Author's note - "low/pessimistic" case scenario valuation calculation updated after publication to fix an calculation error, thesis unchanged
Blueknight Energy (NASDAQ:BKEP) has changed substantially in recent months as it has sold all of its oil-related assets for $164M. They are looking to drop "Energy" from their name, but the appear to remain at a relatively depressed valuation, even though the stock has rallied on the asset sales.
What remains is a high quality asphalt terminal network as below.
source: Blueknight investor presentation
These sorts of assets are not easy to replicate and can command attractive returns. There is value in having 53 facilities across 26 states making it easier to serve larger customers. The prospects of new entrants and undisciplined price wars are unlikely. It is also unlikely that asphalt will be substituted for a different product.
The key to the story is really understanding the new capital structure and the secure economics of the business. This is not a commodity-related business, it's logistics based on take or pay contracts for a crucial construction material used primarily in roads, roofing and runways. It's always been a sound business, but was hidden under the volatility of energy assets, which attracted more attention despite their smaller size.
|taxes (very low due to MLP structure)||$0M||$0M||$0M|
|capex (management guidance)||$6M||$5.5M||$5M|
|FCF to equity (excl. preferreds)||$9M||$15.5M||$22M|
|Unit value at 15x multiple 41.1M units||$3.28/unit||$5.66/unit||$8.03/unit|
|Upside (from $3.26/unit)||1%||73%||146%|
To review assumptions - management has EBITDA at around $50M and it has been stable at $49M-$50M for the past two years. Interest costs are based on debt of $100M after disposals. They pay hardly any taxes due to being an MLP. Capex guidance is in the range of $5.5M-$6.5M and the preferred payments are based on historicals. Management target for cost savings are $1.5M-$2.5M as discussed below, so the "High/optimistic" case above assumes both full delivery on cost savings and some incremental volumes from infrastructure spend on bolt-on acquisitions after costs. Hence the high/optimistic case is likely a stretch for 2021, but perhaps not for 2022.
Net, there appears to be nice convexity in this business. It is likely that they optimize a few costs after the asset sale and that benefit falls to unit holders. Current management guidance is for $1.5-$2.5M in run-rate cost savings. More than half of this, according to management, is headcount elimination related to the oil services assets. The second piece is the ending of transitional contracts. The timing of the benefits will therefore be dependent on deal close, and will likely straddle calendar 2021 and 2022.
While $2M in cost savings may appear somewhat trivial, we should note the sensitivity of the units to these cost savings. A $2M permanent cost reduction that falls through to the units on a 15x multiple is worth +$0.73/unit. This is representative of the general spirit of the BKEP story, small gains for the business could boost unit holder returns materially.
There are ample reports that the U.S. transportation infrastructure is aging and needs a refresh. There appears to be bi-partisan support for such spending. However, other topics have taken priority so far.
For example, this McKinsey report shows that infrastructure's share of GDP spend has been in decline and that perhaps a trillion of extra spending is needed to repair U.S. roadway and transit infrastructure. Were that to happen, Blueknight would be a likely beneficiary. However, for now, more muted levels of spend still provide a reasonable return for Blueknight unit holders.
As you might expect, the company management is bullish on U.S. infrastructure spend. Of course, it would be great if they were right, but the key is extra spend isn't necessary for the investment to work:
source: Blueknight investor presentation
Another way to play Blueknight is through the preferreds (BKEPP). These currently offer a yield of a little under 10%. Management have indicated the potential to reduce the preferreds should acquisitions on favorable terms not present themselves.
I prefer the risk/return on the units given the current capital structure, but the overall dynamic means that the preferreds are not unattractive. In fact, I currently hold some preferreds too.
The main risk is with its reduced leverage and sharper focus the company destroys value with an acquisition spree. The company states that "Disciplined investments in high-return growth opportunities are possible" and that they may "Pursue attractive, low-cost sources of capital for potential larger opportunities". They appear to have around $250M incrementally available on their credit agreements.
This could include filling out their U.S. distribution map, or perhaps exploring other assets in the asphalt value chain such as hot mix plants or shipping assets. The latter seems unlikely given they did just dispose of certain transportation assets, such an acquisition would be less desirable. Acquiring more terminals would make sense given their existing customer relationships and network externalities.
However, it's always possible they overpay. On the positive side, management have also mentioned the possibility they use a tender (or similar structure) to purchase preferreds if attractive deals are unavailable.
Secondly, of course, unit holders are the residual claimants behind both debt and preferreds. This does create some compelling upside scenarios as discussed, but the same dynamic can work in reverse, with long-lived take or pay contracts the downside is perhaps less of a concern, but the risk remains.
Finally, we should note that Blueknight is an MLP. Many investors aren't able to own this asset type, and that appears to constrain valuations (not necessarily a bad thing for unitholders happy to receive high yields). In addition, MLPs are also often energy-related (as indeed Blueknight was) and so sentiment concerns have weighed too.
Blueknight appears too cheap to ignore for those that can own MLP assets. It's a stable business with high returns on capital. Once it's understood that it's not an energy asset and delivers stable yields with the prospect of some upside should infrastructure spend ramp and/or cost reductions come through it may re-rate such that the units could double or better. The downside case appears favorable, the units may still be cheap even if the company under delivers against recent history.
The major risk is that they are effectively sitting on dry powder after deleveraging, and do an ill-conceived acquisition that's either expensive or dilutes the value of the attractive assets they currently own. That said, this may be a business where rolling up adjacent sites, at a fair price, to further build out their network is an attractive strategy.
This article was written by
Disclosure: I am/we are long BKEP. 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.
Additional disclosure: Also currently long BKEPP. Not intended as investment advice. Author's stock, preferred and unit positions may be updated without notice. No warranty is given on the accuracy of the information in this write-up and any accompanying comments or that it will be updated. Investing involves risk of permanent capital loss. MLPs and preferreds have unique attributes and tax circumstances that should be understood before investing.