This research report was jointly produced with Seeking Alpha Author Long Player.
Buckeye Partners (BPL), one of the largest and most established Midstream MLP, has recently traded at $40.63 and pays a yearly distribution of $5.05 for a yield of 12.4%.
Mr. Market is seeing skeletons everywhere in the Midstream space. That includes when the closets are truly empty. The result is an absolutely absurd decline in BPL price that far surpasses any type of reasonableness. The anticipated death and corporate bleeding just will not happen. Management has a plan to fix the current issues that Mr. Market ignores while concentrating on the negatives. That irrational perception is going to change as the anticipated results roll in during the second half of the fiscal year.
Source: Buckeye Partners Investor Presentation Dated February 27 to March 1
Buckeye Partners has the three main lines of business as shown above. Domestic Pipelines & Terminals and Merchant Services divisions are pursuing growth plans. Neither has anything more than normal business challenges in the current operating environment. All the headlines causing the stock price weakness emanate from the Global Marine Terminals division. Much of the headline challenges will be resolved in the second half of the fiscal year. Newspaper headlines are generally far scarier than reality.
The pipeline business is largely fee-based and very resilient to industry downturns. A similar story exists for the terminals business. The result is that the partnership has a steady income during downturns to support the distribution. Management has stated on many occasions that the goal is to grow the distribution. Nevertheless, at the same time, a secondary goal exists to be sure the distribution can be maintained during oil and gas industry downturns. That is why management previously stated the support for the current distribution even if the coverage becomes scant for a quarter or two. The market has never worried about the coverage in the past. Now, for some reason, there is an irrational worry about the distribution despite a more than 20-year history frequently cited by management.
Actually, the second half of the year, as well as 2019, appears to have remarkably strong comparisons ahead. All that needs to happen is for the next few months to pass without financial Armageddon. The odds of a quiet three months appear to be a relatively sure thing. If anything, many favorable things can happen (the idle marine terminal capacity can be leased, the pipeline projects completed, and more growth of VTTI). The bad news is out and over with during the last fiscal year.
The Reason Behind the Pullback
During the conference call, management discussed with shareholders the reality of the finances. Management stated that the ratings agencies (such as Moody’s) would work with the company because the company had a solid plan to restore coverage of the distribution. The marine terminals division has a long history. That long history of high percentage use and profitability is the expected norm. The lenders evidently agreed with the exit of a major customer and are also working with the company until the situation is resolved. The current price of BPL reflects none of this.
As shown above, one would think a disaster happened. Declines close to 50% over a period of 3 years normally signal long-term embedded problems. The current problems are much more transitory than the decline would have an observer believe. The company has fallen below the 100% distribution coverage several times in the last five years. None of those times has provoked the current reaction. Yet every single time in the past, the distribution coverage recovered to acceptable norms. This time is not going to be any different. There may be some tight or below acceptable coverage for a quarter or two. But management already has plans to deal with the situation.
We discussed in a previous article the loss of a major customer followed by capital investments to upgrade and right-size the assets to the market. This resulted in a temporary loss of cash flow from operating activities as well as a heightened usage of capital to upgrade the corresponding assets. But this situation is far from permanent. In fact, it is unlikely to last more than 18 months. Much of the upgrade work (and cash requirements) probably is completed, and the marketing of the idle capacity was already underway. The challenges caused by the exit of the major customer should resolve itself in short order. The only thing left is to report the increasing cash flow as the upgraded facilities are leased to new customers.
Buckeye Partners LP did issue more than 6 million shares at $42.60 in February 2018. Management is usually an expert at when to sell partnership units for the best deal. Investors can usually expect that a bargain will follow the stock sale which usually happens after a secondary offering. That appears to be the case with BPL. That stock sale has led to a fantastic bargain price for these units. The BPL stock is now trading below the private offering price.
Management had expressed that coverage may fall below 100%. However, the privately placed units will allow for payment in kind until they convert to regular units. Any potential liquidity needs will be aided by that arrangement. Think of the arrangement as a “just in case” safety valve. Most likely, that shortfall will be caused by the major customer exit, combined by the newly acquired VTTI acquisition and the ongoing pipeline expansion projects. However, there is every chance the leasing of the idle marine terminal capacity will happen on schedule, so the safety valve will not be necessary. The market is punishing a cautious strategy from a management that thinks ahead. The VTTI subsidiary is growing and needs cash. Cash needs may come at a more favorable time. But the safety value is there “just in case” so growth plan proceeds as scheduled.
Summary of the Limited Partnership Pullback Issues
The period of weak distribution coverage is rapidly ending.
- BPL has quite a few domestic projects, mostly pipelines coming to completion and online over the next 12 months.
- The marine terminal idle capacity issue should be resolved satisfactorily.
- BPL distribution coverage should recover in the second half of the year. Later in 2019, distribution growth should resume. Management has already guided and there is no reason to doubt the dividend coverage.
- The share prices are far too depressed for these temporary issues. Mr. Market took the bad news overboard to the bottom of the sea. Meanwhile management is expanding some of the pipeline network, marketing the marine terminals idle capacity, and growing the VTTI partnership.
The outcome of all that work-in-progress will be a soaring partnership price.
Current Valuation Based Upon DCF - 50% Upside
We expect distributable cash flow ('DCF") to quickly climb to 120% of the distribution within the next twelve months. Management is actually aiming for that coverage by January 2019. There are solid hopes for greater coverage that will result in a resumption of the distribution growth in the second half of 2019.
The current valuation assuming extremely tight coverage of distributable cash flow would be the 12.4% yield shown above. Using a distribution coverage of 1 times, the valuation comes at just 8.0 times rock-bottom 12-month annualized FFO. This company is going to show a lot of earnings and cash flow growth very soon. A lot of the timing depends upon customer lease accommodations, completion of ongoing capital projects, and decisions of VTTI to declare a dividend to the partners instead of reinvesting the earnings. However, the cash is very clearly on the way and on the way soon.
As such, BPL price could easily appreciate 50% over the next 12 months. That would put the price of BPL at around $60, which is not unreasonable. BPL has traded above $60/share most of the years 2016 and 2017. That appreciation may approach 100% if BPL returns to its favored status in the stock market. There is a solid plan in place to grow earnings. The lenders have approved that plan. The newly placed units will help ensure that the distribution to the rest of the unit holders is maintained until the recovery in the marine terminals division is well underway. The capital budget is pursuing some very profitable growth projects.
BPL has an “ace in the hole” that is seldom seen elsewhere. The VTTI subsidiary generates a lot of cash and is also growing. But limited partnership unitholders will only see the distributions received by BPL from the VTTI joint venture. Management only reports distributions received and "voluntarily" reports EBITDA. VTTI cash flow is not consolidated with BPL. Therefore, investors do not know how much cash they keep for reinvestment and how much comes back to the partners. Think of it like BPL owning stock and picking up the dividends.
This reporting, in effect, hides a fair amount of reinvested cash flow. In short, the distributable cash flow calculation will not reveal the total picture due to the nature of the joint venture. The partnership has a history of above average growth. The VTTI joint venture should enable that history to continue in the future. Clearly, the market has assigned no value to that very likely above average growth.
Recent articles published on Seeking Alpha by other authors have highlighted the following risks. We will address them one by one.
- Idle capacity and a price war: An article highlighted idle capability and price war in relation to BPL's assets. However, what about demand? Yes Venezuela is a mess, but Brazil, Columbia, and Argentina are not. Canada and the US are doing pretty well too. That capacity may be in demand. BPL has a long history of waiting out price wars. Backwardation is relevant but only part of the picture. The rest is logistics. Companies will contract for storage space for obvious reasons with or without backwardation.
- Short-lived contracts: One argument was that storage contracts are often short-lived. However, there is no evidence of that either the management presentation or the 10-K. The fact is that BPL often goes with long term contracts... they always have. Whether or not they can this time is another matter.
- Caribbean assets carry substantial risk: If we look closer, they represent only 23% of one division and that one division does not represent all that much in the profit center. So there has made a big deal out of about 6% of revenues or so. Kicking out Venezuela's state-run petroleum firm PDVSA and blocking them from using their terminals was a good thing. But management did not do that before they had a plan and a contingency plan. Neither BPL nor NuStar Energy LP (NS) will throw profits out the window.
- Recovery risks: Any recovery posses risks, and this is why the VTTI continuing assimilation/restructuring is important. Also important is the domestic growth. For the stock to be a serious risk VTTI has to run off the rails and the domestic business decrease substantially. Then top it off by adding no marine customers. This is very unlikely to happen.
If anything, all these negative reports about BPL may be a sign that the stock hit bottom.
BPL has a long history of conservative leverage. The leverage ratio shown above is a little over 4 times. Many of the partnerships covered have ratios in excess of 5 times. That history of conservative financial leverage (and corresponding financial ratios) is not projected to change anytime soon. The ratings agencies (like Moody’s) have maintained the relatively high financial strength ratings. Those financial ratings attest to a very financially healthy partnership that hit a bump.
Management has done its best to minimize any chance of a downgrade. Bank lines remain at normal capacity. The only thing that has changed is the completely irrational market fear about the future of the company. The current unfounded fears should dissipate as the solid results appear as projected by management. This management has an excellent long term track record. There is every reason to believe this bump in the road will soon be a memory. Growth projects are continuing as planned.
VTTI is also growing rapidly. The market has completely ignored the unfolding story at this subsidiary. All the challenges have stolen the headlines. Management often reports EBITDAX from VTTI. However, management does not report BPL's cash flow from operating activities, combined with the decision to allow some cash to be reinvested to fund the rapid growth. That growth has often been in excess of 20% a year. Sometimes that growth approaches 40% in a year. VTTI is considering acquisitions to aid the current growth rate. VTTI has an excellent track record of profitable acquisitions. VTTI is projected to generate a lot of cash in the future. That rapidly increasing cash flow will eventually receive consideration by the market, and BPL shares should prove to be extremely rewarding over the next five years. BPL, with a generous yield of 12.4%, is only one of many Midstream MLPs which represents an extreme bargain with a lot of leeway for error.
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Disclosure: I am/we are long BPL.
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.