2023-09-27 17:34:07 ET
Summary
- NuStar Energy's preferred shares have performed better than its common shares, with the 7.625% Series B Fixed to Float Cumulative Redeemable Perpetual Preferred Units appreciating to par.
- Q2-2023 revenues for NuStar showed steady performance in pipelines, but a decline in storage revenues pushed EBITDA lower.
- We examine the falling distribution coverage and update our thesis.
On our previous coverage of NuStar Energy L.P. ( NS ) we suggested investors aim higher up the capital chain for income and leave the common shares alone. That might have sounded controversial and a losing play, especially since NS delivered about 25% in total returns. But the secondary securities did better. NuStar Energy L.P., 7.625% Series B Fixed to Float Cumulative Redeemable Perpetual Preferred Units ( NS.PR.B ) for example, appreciated from $20.29 all the way to par and alongside the distribution provided a better total return.
We look at the current setup for NS, and the three floating preferred shares today and update our outlook.
Q2-2023
NS had steady revenues from both the pipelines and storage segments in Q2-2023. The pipelines did show a small increase which was powered by the refined products and ammonia subsegment. The storage showed modest declines, but that was to be expected to some extent with the asset sales that we saw last year.
NS has been decreasing the weighting to this segment over time and reducing its asset base here. We can see this to some extent by comparing the revenue run-rates in 2021 for the two segments.
Getting back to today, there are some serious reverse economies at play as revenues decline. Operating income dropped by almost $10 million year over year.
Overall adjusted EBITDA declined year over year by 2.5%, mainly from drops in the storage revenue.
Distribution Coverage Ratio
At first blush, the distribution coverage ratio looked awful at just 0.82X.
That was driven by the premium of $36 million to redeem the series D preferred shares. These are an independent series from the three publicly traded ones and were about to reset to an insanely high dividend rate of 13.75%. So that was inevitable that NS would address that problem. But one point to note though, is that even the adjusted distribution coverage has been falling.
What is to blame for that? There is a combination of events here. From the falling storage revenues and operating income, which results in lower EBITDA, to the 14% increase in interest expenses. To these stresses, we will add that the preferred distributions increased across the board as all three NS preferred shares increased as they moved to floating rates. Other than NS.PR.B mentioned above NS has 1) NuStar Energy L.P., 8.50% Series A Fixed to Float Cumulative Redeemable Perpetual Preferred Units ( NS.PR.A ) and 2) NuStar Energy L.P., 9.00% Series C Fixed to Float Cumulative Redeemable Perpetual Preferred Units ( NS.PR.C ).
Outlook
Our focus here has been on the longer term value in the business. On that front, we see the pipelines in key Permian regions as extremely valuable, but we are less enthusiastic about the storage terminals. Over the next 12 months, we could see another round of pressure on storage terminals as we have once again entered a huge backwardation (where future months are lower than front end months) on the oil futures curve.
Again, with more reverse economies of scale at work, you could see EBITDA fall even faster.
All the publicly traded preferred units will see higher payments. NuStar Logistics, L.P. SB NT FX/FL 43 ( NSS ) which is a floating baby bond, will also continue to see a ramp up in payments. NS also issued $200 million of common equity to help with the redemption of the D series preferred shares. This will dilute the common unit returns further. Further out, NS has debt maturities in 2025 , 2026 and 2027 which will likely be refinanced at higher rates. Looking at the EV to EBITDA values here, NS looks all right at 7.5X.
But the security is still deep into junk territory while the three comparatives we have shown, Energy Transfer LP ( ET ), Enterprise Products Partners L.P. ( EPD ) and Kinder Morgan, Inc. ( KMI ) are all investment grade. The debt to EBITDA looks good and has certainly improved, but it ignores the middle-heavy capital structure.
What we mean by that is it counts only the senior debt and ignores NSS and the boatload of preferred shares that stand above the common equity. Now, it did redeem the preferred D Shares, so that reduces some senior security overhang. But we don't see value as compelling. The company is spending a decent amount of capex beyond what it classifies as maintenance capex, and the distribution coverage has still fallen. We had a game plan to upgrade the common shares if they fell below $13.00 and the D shares were redeemed. We did get one of those, but at present the price is far above where it needs to be to create a good risk adjusted entry. Unlike the previous time, where we saw value in the preferreds and NSS, at present, we think all securities are unattractive. Yes the yield on NSS and preferred shares is incredibly high, but the risk is now on the downside in the next rate cut cycle. Common units are too expensive here relative to their return prospects and we think they are borderline sell (so Sell over $18.00).
Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.
For further details see:
NuStar: A Look At The Declining Distribution Coverage