In May 2016, I recommended my income-seeking subscribers load Blueknight Energy Partners' (NASDAQ:BKEP) Preferred stock at $6.89. Based on the price of $6.89, the yield was as high as 10.4%. And more importantly, that was a secure dividend. And I want to emphasize on this, because my Premium Picks for my subscribers always combine the bond-like risk with the high yield.
This underfollowed Preferred stock that trades under the ticker BKEPP has risen 20% since I recommended it, and closed at $8.15 yesterday. Therefore, and aside the high yield, my subscribers also enjoy significant capital gains within less than two months.
The important going-forward questions are: Does the dividend remain safe? At the current price of $8.15, is there any upside left? If investors buy at the current price of $8.15, will they generate significant capital gains while also enjoying high yield with low risk? I will try to answer these questions in the next paragraphs.
Digging Into The Assets
Blueknight Energy Partners is a very small midstream company relative to its popular, billion-dollar peers. It is still unknown and underfollowed. It provides midstream services for the crude oil, residual fuel oil and asphalt cement industries.
Specifically, its strategic asset portfolio includes 15.9 million barrels of crude oil and petroleum product storage capacity, 976 miles of pipeline, approximately 170 crude oil transportation and oilfield services vehicles and 45 liquid asphalt cement terminals and storage facilities.
Its business is conducted in the United States, from coast to coast. And its operations include:
1) Crude oil transportation pipelines, gathering systems and a truck fleet to carry crude oil from producing fields to logistics hubs.
2) Liquid asphalt cement and residual fuel oil terminalling and storage facilities.
In February 2016, Blueknight expanded its existing asphalt terminal network by making two accretive acquisitions. It acquired two asphalt terminalling facilities from Axeon Specialty Products, located in Wilmington, N.C. and Dumfries, Va. Furthermore, it entered into a long-term storage, throughput and handling agreement with Axeon Marketing LLC. Axeon, or its predecessor, has been a customer of Blueknight since 2009 and currently leases other BKEP-owned facilities in the region. Axeon will continue supplying various products and services to its existing customer base out of the North Carolina and Virginia facilities.
The Wilmington, N.C., facility includes approximately 260,000 barrels of asphalt storage and 70,000 barrels of light fuel storage with water access. The Dumfries, Va., facility includes approximately 87,000 barrels of asphalt storage and 468,000 barrels of light fuel storage with water access along with connections to Plantation Pipeline.
The transaction was financed by borrowings under the company's existing credit facility and brought Blueknight's existing asphalt and residual oil storage network to a total of 45 terminals located in 23 states.
Digging Into The Preferred Stock
According to Preferred Stock Channel, Blueknight's Preferred stock is a par $6.50 cumulative preferred convertible partnership unit with an 11% coupon. Its par value is approximately $196 million based on 30.16 million outstanding preferred units.
As expected, the preferred holders are senior to the common equity holders, as quoted below:
"The Preferred Units rank prior to our common units as to both distributions of available cash and distributions upon liquidation. Holders of our Preferred Units are entitled to quarterly distributions of $0.17875 per unit per quarter (or $0.7150 per unit on an annual basis). If we fail to pay in full any distribution on our Preferred Units, the amount of such unpaid distribution will accrue and accumulate from the last day of the quarter for which such distribution is due until paid in full".
A majority of BKEPP is owned by the general partners (Vitol and Charlesbank). Specifically, Vitol and Charlesbank owned 18.3 million preferred units (~60% of the total outstanding preferred units) as of March 2015.
Moreover, it's worth noting that privately-held Vitol is the world's biggest independent oil trader and one of the biggest commodity trading companies worldwide. Charlesbank is a private equity investment firm whose assets under management currently are $3 billion.
According also to the prospectus here, the Partnership may force conversion if the common unit exceeds $8.45, as quoted below:
"We have the right in certain circumstances to force the conversion of all outstanding Preferred Units to common units. These circumstances include a situation in which holders of a certain number of Preferred Units have elected for the Preferred Units that they hold to be converted to common units, then we could then force all remaining outstanding Preferred Units to convert to common units. Vitol and Charlesbank, the owners of our General Partner, own enough Preferred Units such that if they converted all of them to common units, we would be able to exercise this mandatory conversion right. In addition, we also will have the right to force the conversion of the outstanding Preferred Units at any time on or after October 25, 2015 if the daily volume-weighted average trading price of our common units is greater than $8.45 for twenty out of the trailing thirty trading days".
On that front, it must be noted that fellow author Richard Lejeune found in the company's presentation that the conversion ratio is 1:1. For details, please check his article here.
As a result, and assuming that the common unit reaches $8.45, the conversion option for the Preferred stock provides a potential return of about 4% based on the current price of $8.15, without including the distributions received until the conversion date.
Digging Into The Balance Sheet
In the midst of this unprecedented energy downturn, the company is doing well operationally because:
1) The asphalt terminalling segment reported another strong quarter with operating margin, excluding depreciation and amortization, increasing $2.6 million or 30% for the three months ended March 31, 2016 as compared to the same quarter in 2015.
2) Crude oil terminalling and storage operating margin increased 27%, or $1.1 million, year over year. This increase reflected improved contract storage rates negotiated during the second half of 2015.
3) Volumes and operating margins for the trucking and producer field services segment continued to face challenges due to pressure on trucking and producer field service rates precipitated by the decline in crude oil prices. As a result, decreases in the company's pipeline and trucking and field services businesses partially offset increases in other segments of the business.
The company's net debt was $275 million as of March 2016. At the current price of $5.45 (common) and $8.15 (Preferred), the company's EV is approximately $700 million.
Meanwhile, the company's adjusted EBITDA increased to $13.6 million for the first quarter of 2016, up from $12.9 million for the same period in 2015.
My estimate is that the company's adjusted EBITDA in 2016 will be between $65 million and $70 million. On that front, I take into account that:
1) Q1 is typically the company's lowest quarter due to the seasonality of its asphalt terminalling segment, which is the largest contributing segment. Typically, the asphalt season starts kicking in the second and third quarters, although sometimes it can be the third and the fourth quarters. Therefore, the benefit from the two recent acquisitions wasn't realized in Q1, but the next quarters will gradually begin to better reflect the positive impact of these two acquisitions.
2) In December 2015, President Obama signed a five-year $305 billion highway bill. Although this highway bill fell short of a six-year, $478 billion proposal he sent to Congress, the new law calls for spending approximately $205 billion on highways and $48 billion on transit projects over the next five years. As such, he will put Americans to work rebuilding their crumbling roads, bridges and transit systems. And there is no question that Blueknight Energy Partners will benefit a lot from this highway bill, given that a significant part of its revenue is coming from its low-risk asphalt business.
As a result, the company currently trades approximately 10.5 times its adjusted EBITDA, while its leverage is approximately 4 times. Obviously, the company's current valuation is reasonable while its leverage is quite manageable.
From a CF standpoint, the quarterly and annual distributions per preferred unit are $0.1787 and $0.7148 respectively. Therefore, these figures translate into approximately $5.4 million and $21.6 million out of the company's DCF on a quarterly and annual basis.
Additionally, Blueknight announced a first quarter 2016 cash distribution of $0.1450 per common unit, which is equal to the previous quarter's distribution and a 3.9% increase over the first quarter 2015 distribution. This means that the quarterly and the annual distribution for the common units is about $4.8 million and 19.3 million respectively.
Therefore, the total (common and preferred) distribution on a quarterly and annual basis is about $10.2 million and $40.9 million respectively.
Meanwhile, the company's distributable cash flow was $8.6 million for the three months ended March 31, 2016, as compared to $11.0 million for the three months ended March 31, 2015.
My estimate is that the company's DCF in 2016 will definitely exceed $40 million (conservative scenario), given that the maintenance CapEx for 2016 is in the $5 million to $7 million range. For reference, Blueknight achieved record distributable cash flow of $54.2 million in 2015, based on annual adjusted EBITDA of $70 million.
After all, the coverage ratio was approximately 0.81 times in Q1 2016, but it will definitely exceed 1 times by year end.
Additional Key Factors Providing A Margin Of Safety
Aside the reasons mentioned above (i.e. two accretive acquisitions, the highway bill, coverage ratio above 1 times by year end etc.), the dividend on the Preferred stock is safe because the company has a history of distribution increases for the common equity holders.
Specifically, Blueknight Energy Partners' quarterly distribution for the common unit holders was $0.11/unit in 2012, $0.12/unit in 2013, $0.13/unit in 2014, $0.1395/unit in 2015 and $0.145/unit in 2016.
And even more importantly, the company increased its distribution for the common unit holders during this unprecedented energy downturn, while most other energy stocks have cut or eliminated their distributions since 2014.
In addition, the CEO stated a few weeks ago:
"Lastly, we have an inherent competitive advantage over many of our competitors due to our diverse portfolio of assets, solid counterparties, more than 95% of our operating margins being fee-based, a conservative balance sheet with no significant 2016 required project capital and highly supportive General Partner sponsors."
On top of that, the safety on the Preferred stock is also supported by the following facts, as presented during the CC of March 2016:
1) Most of the company's revenues (more than 80%) have already been locked in for 2016.
2) Per reference the two businesses that make up 85% of the company's operating margin (the terminalling businesses, both crude and asphalt), Blueknight is contracted out for the remainder of the year.
3) Counterparties are very strong, and the company has no counterparty credit concerns at this time.
Everybody can recommend a stock, either it's a stock for capital gains or a high-yield dividend stock for the income seekers. There are numerous dividend stocks out there and as such, recommending a dividend stock "is so easy that even a Caveman can do it", according to the popular GEICO's commercial.
But, do you remember what happened to Kinder Morgan (NYSE:KMI) in December 2015 when it slashed its dividend? I had forecasted it given that Kinder Morgan was one of the most heavily indebted firms of the midstream sector. Why did it catch you by surprise? Why were you surprised when Chesapeake Energy (NYSE:CHK), PetroQuest Energy (NYSE:PQ) and Rex Energy (NASDAQ:REXX) suspended their Preferred stock dividend to preserve liquidity and strengthen their weak balance sheets? Didn't you check their extremely weak balance sheets before loading their Preferred shares? Why were you surprised when Magnum Hunter Resources (MHR), Energy XXI (EXXI), SandRidge Energy (NYSE:SD), Breitburn Energy Partners (BBEP), Goodrich Petroleum (NYSEMKT:GDP), Halcon Resources (NYSE:HK) and Miller Energy Resources (NYSE:MILL) suspended the rich dividend on their Preferred stocks and then filed for bankruptcy? Didn't you check their horrible balance sheets before loading their alluring Preferred stocks? If you had read my articles here and here and here, you would have expected their sad ending.
This is why, I emphasize on the fact that when it comes to my Premium Picks and Premium Research, my key criteria is the combination of high yield with bond-like risk.
And of course, this is the case with Blueknight Energy Partners' Preferred stock too. Thanks to the reasons mentioned above, the yield is approximately 9% at the current price of $8.15, while the risk is very low. To me, the Preferred stock carries a bond-like risk.
And when it comes to the upside potential from the current price levels, there are two options:
1) Assuming that the common unit reaches $8.45, the conversion option for the Preferred stock provides a potential return of about 4% based on the current price of $8.15, without including the distributions received until the conversion date. Given that the common stock closed at $5.45 yesterday, it has a rather long way to exceed $8.45.
2) Investors could push the Preferred stock above $10 in the coming months, given that the yield remains high (above 7%) at those price levels. Frankly speaking, this option is not out of the question.
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Disclaimer: The opinions expressed here are solely my opinion and should not be construed in any way, shape, or form as a formal investment recommendation. Investors are reminded that before making any securities and/or derivatives transaction, you should perform your own due diligence. Investors should also consider consulting with their broker and/or a financial adviser before making any investment decisions.
Disclosure: I am/we are long BKEPP.
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.