- Dividend cuts to improve balance sheet will enhance long-term shareholder value.
- Near-term operational milestones at Casper and Hardisty will enhance take-or-pay revenues for USDP's terminalling services business.
- USDP is well positioned to take advantage of recovering crude prices, and the growing price differential between WTI/Brent and WCS.
- USDP is technically attractive, and fit for witnessing slow but stable price growth over the medium-to-long term.
USD Partners (NYSE:USDP) was on a tear prior to the reduction in oil demand, and the Saudi-Russian oil price war that was triggered amid the prevailing pandemic. The company's dividend profile had seen 19 consecutive dividend hikes until recently, when USDP slashed its quarterly payout by ~70% QoQ in an attempt to reduce its towering debt in these shaky times; which is a good management decision, in my view. However, this ended the prolonged era of dividend hikes.
The oil market crash had a devastating impact on the share price which tanked from its 52-week highs to its 52-week lows in a short span of time, thus technically providing a very attractive entry point in a company having stable cash flows and suitable medium-to-long term growth opportunities embedded with the Hardisty DRU and the Enbridge DRA projects, debt reductions, and the prospects of gradual recovery in oil prices. This classifies USDP as a long-term buy. Let's get into the details.
Figure-1 (Source: Houston Chronicle)
Q1 2020: Quick overview
During Q1 2020, USDP reported a net loss of $33.8 million (owing primarily to an impairment loss recorded at the company's Casper terminal) against revenues of ~$30 MM. With the exception of Q1 2020, USDP's revenues and net income have remained relatively consistent during the prior 4 quarters (Figure-2) and indicates stability of its business model. However, the economic challenges triggered by the pandemic has indirectly impacted its business outlook. A gradual but sustainable recovery in oil prices is around the corner and this is positive news for USDP (discussed later).
The company reported $4.62 MM cash & equivalents at the end of Q1. USDP's Q1 DCF (read: distributable cash flows) have seen suitable YoY improvement from $8.4 MM to $9.8 MM and the liquidity profile looks sound enough for a distribution company that's delivered 19 consecutive hikes in QoQ dividends. Yet we see a ~70% dividend cut during the quarter as USDP tries to reconfigure its balance sheet amid challenging times (debt accounts for ~88% of the balance sheet).
Casper Terminal is in a pickle
The impairment loss of Casper's goodwill stemmed from current economic conditions, the adverse impact of those economic conditions on the crude oil markets, and the consequent decline in petroleum products' demand. On the surface, I see two problems associated with Casper:
- Possible reduction in future revenues due to the fact that a major customer agreement relating to Casper had expired in August 2019 thus impacting Casper's legacy revenues; and
- Reduction in expected throughput levels at Casper due to declining crude markets (this also served as a primary catalyst for impairment).
To elaborate the significance of these problems, it's worth taking a look at relevant extracts of USDP's 10-Q (emphasis added by author) in the same sequence as the problems highlighted above,
- We have not yet entered into arrangements to replace all of the revenue previously provided by the legacy contracts at the Casper Terminal. Our ability to secure additional commercial opportunities and replace the revenue previously generated under the expired contracts may be limited until Enbridge successfully completes its DRA project, which we now expect to occur sometime in the second half of 2020.
- In March 2020, we tested the goodwill associated with our Casper terminal for impairment due to the overall downturn in the crude market and the decline in the demand for petroleum products, which could lead to delays or reductions of expected throughput levels and changes in expectations for current and future contracts at the Casper terminal.
In my view, both points above are somewhat inter-connected. Since Casper has recently seen conclusion of a legacy contract (details aren't disclosed by the company but management discussion indicates that those were significant contracts), it's uncertain when and to what extent USDP will be able to execute future contracts. The revenues brought in by these future contracts would be adversely affected by the prevailing crude market conditions since currently there's insufficient demand to match the supply glut. However, as economic restoration is underway in major economies, it's being expected that the oil supply glut might ultimately transform to a supply crunch, and oil prices would see suitable upside. Then again, Rome was not built in a day. Recovery in crude prices would take time. Perhaps by the end of FY 2020 we can expect to see oil prices edging closer to their previous high levels.
Moreover, if the Enbridge DRA (read: Drag Reducing Agents) project is completed as forecasted during H2 2020, favorable future contracts are likely to enroll for USDP's Casper Terminal since it would entail improving Canadian crude supplies to the market.
Hardisty makes all the difference
On the flip side, the Hardisty Terminal witnessed revenue growth during Q1 due to increased rates applicable to a portion of Hardisty's terminaling services agreement. Additionally, USDP entered into an agreement with USD Group LLC (referred to as the 'Sponsor') for rendering terminaling services at the Hardisty South facility (a property of the Sponsor) that enabled USDP to process throughput volumes in excess of Hardisty's throughput capacity. Hardisty is a promising business unit since USDP secured long-term take-or-pay contracts for 100% of Hardisty's terminaling capacity. Hardisty provides an opportunity to secure USDP's future cash inflows by stretching a significant portion (roughly 32%, refer to Figure-3) of Hardisty's current contracted capacity beyond 2030, subject to completion of the Hardisty DRU (read: Diluent Recovery Unit) project. The company expects the DRU project to be placed into service in Q2 2021 which acts as a catalyst for fueling near-to-long term growth. Another CSF (read: Critical Success Factor) for Hardisty's sustainable cash flows is negotiation of contracts with customers that expire during FY 2022, as shown below. Negotiations are underway to secure long-term 10+ year contracts (nearing contract expiry) for the terminal's capacity, with new or existing customers and the prevailing oil market dynamics would be pivotal in determining the terms of these future contracts.
Figure-3 (Source: Presentation)
On that note, it's worth mentioning that existing supplies of WCS (read: Western Canadian Select) exceed the pipeline transportation capacity due to the recent COVID-triggered drop in oil demand. This implies that demand for USDP's rail transportation/terminaling will increase as Canadian oil producers will look to ship those towering crude inventories to the market. Hardisty is an origination terminal where different grades of WCS are loaded onto railcars for transportation to the market; and it's poised to take advantage of this situation. Plus, the successful completion of Hardisty DRU project would enhance the terminal's capacity. In my view, this is a positive for USDP's near-to-long term growth outlook. How? Let's see. USDP notes in its 10-Q (emphasis added),
As inventory levels in Western Canada grow to maximum capacity as expected resulting from the recent events, we expect demand for and utilization of our rail terminals will increase as produced barrels will need to be exported, in the event relative price differentials make it economic to do so, which continues to remain uncertain and difficult to predict. In the long-term, we expect demand for rail capacity at our terminals to increase over the next several years and potentially longer if proposed pipeline developments do not meet currently planned timelines and regulatory or other challenges persist. Our Hardisty and Casper terminals, with established capacity and scalable designs, are well-positioned as strategic outlets to meet growing takeaway needs as Western Canadian crude oil supplies continue to exceed available pipeline takeaway capacity.
The price recovery rates of both WTI (read: World Texas Intermediate) and Brent crude are picking up pace in relation to WCS (Figure-4). This implies that the relative price differentials between WCS and the two principal oil indices are gradually improving; though they are still far from the highs witnessed during the past 12 months (Figure-5), and indicates room for further enhancement of price differentials amid extension of oil supply cuts by OPEC+.
Figure-4 (Source: Oil Price.com)
Figure-5 (Source: Oil Price.com)
Dividend cuts and Debt reduction
Q1 2020 dividend per share (or DPS) of $0.111 is significantly adverse compared with Q4 2019 DPS of $0.37. The ~70% QoQ dividend cuts are aimed to spare free cash flows for servicing the towering ~$222 MM debt. USDP's debt pertains to a revolver capped at $385 MM out of which $224 MM has been utilized so far. The company is counting on its OCF (read: Operating cash flows) to improve the highly leveraged balance sheet. However, I believe the global economic challenges highlighted earlier section may prevent any material hike in OCF at least during the remainder of the current year. Nevertheless, I believe that USDP's dividend cuts-cum-debt reduction initiative is a good management decision that would enhance shareholder value over the long-term. My forecasts for debt reductions during FY 2020 are:
- Annualized DCFs based on Q1 results ($9.9 MM X 4)=$39.6 MM
- Annualized Distributions based on Q1 results ($3.0 MM X 4)= $12.1 MM
- Cash available for debt servicing, per annum= ~$27.5 MM
[Author's Note: These calculations assume that USDP will continue to pay flat quarterly dividends of $0.111/unit throughout the year. In case its operational environment suffers from a continuing oil market turmoil, the DCFs might take a hit and consequently these numbers would also need to be revised. However, in the current macroeconomic environment there's a remote chance of further turmoil in oil markets.]
Technical Analysis and Investor Takeaway
USDP's 52-week price range lies between $1.00-11.95, and the high-low spread is huge (~11x). At the time of writing, USDP's share last traded at $3.61; on track of recovery from its tragic lows but still significantly lower than its 200-day EMA (Figure-6).
The stock is technically attractive, and the technical price chart (Figure-7) indicates that the gradual recovery in price will continue especially in the wake of restoring oil prices amid extended production cuts. This would act as a near-term growth catalyst.
Figure-7 (Source: Finviz)
However, since I believe that economies will take months to restore their activity scales to pre-COVID levels, demand for oil gradually build and oil price recovery will also be slow (though sustainable). This would rule out chances of a material recovery in USDP's share price during FY 2020, and we could set a conservative price target of ~$4.2-4.5 for the end of the current year.
Further, as USDP achieves the operational milestones for Casper and Hardisty terminals (expected during the next 12 months), the share price is set to witness further upside over the medium-to-long term. Finally, the dividend cuts would help improve the gearing of USDP's balance sheet and thus help improve long-term shareholder value.
This article was written by
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