of Advisors asked:

“Just following up on that FERC impact question. . . is it reasonable to assume from a baseline level, if the roughly 9% increase went into effect July 1st, nothing else changes, we’ll see pipeline EBITDA go up in Q3 by something similar to that amount…?”

Barron answered, “Yes. Similar to that amount with the exception of the oil field.” Management also reminded the analyst that OpEx increases with inflation, so “it won’t be a dollar-for-dollar increase in EBITDA.”

In summary, the business was performing at high rates even at the higher gasoline prices, which are now lower along with an index of inflation. Management still expects net profits to be unchanged or higher.

The Quarter Results

Returning to the quarterly results, investors get a sense of the business performance. The quarterly EBITDA equaled roughly the same year over year ex-the divestitures. The distributable cash flow (DCF) ratio equaled 1.88. Pipelines at $145 million EBITDA, storage at $49 million EBITDA, and Fuels marketing with an EBITDA of $7 million expectedly performed slightly above or below its comparable 2nd quarter of 2021. NuStar carried a slightly lower debt at $3.1 billion with $900+ available on its revolving credit facility. The leverage is now below the target of 4 at 3.93. Management guided full year EBITDA unchanged at $700 – $750. Capital expenses remain ranged at $115 million to $145 million, a $20 million reduction, most of which is targeted at the Permian. The company also added that capital for 2023 is being reduced by $40 million.

Management still expects performance from the California facility targeted at renewable fuels to improve. This asset handles 5% of California’s biodiesel, “13% of ethanol, 21% of its renewable diesel and almost 90% of the sustainable aviation fuel sold.” Growth within the West Coast asset is expected to continue.

Risks vs. Investment

Our own analysis includes three critical events: extinguishing at least the preferred D shares, likely massive growth in the Permian, and a future natural decay in crude production primarily with fracking. Beginning with the first, extinguishing at least the preferred D shares, it is clear that NuStar has to generate at least $700 million in cash over a few year period, $200 million plus each year. Again, from our Seeking Alpha article, NuStar Energy’s Quandary Solved; Ah, Maybe, surplus cash generation might exceed $100 million in 2022, a good start. With a the cost savings identified, NuStar will likely possess $150-$300 million in the early part of 2023. This is a good start toward paying down the D shares. It must continue.

The next event, continual massive growth coming from the Permian Basin, adds more cash. The above included slide summarizing the Permian performance predicts that crude from that region might double in the next few years. For NuStar, the Permian system carries about one-third of the companies throughput, but represents only 10% of the total pipeline length. Since the company doesn’t break out Permian revenue, we are left to estimate. It is probably near or slightly less than one-quarter of the pipeline segment or $600 million a year. In total, Permian revenue might increase the company’s EBIDTA by $150 million a year being added incrementally, which is significant. It seems clear that NuStar’s business is sufficient to extinguish the preferred D shares. But, also in our view, it needs to also extinguish the series A with a liability of $200 million.

The analysis doesn’t end here. An article at OilPrice adds a new wrinkle. An unnamed executive answered a question concerning the future of shale.

Shale will likely tip over in five years, and U.S. production will be down 20 to 30 percent quickly. When it does—this feels like watching the steam roller scene in Austin Powers. Oil prices in the late 2020s will be something to behold,” the executive concluded.”

This five-year prediction could hit at the end of NuStar’s reigning in its preferred issues. How fast and exactly when this event begins and how it follows isn’t fully known, but within our qualitative analysis, the timing at some point fits.

NuStar now pays $0.40 per quarter in dividend. We expect that to continue and grow toward $0.50 or slightly higher as the preferred shares are extinguished. What isn’t clear is what kind of capital will be needed for branching its business into more lucrative paths. For us, the company remains a relatively safe dividend paying company. With its trading between $13 – $17, NuStar is a higher yielding entity, one worth at least a modest position. With the next dividend payment approaching, we expect an upward movement toward $16. We covered our $15 calls that were sold with the price in the $16’s for nice gains. We plan to sell either $17.5 or $15’s depending how close the price approaches $17.

NuStar is aligned with some premium assets and deserves investor’s attention at stock prices under $16. Strong needs for oil or petroleum products aren’t going away in most of our lifetimes. But, investors should understand that while this is not a rapid dividend growth model, still NuStar is in vogue.

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