NuStar: Finding Profits on the Bottom of the Barrel

As soon as President-elect Obama began to float his ideas of economic stimulus by means of public works, among other proposals, many savvy investors began to seek out investments that would benefit from such a plan. The details of Mr. Obama’s stimulus measures are still being debated, but there is little doubt that public works and massive infrastructure spending will be one major platform. It was soon after such pronouncements that we wrote a blog on the potential of construction materials firm Vulcan Materials (VMC) in Stock! Are You Out of Your Vulcan Mind? and since that time the stock has vaulted up by more than a third. Vulcan is not alone in its stellar performance of late as many of the so-called “Obama infrastructure plays” have enjoyed quite a bit of momentum.

One of my esteemed colleagues here at Ockham called to my attention an interesting NPR report. The story detailed one of the more volatile commodities that is sure to be a major part of the proposed stimuli: asphalt. Most, if not all, major road upcoming projects will be made of asphalt with the state of New Jersey alone accounting for potentially $300 million's worth of “shovel ready” paving projects on tap, according to NJDOT. There is a growing concern that a shortage of the petroleum-based product is an inevitability.

Obviously, for a petroleum derivative, the price of crude has great influence over asphalt prices. Asphalt is made from the heavy stuff near the bottom of a barrel of crude, so as crude becomes more valuable, producers make every effort to squeeze as much as possible out of the barrel. However, with the increased demand for asphalt, it may be beneficial for producers to put more emphasis on asphalt. Ben Teplitz, an industry analyst, says this decision makes financial sense as well,

“The last time I checked, it did not pay to make gasoline, but it paid to make asphalt. The difference was over $13 a barrel.”

Yet, as crude and asphalt prices have declined, many producers have shifted away from asphalt. The exception is NuStar Energy (NS), a San Antonio based Limited Partnership, which in March 2008 purchased CITGO’s asphalt-refining operations and assets for around $450 million. Mike Pesce, Vice President of Refining, explains the bustling potential for asphalt when these infrastructure projects begin,

“The U.S. overall has a net shortage of around 20,000 barrels a day of asphalt. If these projects come in as we’re seeing them come in, you’re looking at a potential of extra demand in the United States of around 250,000 barrels a day.”

There is no doubt that we see great potential in proposed public works projects from the Obama administration, and NuStar may be one of the very best companies to own. NuStar has experienced some explosive sales growth in the last few years. In 2001, the company was bringing in just a shade under $100 million in revenue. By fiscal 2005, that revenue number had ballooned up to $660 million. Now, in 2009, the company is projecting more than $3 billion in sales. So, it is not surprising that our historical study comparing current price-to-sales of .79x to the historical range of 2.3x to 3.1x makes the company look extremely undervalued. Similarly, price-to-cash earnings show that the company is undervalued compared to historical norms, but it is less drastic than the revenue metric.

However, a few words of caution are in order; first, NuStar has undertaken quite a bit of debt in order to finance this rapid expansion. This is certainly okay as long as the company can continue to grow, but in these times of unsure credit markets, it is certainly worthy of mention. Furthermore, the company is banking on the proposed infrastructure spending by the government, but President-elect Obama’s spending appears to be taking quite a bit of heat right now as the federal deficit is said to be staggering for the year ahead. The Congressional Budget Office has said that the federal deficit could amount to 8.3% of GDP, far outpacing the post WWII high of 6.4% during the Reagan Administration. The proposed stimulus of $675-$775 billion could face increased resistance from house members, especially Republicans, if the economic prospects continue to worsen. As Rep. John M. Spratt, Jr (D-S.C.) puts it,

“I keep telling them to defer judgment: Don’t do anything permanent now. Otherwise, how do you get rid of a deficit of this magnitude?”

In addition to what is becoming an increasingly gray area of government stimulus, NuStar is up 36% in the last 6 weeks. So, it is yet another of the “Obama infrastructure plays” that many were looking to as a great long term buy, but has now appreciated so rapidly that it is tempting to take that return off the table. 36% return is a wonderful return for an 18 or 24 month investment; in this economy it is not wise to let that opportunity slide. After all, by all indications we are in a serious recession which has already lasted 13 months, and many pundits think the worst may be yet to come. While NuStar and others could certainly get a great boost by the many projects that could come on-line in the latter half of this year, it seems that investors may be able to pick up these shares after the next downturn at even more attractive valuations.

Comments

[zoebird126]

If you agree with me that this is a long term great investment, think about NSH rather than NS, although both are are interrelated. Check on the backround of the man behind these, William Greehy who was behind Valero when it was just a "puppy". Quite impressive! Zoe

2009 Jan 09 08:24 AM

[macsmart]

Both NS and NSH are terrific investments, but NSH is likely the better one to buy right now.

2009 Jan 09 11:24 AM

[ockham]

I received this response from Investor Relations at NuStar, please note his clarification:

To Whom it May Concern:

I am the Director of Investor Relations at NuStar and wanted to say I really enjoyed your recent article titled, "NuStar: Finding Profits on the Bottom of the Barrel."

However, I would like to clarify one point in the article.

In the article, Mike Pesch, Vice President of Refining at NuStar, explains the net shortage of asphalt as follows:

“The U.S. overall has a net shortage of around 20,000 barrels a day of asphalt. If these projects come in as we’re seeing them come in, you’re looking at a potential of extra demand in the United States of around 250,000 barrels a day.”

The word "projects" was not meant to describe the expected infrastructure projects from the proposed stimulus plan, but rather the "coker projects" that refineries will be undergoing over the next few years that we believe will result in this tighter supply of asphalt.

You see, the whole rationale as to why we purchased this business from CITGO in March 2008 was based on the installation of coker projects, not infrastructure projects.

This is part of a strategy that is based on our belief that asphalt margins will improve as supply will be limited compared to continuing global demand as more coker units are added by refineries in the U.S. and abroad. In fact, the whole notion of infrastructure projects was not even an topic of issue at the time we first announced the acquisition in November 2007.

To explain further the coker rationale….Higher refining margins have improved coker economics, which have led to many refineries to add coker projects in the U.S. and around the world. Coker units allow refineries to take what was formerly used to produce asphalt and upgrade it to higher value products like gasoline and diesel. As more of these coker units come online, the asphalt supply is expected to get tighter or as Mike Pesch mentions, going from 20,000 barrels per day net short asphalt to around 250,000 barrels per day net short asphalt by 2013.

So, we are not necessarily banking on infrastructure projects, but rather coker projects coming online and causing the asphalt market to become tighter.

The proposed stimulus plan is really just "extra gravy" for us if it comes to pass.

Please let me know if you have any further questions. Again, great article. Thank you.

Mark Meador

NuStar Investor Relations

2009 Jan 09 06:08 PM