NuStar Energy (NYSE:NS) is a Texas based energy partnership operating in three business areas: liquids storage, liquids transportation as well as asphalt and fuels marketing.
In March 2008 NuStar entered into the asphalt business, which made it a company quite different from its peers. The company had stayed in that business for four years and, quite suddenly, in July 2012 sold half of its asphalt stake to another company. In this article I would like to track down the history of that deal and its influence on the company's financial standing.
The asphalt adventure started in 2007 when NuStar decided to acquire the asphalt assets of CITGO Petroleum Corporation (subsidiary of Petroleos de Venezuela - the national oil company of Venezuela). The assets comprised two asphalt refineries and three asphalt terminals. Additionally, Nu Star gained the access to 15 terminals leased by CITGO. The assets price was $450 million plus $360 million for the inventory - for a total of $810 million. The transaction was completed in March 2008. In that way NuStar became the third largest asphalt producer in the United States and the biggest one on the East Coast.
What was the idea of getting into the asphalt business? It's actually quite an interesting story. NuStar spotted certain patterns emerging in the refining industry and decided to bet some money on it. Briefly, at this time the asphalt refining margins and asphalt assets prices were very low. In 2006 and 2007, due to steeply rising crack spreads (the difference between petroleum product and crude oil prices) many refiners decided to focus mainly on producing gasoline, diesel etc. As NuStar was observing in 2007 - many refiners started upgrading vacuum towers bottoms in cokers to produce higher value products rather than to produce asphalt. In this way, NuStar expected the domestic asphalt supply to shrink. On the other hand the company believed that due to the US highway system modernization requirements, the demand for asphalt paving would be growing. Due to these two factors, NuStar expected the refining margins for asphalt to rise. In my opinion, it was quite an interesting contrarian idea for trying to set up the new business. Browsing through company documents I could find a lot of enthusiasm at that time - the future seemed to be bright, and buying the asphalt assets was declared to be a great step forward in NuStar's history.
But the world is very tricky and...the financial crisis of 2008 - 2009 broke out.
What happened then?
In April 2009 Nustar announced the implementation of the new technology to blend and supply the next generation of asphalt known as warm-mix asphalt.
During these years NuStar reported on continuous low demand for asphalt followed, by weak results of the Asphalt and Fuels Marketing segment.
Then, quite suddenly, in July 2012 the company made an announcement that 50% of the asphalt business had been sold to Lindsay Goldberg LLC's affiliate (LG). The agreement between NuStar and LG provided for creating the joint venture owning all the assets of the asphalt business. Each company (NuStar and LG) had 50% of the voting rights.
The details of the transaction at the closing were:
- $175 million - cash received from LG for 50% stake in the joint venture
- $263.8 million - cash received from the joint venture for inventory of the asphalt business (according to the company statements, on 30 June 2013, part of that payment, i.e. $77.7 million, was still due)
On the other hand, the amount due for inventory was financed by NuStar's so-called credit facility. This is essentially NuStar's commitment to finance the joint venture's working capital requirements until 2019 and up to $250 million. Apart from the credit facility, NuStar has another financial commitment to the joint venture, this time up to $150 million (also due to the joint venture's working capital requirements) - in that case this commitment is in the form of guarantees or a letter of credit.
After establishing the joint venture with LG all the asphalt business assets were deconsolidated from NuStar statements and since then are reported as an investment in joint ventures.
At this point the story ends, as according to the company's statements, NuStar is now more about exiting this business completely than developing it further.
Now, let us try to summarize the financial aspects of the asphalt adventure. To make things clearer I divided my considerations into economic and risk aspects:
It is quite hard to estimate the results of the asphalt business. These operations are the part of the Asphalt and Fuels Marketing segment, which means that they were reported together with fuels marketing operations and San Antonio refinery operations. To simplify the matter I have focused on the whole segment results, with the assumption that the asphalt business is mainly responsible for the segment's disappointing results (if it was not the case the management would not take the decision to sell it).
To determine the profitability of the three main NuStar segments: Storage, Transportation and Asphalt and Fuels Marketing, I used the concept of an economic income. Simply put, this is the income the segment records taking into account theoretical costs of capital and the real costs of debt (quite opposite to the standard accounting where only debt expense is included). It means that if we know:
- operating results of the segment,
- value of the assets utilized by the segment,
- costs of debt and costs of capital,
we can estimate whether the segment adds any value to the company.
The results are in the table below.
As can be seen, the most profitable NuStar segment is Transportation - these operations create the highest value to the company. What is more, they absorb relatively small amounts of capital. The Storage segment also creates value though less than the Transportation segment. These segments, apart from creating value, are also quite stable. Therefore these fee-based segments are the core businesses of the company.
Now, let's look at the Asphalt and Fuels Marketing segment. The last year this segment generated relevant value was 2008. Then the asphalt business was acquired and the experiment started. Apart from 2010, when some value was added, the remaining years showed decreasing value. In other words, this segment was sort of a breakdown for the company - not only has it been erasing value but it has also been drawing management's attention away from other value creating opportunities.
At this stage NuStar has (finally) abandoned the failed asphalt adventure and, hopefully, from now on it will concentrate on storage and transportation, its core businesses.
Risk On A forward Basis
Although the asphalt business has been deconsolidated there is still a significant financial risk to the company. At the end of June 2013 this risk can be estimated as (in millions of dollars):
NuStar 50% stake in the joint venture
maximum value of credit facility
maximum value of guarantees and a letter of credit
receivable from the joint venture
$490.4 million constitutes about 20% of NuStar equity so hypothetical bankruptcy of the joint venture could have had quite a big impact on the company's standing. Due to the lack of knowledge on present ongoing asphalt operations, I am not able to estimate the chances of the joint venture going bankrupt. The only thing, which I could find in the company's statements, is a brief mention that the business was not going very well.
In my opinion, selling part of the asphalt business is a step in the right direction. Although this business is still part of NuStar, the risk of further value destruction has been greatly reduced. Management should now have time to focus on developing the NuStar core, fee-based businesses (transportation and storage).
A quick look at NuStar's most recent financial results confirms this fact. NuStar seems to be recovering after the asphalt business adventure (for example, gross margin has jumped from 17.3% recorded in 2011 and 2012 to 28.3% in the second quarter 2013).
And while the majority of investors still perceive NuStar's stock as unattractive, management is presently a net buyer.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.