- The crude oil by rail-focused USD Partners seems rather overlooked along with their sustainable high 8.50% distribution yield.
- Despite seeing non-cash impairments during 2020, they performed very well with their operating cash flow increasing almost 20% year on year.
- Management seems positive regarding the outlook for 2021, which sets them up well to grow their distributions higher quite soon.
- By the end of the third quarter of 2020, they should have deleveraged down into the moderate territory and thus have scope to materially increase their distributions.
- Given this positive outlook and continued strong performance, it should be of little surprise that I will be maintaining my bullish rating.
When originally analyzing the crude oil by rail-focused midstream operator, USD Partners (OTC:USDP), my previous article found that their small and rather overlooked partnership was offering a sustainable distribution that now still presently offers a high 8.50% yield. A follow-up analysis is now provided that reviews their prospects to grow their distributions even higher in the foreseeable future, along with their subsequently released results for the fourth quarter of 2020
Executive Summary & Ratings
Since many readers are likely short on time, the table below provides a very brief executive summary and ratings for the primary criteria that was assessed. This Google Document provides a list of all my equivalent ratings as well as more information regarding my rating system. The following section provides a detailed analysis for those readers who are wishing to dig deeper into their situation.
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*There are significant short and medium-term uncertainties for the broader oil and gas industry, however, in the long-term they will certainly face a decline as the world moves away from fossil fuels.
**Whilst the oil and gas industry to which they service has high economic sensitivity, given the more stable nature of the midstream sub-industry this was deemed to be average.
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Instead of simply assessing distribution coverage through distributable cash flow, I prefer to utilize free cash flow since it provides the toughest criteria and best captures the true impact on their financial position. The main difference between the two is that the former ignores the capital expenditure that relates to growth projects, which given the very high capital intensity of their industry can create a material difference.
The original analysis warned that their former quarterly distributions of $0.37 per unit versus their current $0.111 per unit had very limited prospects of being reinstated. This issue only arises due to the relative size of their former distribution payments versus their operating cash flow at $42m and $38m respectively during 2019. Thankfully this does not automatically mean that their distributions cannot grow during the coming years, especially given their subsequently discussed stellar free cash flow after distribution payments.
Now that their results for the entirety of 2020 are available it can be seen that they performed surprisingly well with operating cash flow actually increasing a very impressive 19.18% year on year to $46m versus only $38m during 2019. Even after removing the impacts of working capital movements, their operating cash flow for 2020 only decreased by approximately $1m and thus confirms the underlying strength of their results.
If this performance continues their operating cash flow would actually sit slightly above their former higher distributions at $46m versus $42m respectively. Although a positive change, at the same time it would still not be reasonable to expect them to be fully reinstated anytime in the foreseeable future given the thin margin for any capital expenditure. It was excellent that management struck a positive tone regarding 2021 during their fourth quarter of 2020 results conference call with a few quotes provided below for context.
"The outcome of all that is particular to Canada. Canada has returned to pre-COVID production levels and with this new announcement of spending, our expectations are that in 2021 we will actually be producing at higher levels than we did pre-COVID levels."
"…we expect throughput levels at Hardisty, at Casper and at our Stroud terminals will continue to trend upwards through 2021."
"So as we think about, we are now moving into where crude by rail matters…"
- USD Partners Q4 2020 Conference Call.
This positive outlook should help support their cash flow performance into 2021 and thankfully they should have ample free cash flow after distributions to deleverage and support higher distribution payments. Their new quarterly distributions of $0.111 per unit only cost them $12m per annum, based upon their latest outstanding unit count of 27,685,577. Once subtracting a further approximate $3m for capital expenditure and miscellaneous cash expenses leaves them with approximately $30m of free cash flow after distribution payments. Following the very strong distribution coverage this provides, it was interesting to observe management during their fourth quarter of 2020 results conference call hinting that their distributions could increase after deleveraging.
"Obviously the distribution question is subject to the board's discretion on a quarterly basis, but I think I can say that the fact that there were 3.5 times and trending lower, generating a significant amount of DCF coverage and DCF yield. So only those things help the discussion with regard to distribution policy going forward."
- USD Partners Q4 2020 Conference Call (previously linked).
It is also interesting to consider how the outlook surrounding their crude oil by rail-focused assets has seemingly improved since the election of the Biden administration in the United States. The two primary methods of transporting crude oil are either via pipelines or rail with the former being the most cost-competitive for oil produced in large long-life basins. This means that new pipelines are arguably their main threat and now that the Biden administration sits in the White House these should only become more difficult to receive environmental approvals, an example is the cancelation of the controversial Keystone XL Pipeline.
Whilst the speculation is not the focus of this analysis, it nevertheless would not be surprising if they were acquired in the coming years by a larger midstream organization. The difficulties that the large midstream operators are likely to continue facing in building new assets along with caution about future oil and gas production volumes naturally increases the attractiveness of acquisitions, such as Energy Transfer (ET) acquiring Enable Midstream Partners (ENBL).
The extent that these variables impact their future valuation remains largely unknown since they relate to unpredictable aspects that will take time to transpire. At least if nothing else, investors can reasonably expect to receive their high distribution yield with the timeline for future growth likely being determined by their financial position and deleveraging.
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The fourth quarter of 2020 saw their net debt continue shrinking thanks to their free cash flow after distribution payments, dropping an impressive 4.28% in the quarter alone from $193m to $184m. It was also positive to see their equity begin rebuilding after being essentially wiped out earlier in 2020 from a $34m impairment. It was rather peculiar to see this happen because their financial performance otherwise remained resilient and thus would have normally foretold little to no impairments, as discussed in my previous article regarding BP Midstream Partners (BPMP).
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Following this solid quarter of cash flow performance and lower net debt, it was no surprise to see all of their leverage metrics showing improvements during the fourth quarter of 2020. Their net debt-to-EBITDA now sits at 3.89 versus 4.25 previously and thus is getting quite close to the moderate territory of between 2.01 and 3.50. This helped cement an overall improvement to their leverage versus the end of 2019 across all of their financial metrics apart from their gearing ratio, which was impacted by the previously mentioned impairments but thankfully this has little bearing on their distribution sustainability.
If they keep their distributions at their current level then their net debt of $184m at the end of 2020 should fall below $166m during the third quarter of 2021, based upon their $30m per annum or $7.5m per quarter of free cash flow after distribution payments. This means that their net debt-to-EBITDA would then be sitting below 3.50 and thus into the moderate territory, assuming their EBITDA is broadly flat with 2020 as per my calculations. Once reaching this point, their requirement to deleverage further would be minimal and thus it would be quite likely to see management reviewing their distributions with an eye towards material growth.
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Although their liquidity weakened during the fourth quarter, it was only to a small extent and thus still remains worthy of a strong rating with current and cash ratios of 1.15 and 0.59 respectively versus the previous 1.24 and 0.75 respectively. They are producing free cash flow after distribution payments and are repaying their credit facility that houses the entirety of their debt, as the table included below displays. This means that they are not reliant on their credit facility and thus should find refinancing quite easy before it matures in November 2022.
Image Source: USD Partners 2020 10-K.
Whilst a sustainable high 8.50% distribution yield is already enticing for income investors, the prospects for further growth after a relatively very quick deleveraging is very appealing. Given their continued strong performance, it should be no surprise that I will continue maintaining my bullish rating.
Notes: Unless specified otherwise, all figures in this article were taken from USD Partners' 2020 10-K (previously linked), 2019 10-K and 2017 10-K SEC Filings, all calculated figures were performed by the author.
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