At first glance, NuStar Energy L.P. (NS) looks like a very attractive income investment. This MLP sports a current yield well above 9% and has increased the distribution every year since its 2001 IPO. It is more typical to find MLP stocks yielding 4% to 5% if they have histories of distribution growth. However, NuStar may currently be propping up the dividend to maintain the growth record and not because the cash flow supports the distribution rate.
Note: MLP companies such as NuStar Energy have units and pay distributions. The words stock, shares and dividends may be used here with the understanding that the rules of MLP units apply including the tax consequences of investing in MLP units.
NuStar initially was a petroleum pipeline and storage MLP. In 2007, the company started expanding into refining and asphalt production. This article by John D. Thomason provides a concise background and history of the company. The move into asphalt production and sales increased revenues in a big way, but by the end of 2009, this portion of NuStar's business was showing reduced profit margins and by the first half of 2012, the company was losing money on its asphalt and heavy fuels marketing segments. In September 2012, NuStar sold a 50% interest in its asphalt business and in January 2013, the company sold a refinery to Calumet Specialty Product Partners L.P. (CLMT).
Cash Flow Falling Short
Now that NuStar has pretty much divested itself of the business lines that did not live up to expectations, the company plans to focus on and grow what are again the core segments of pipelines and petroleum storage. However, the effects of the problem segments did hit distributable cash flow hard for the first three quarters of 2012. In the first 9 months of 2011, NuStar reported DCF for limited partners of $245 million or $3.79 per unit. For the same period of 2012, the numbers were $114 million and $1.59 per unit. In spite of the much lower cash flow, the three quarterly distributions paid in 2012 totaled $3.285, compared to the $3.245 per unit paid for the same period in 2011. Distributable cash flow was less than half of the actual cash distributed.
It is interesting to note that cash distributed to the general partner company, NuStar GP Holdings, LLC (NSH) increased during the three-quarter period and the general partner received 24% of the NuStar total distributable cash flow for the 9 months compared to 11% of the cash flow in 2011. The difference is due to GP incentive distribution rights that are paid based on the distribution rate paid on LP units.
Future Cash Flow Projections
NuStar Energy divides operating income into the three segments of Storage, Transportation and Asphalt and Fuels Marketing. For the first 3 quarters of 2011, the three segments produced total operating income of $341 million. Asphalt and Fuels Marketing dropped into negative territory for the first 9 months of 2012 and the other two sectors generated total operating earnings of $272 million - $70 million less than the total when business was better. I think it is important to note that NuStar Energy currently has over 72 million outstanding LP units, compared to about 46 million in 2007. The expansion into asphalt and fuels was funded in part with additional equity offerings and the remaining parts of the company must now support the distributions on this much larger number of units.
Management has embarked on a campaign to aggressively expand the company's transportation and storage operations. In December the company announced the purchase of midstream assets in the Eagle Ford shale play from TexStar Midstream Services LP for $325 million. Internal capital growth spending for 2013 is forecast at $625 million, on top of $415 million spent in 2012.
Dividend Coverage Returns - Someday?
It appears that NuStar Energy has a valid plan to return to the days of increasing distributions after the less than stellar results from the 2007 to 2012 foray away from the core businesses. My biggest concern is the decision to continue to pay the distribution rate covered by about half the necessary cash flow. Management does not expect to get back to greater than 1 to 1 coverage of the distribution until the fourth quarter of 2013.
Right now, NuStar Energy is a company which is not covering its distribution payments with big plans to get there in a year or so. Investors are compensated for the wait by the 9% plus yield. I would be more comfortable with this company if it bit the bullet and reduced the quarterly dividend until cash flow again actually supported the payout. One reason for maintaining the dividend may be to support the dividend of NuStar GP Holdings, where any LP distribution reductions would be multiplied.
My current recommendation on NuStar Energy is to not invest and stay on the sidelines until it is clear that distributable cash flow is at least close to covering the actual quarterly payout.