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Blueknight Energy Preferred: Strong Q3 Results And A Fully Covered 13.8% Yield

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About: Blueknight Energy Partners, L.P. (BKEP), BKEPP
by: Richard Lejeune
Richard Lejeune
Deep Value, dividend investing, micro-cap, newsletter provider
Summary

BKEPP offers a 13.8% yield with 1.5X coverage.

Q3 results were very encouraging.

The midstream sector is out of favor as investors chase "green energy" stocks.

BKEP is focused on asphalt terminals. Asphalt is here to stay even in the unlikely event that we all switch to electric cars.

The last couple of years have not been kind to Blueknight Energy Partners L.P. (BKEP) and Blueknight Energy Partners L.P. Preferred (BKEPP). Margins fell at its Cushing oil storage facilities as oil moved into backwardation. This forced a reduction in the quarterly common dividend from 14.5 cents to 4 cents. The planned Cimarron Express pipeline project was aborted at a cost of $12 million as the expected production growth in the STACK area failed to materialize and former pipeline partner Alta Mesa Resources (AMR) spiraled towards bankruptcy.

Shareholder unhappiness was compounded further when General Partner Ergon launched a lowball takeover offer that was withdrawn following shareholder outcry. Meanwhile the midstream sector has been diving. There are fears that U.S. oil production has peaked. Elizabeth Warren, Bernie Sanders and other leading Democratic U.S. Presidential candidates are clearly enemies of the oil and natural gas sector. This includes the midstream sector companies that support the oil and natural gas producers.

It's no wonder that the par $6.50 BKEPP cumulative preferred stock now trades at just $5.23 with a hefty 13.8% yield. BKEP is a partnership so owning either BKEP or BKEPP will generate a K-1.

Surprisingly good Q3 earnings

Despite all this negativity, BKEP delivered surprisingly solid Q3 results. Q3 EBITDA was $18.0 million vs. $14.5 million in the prior year. This was especially impressive as these improved results were achieved without 3 asphalt terminals that had been sold to help finance the failed Cimarron Express pipeline.

1.2X common stock dividend coverage

BKEP is now more than fully covering its reduced dividend as noted by CEO Mark Hurley on the Q3 earnings conference call:

"Distribution coverage for the third quarter was 1.43 times and for the first nine months of the year above 1.2 times, these values compared to 0.92 times in the third quarter of 2018 and 0.88 times for the first nine months of 2018."

Q3 is a strong seasonal quarter for BKEP. Q4 coverage is not expected to be as strong as the 1.43X coverage that BKEP achieved in Q3, but the company does seem on target to achieve its goal of 1.2X coverage for 2019.

1.5X Preferred stock dividend coverage

The 4 cent quarterly dividend on 40.8 million shares of BKEP amounts to $6.5 million annually. The 17.88 cent quarterly dividend on 35.1 million shares of BKEPP amounts to $25.1 million annually. Therefore, the company's projection of 1.2X dividend coverage (including both the common and preferred) implies annual distributable cash flow of 1.2 X ($6.5 + $25.1) million = $37.9 million.

The BKEPP preferred is senior to the BKEP common. Therefore, the preferred dividend coverage for 2019 is about $37.9 million / $25.1 million = 1.5X.

Mixed signals from insiders

Things seemed especially bleak for BKEP when a 9/12/209 SEC filing showed that Director Robert Lampton had sold his entire stake of 150,000 shares of BKEP. Director William Lampton then sold his entire stake of 83,350 shares the very next day. Management was asked about the reasons for the insider sales on the Q3 earnings conference call (see page #4) and they declined to comment. But insider sentiment was not all negative. CFO Andrew Woodward purchased 50,000 shares on 11/13/2019.

Improving liquidity

There had been some concern about BKEP having the liquidity available to repay Ergon the $12.1 million owed for the aborted Cimarron Express pipeline. However, this was addressed in the Q3 earnings report:

"At the end of the third quarter of 2019, total availability under the credit facility was approximately $140.4 million, and availability subject to covenant restrictions was $46.4 million..."

Asphalt can't be replaced with windmills and solar panels

The midstream sector has traded lower in part due to concerns about a move towards "greener" energy sources. However, not all midstream companies are alike. The asphalt terminal business accounts for almost 3/4 of BKEP's cash flow. Even if we all switched to electrical cars tomorrow, asphalt would still be needed to pave the roads we drive on. There have been some interesting failed attempts to surface roads with solar panels. Even if this succeeded, asphalt is still used to support the surface layer of solar panels. Even the most radical of the "green new deals" are not calling for the abolition of roads and the periodic need to repave them. We could all be riding around on bicycles and we're still going to need asphalt. In fact asphalt is recycled when roads are repaved. It's a surprisingly green product.

Will Ergon make a higher bid?

On 8/5/2019 Ergon (the General Partner) made a bid to take the company private. The bid of $1.35 per share for BKEP and $5.67 per share for BKEPP was withdrawn on 9/11/2019 after many shareholders complained that this lowball bid by Ergon was inadequate. Both BKEP and BKEPP have since traded lower. An increased Ergon bid could be a catalyst for these issues to trade higher.

The sale of the Cushing terminals may be a catalyst

Shareholders were especially critical of the proposed Ergon buyout on the Q2 earnings conference call. The proposed transaction appeared to undervalue assets such as the Cushing oil terminals. As investor Kurt Hoffman noted in one of his questions:

"... we saw a ideal in May where CVR Energy sold 1.5 million of Cushing storage to Plains All American I think for $36 million, around $24 a barrel storage. Can you comment on that transaction, and if that $24 barrel valuation metric could be fairly applied to the storage of Blueknight"

BKEP owns 6.6 million barrels of crude oil storage at Cushing. At $24 per barrel those facilities would have a valuation of $158 million. The Q3 operating margin for those terminals was $3.3 million or $13.2 million on an annualized basis. A sale of the Cushing oil terminals on similar terms would be about 12X EBITDA. Such a sale would enable BKEP to substantially deleverage its balance sheet and focus on its more consistent asphalt business.

What are the major risks?

See pages 1 - 15 of the 2018 annual report for a detailed listing of all risk factors. A few of the major risks are highlighted here briefly. The asphalt business is heavily dependent on federal, state and local funding for road work and would be impacted if there was a reduction in such funding. Bad weather including excessively wet or cold weather can reduce the demand for asphalt. The Cushing oil terminals owned by BKEP are now fully leased out to customers. Lease renewals at favorable pricing could be challenging if oil remains in backwardation which makes oil storage unprofitable.

Conclusions

Despite strong Q3 earnings and improving dividend coverage, BKEP and BKEPP have traded lower along with their midstream peers. The midstream selloff may be due to concerns about "green" policies, but the asphalt business would not actually be harmed by such policies. A potential sale of the Cushing oil terminals or a higher bid by Ergon could be a catalyst for BKEP and BKEPP to trade higher. Income investors can enjoy a generous and fully covered 13.8% yield from BKEPP while waiting for a catalyst to move this depressed issue higher.

Disclosure: I am/we are long BKEP, 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.