OKE - NuStar Energy: Embracing Green Trends

2023-06-27 05:05:20 ET

Summary

• NuStar Energy has been in a bind for some time. Slower Permian growth and the pandemic have really pressured the balance sheet.
• The ONEOK buyout offer for Magellan provides an interesting comp.
• Beyond that valuation, NuStar's opportunities in renewable diesel storage plus its ammonia pipeline foreshadow a lot of value in "green" investments.
• This could attract disproportionate institutional capital in a space that is starved for it.

NuStar Energy ( NS ) has never been a favorite of mine. It has a reputation of having a boring business model, and that was true in the past. Long haul pipelines with rates tied to FERC and storage combined just don't have a lot of "pizzaz". The acquisition of the Navigator Pipeline system in the Permian was going to be the shot in the arm - and it has been. However, it created an overleveraged balance sheet and management did not cut the distribution far enough to retain capital to meaningfully address the problems that deal caused. As Navigator now is within range of maximum operating capacity, that means we have a boring business with a busted balance sheet. Why be interested?

Things have changed to an extent. While odds are slipping on the merger, the purchase price ONEOK ( OKE ) was willing to pay for Magellan ( MMP ) has driven a lot of other companies with interest in crude and storage assets. NuStar is also pivoting some of those assets on the West Coast and is building a "green" business. While that might be a naughty word for some reading this, it's a great driver of interest from big institutional money and unlike solar / wind where it can be suspect, NuStar is also making great returns on investment.

ONEOK/Magellan Deal

Crude oil focused midstream firms are relatively rare compared to those focused on natural gas and natural gas liquids; Magellan Midstream and NuStar Energy are two of only a handful of options. It's doubtful that anyone following midstream even tangentially has missed the news of the proposed merger between ONEOK and Magellan Midstream. Personally, I'm not a fan of the deal. I don't think it makes sense due to limited commercial synergies and weak regional overlap. Neither do many unitholders given the strong odds the transaction gets voted down by Magellan owners.

All that said, Magellan Midstream is not cheap. This purchase values the entity at more than 12.0x 2023 EBITDA - more than literally every company in my midstream coverage. Paying a premium for what was already one of the most expensive firms was a strong signal from a powerful player on the value of in-place crude oil and refined product assets. While there are other reasons ONEOK is likely interested - the people, the tax shield - investors should not ignore implications for other comparable companies.

West Coast Renewable Fuels

NuStar has an excellent opportunity to be one of the premier "green" master limited partnerships, particularly when viewed from the perspective of EBITDA share from these projects. Unlike other participants like EnLink Midstream ( ENLC ) that also are going this route, it does not need to invest heavily in new technologies like carbon capture and sequestration or hydrogen in order to do so.

On the West Coast, management has been slowly converting large portions of their raw and refined product storage and supporting infrastructure to handle renewable diesel and sustainable aviation fuel ("SAF"). This is super low capital spend relative to the cost of new builds: clean the tanks, tweak some pumping equipment, good to go. Rates are the same or better, and unlike fossil fuel products, contracts here tend to be longer duration and with stronger customers overall (Neste, Valero, Phillips 66). Investors have been pressing conventional energy companies on how poor returns can be on renewable energy compared to fossil fuels - that really is not the case here.

Remember that this is the California market. Even something as simple as above ground product storage is impossible to permit. Looking forward, total diesel demand (fossil fuels plus renewables) is expected to be roughly flat over the coming years - certainly so if including SAF given likely increases in airline passenger growth. Given likely scrapping of extremely old equipment and the permitting environment, I think the bias is towards a strong storage market versus weak for renewable products on the West Coast, setting aside any concerns on changes to low carbon fuel standards and renewable diesel adoption. The opportunity here is not over; NuStar does have a decent amount of storage left that it can continue to pivot over time as conditions allow.

Takeaways

Overall, the NuStar Energy outlook looks much improved. While I still have concerns on the pace of balance sheet improvement, EBITDA is moving in the right direction. Not mentioned above are trends in the ammonia pipeline business where several new contracts for blue and green ammonia will add significant EBITDA; the Navigator Pipeline also continues to see growth given its positioning in the Permian. I always prefer natural debt paydown versus a company simply growing its way to lower leverage, but free cash flow is nonetheless improving.

For those with some patience, I think there is some underlying value here. While I don't expect rapid improvement or a buyout offer tomorrow, I'm sitting much more optimistic on the health of the business than in years past.

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