NuStar Energy Series A Preferred Shares - Safe Short Duration Play For An 8.4% Yield

Summary

• NuStar Energy Series A Preferred Shares have a Dec. 15, 2021 call date and are the first NuStar preferred tranche to become due for an optional redemption.
• Despite the overall NuStar Energy leverage, which is on the high side, its Senior Secured Notes are trading well in the secondary market, signaling funding market's risk appetite for NuStar.
• NuStar Energy has no other debt coming due until 2022, and not redeeming its Series A on their call date would virtually shut it out from that market.
• If you think there might be a shallow correction coming in the risk markets, but still want to stay involved in the preferred space, a short duration play is best.

spooh/E+ via Getty Images

NuStar Energy (NYSE:NS) is a pipeline MLP that relies heavily on preferred shares for its capital structure and has all three publicly traded outstanding tranches coming due from a call date perspective in the next year and a half. With the credit markets having absorbed all new high yield issuance and spreads at a record low, NuStar is well positioned to refinance its Series A preferred stock (NS.PA) with a December 2021 first call date, especially in light of the August 2, 2021 terminals divestiture for $250mm and tight secondary market for its Senior Unsecured Notes which indicate appetite for the name. Failure to call the Series A preferred shares in a benign market environment has the potential to close the door on future preferred shares sales, or make it markedly more expensive since people will be pricing the credit cash-flows and present values further out than the 5-year non-call period.

Company Overview

NuStar Energy is organized as a master limited partnership and similarly to industry peers owns crude oil and refined products pipelines and terminals. The company has approximately 10,000 miles of pipeline and 73 terminal and storage facilities that provide approximately 72 million barrels of storage capacity. NuStar Energy is a small, value MLP with a current market capitalization of $1.8 bil.

Source: Company Q1 2021 Presentation

NuStar Energy Preferred Shares

NuStar currently has three tranches of preferred shares outstanding with the first call date being in respect to the Series A notes in December 2021.

Source: Author

Although in the Energy sector, the company follows the general standard market practice of having a call date 5 years after issuance with expectations on pricing date that the debt will be called unless the markets are in turmoil and generally shut for issuance due to risk premia.

Current Debt

NuStar has been behind the curve in deleveraging initiatives when compared with the overall industry. Most peers have been heavily focused on getting to a Debt / EBITDA level below 4x before any increases in shareholder distributions or substantial capital projects. NuStar has chosen to take a slower path in net debt reduction but has nevertheless addressed any short term debt maturities by placing new longer term debt (in September 2020 they issued two $600 million tranches of five-year and 10-year senior unsecured notes maturing in 2025 and 2030) and successfully increasing the tenor of its bank Revolver facility (in March 2020 they extended the revolver term through October 2023).

The company has very recently made further strides in debt management initiatives via divesting on August 2, 2021 eight storage terminals for $250 mm, with the buyer being Sunoco. The sale is expected to close by the beginning of the fourth quarter of 2021 and the resulting proceeds are to be deployed to further improve debt metrics.

Source: Author & SEC Filings

Senior Notes Secondary Market Spreads

Currently NuStar has approximately $3 bil in Senior Notes trading on the secondary market and traded yields can be observed from the market levels. One can observe 1 year cash bonds trading with a 2.7% yield and 5 year cash bonds trading with a 4% yield on the bid side.

Source: Fidelity Investments

These yield and credit spread levels indicate that the funding markets are open for NuStar, and they should be able to place new debt or new preferred shares at current traded market levels without the need for additional subordination or significant premiums to current spreads.

When looking at the historical performance of the capital structure spread between preferred shares and Senior Notes one can see a range of spreads from 200 bps - 500 bps, dependent on market conditions. However, utilizing this historic information to imply a clearing level for new 5 year preferred shares is a bit tricky. Staying on the conservative side and assuming the high range of the spreads one can think that new preferred shares would price at 5 year senior notes yield + 4% to 5%. Hence, taking the 06/02/2026 Senior Notes Yield which is currently 4.019% and adding 4.5% gets us to approximately 8.5% predicted yield on any potential new issuance.

This potential estimated yield for any new 5-year preferred share issuance is very similar to what the Series A preferred shares currently pay prior to re-setting lower to Libor + 6.766% in December 2021.

Will they not call the Series A shares?

One can argue that NuStar can achieve interest savings by not calling the Series A notes and just taking advantage of the lower coupon of 6.886% (currently 3 month Libor is around 0.12%), but the annual saving are far outpaced by the cost of damaging their ability to access the preferred shares market-place in an environment where they are not deleveraging as fast as they need to, and desperately have the need for a capital structure that includes preferred shares which are not counted towards the debt/EBITDA ratio. Since they have a clean balance sheet with no debt becoming due until 2022, have access to the capital markets at good levels and the estimated replacement cost for the preferred shares is similar to current yields before resetting on the call date, all signs are pointing towards a swift re-financing.

The Series A shares returns

The Series A Preferred Shares have upcoming interest payment dates on September 15 and on December 15, 2021 when principal would also be returned in a full call scenario. Given the shares are currently trading at slightly above par, the annualized yield of 8.4% is slightly lower than the coupon rate and the net cash that would be received is as per the below table:

Source: Author

Conclusion

NuStar has been slower than its peers in net balance sheet deleveraging, but has made progress in cleaning up near-term debt maturities. And it is continuing to address net debt levels via internal cash flows and external divestitures (such as the August 2, 2021 terminal sales for net proceeds of $250mm). NuStar relies heavily on preferred shares for its capital structure, and has all three outstanding tranches coming due by the end of 2022 - with the first series (Series A) having a December 2021 call date.

The benign credit market, the company's competitive yield on senior secured debt in the secondary, and lack of any debt maturities until 2022 - coupled with the recent sale of eight terminals for $250mm - make the NuStar Energy Series A Preferred Shares highly likely to be redeemed in December 2021. As such, they offer an attractive short duration play in the energy preferred space.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, but may initiate a beneficial Long position through a purchase of the stock, or the purchase of call options or similar derivatives in NS.PA over the next 72 hours. 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.

The above references constitute an opinion and are for information purposes only.

Comments

[Matt4Coffee]

Will distributions paid on the Preferred units be treated as interest expense, or just like any other (common) distributions? I assume this it is the latter, in which case it probably makes the most sense to hold the Preferred C shares I'm considering buying at this time in a taxable account...

(Though my Preferred B's are currently held in my ROTH!)

[houtex]

@Matt4Coffee
You can, and should, always check the prospectus. For instance for Series C it says “We will treat distributions on the Series C Preferred Units as guaranteed payments for the use of capital that will generally be taxable to the holders of Series C Preferred Units as ordinary income and will be deductible by us. ” I think “guaranteed payments for the use of capital” is different than interest expense, though they may each get similar treatment on the partnership’s books, I don’t believe if you buy bonds you get a K-1 which you will get on the preferreds.

[Eileen Dover]

NS cut dividend big time TWICE in past 3 years. No thank you !!

[BPaone323]

@Eileen Dover A dividend (distribution) cut on the common is a positive for the preferreds.

[ckarabin]

@Eileen Dover The dividend coverage is 223% now too. The y cut the dividend to deleverage. Getting the preferred back will likely be part of that capital reduction

[houtex]

“the company's competitive yield on senior secured debt in the secondary”
Are the notes secured? The 10k indicates most of the notes are unsecured (“The 6.0% senior notes rank equally with existing senior unsecured indebtedness and senior to existing subordinated indebtedness of NuStar Logistics. The 6.0% senior notes contain terms comparable to our other senior notes, including the 5.75% and 6.375% senior notes described above.”), and the FINRA page says none are secured. Is the revolver even secured?

[BPaone323]

@houtex All their publically traded debt is unsecured. Revolvers are always secured.

[houtex]

@BPaone323

“Revolvers are always secured.“

Revolvers aren’t always secured. Don’t make such assertions when they aren’t true.

Anyway, Nustar’s revolver is indeed unsecured according to Moody’s. I was looking yesterday and couldn’t find any mention of the security underpinning the revolver, so I thought it was unsecured, but I never saw any affirmation of that. “NuStar Logistics' various unsecured bonds and its 2020 revolving credit facility are unsecured and pari passu.” www.moodys.com/...

[Preferred Stock Trader]

Not calling a preferred stock in no way damages their access to the preferred market. There are a boatload of preferred stocks that are callable now that haven't been called. A preferred stock is not a bond, it has no maturity date, and nobody owning a preferred stock should expect a company to call it unless it makes sense for the company to do so. I will take the other side and predict they will not call the preferred stock. They let their NSS bond float rather than calling it and it will have the same yield as NS-A after NS-A's call date. If they are going to call something, which I don't think they are, it will be NSS and not NS-A.

[Binary Tree Analytics]

@Preferred Stock Trader hi - thank you for the comment. The NuStar Logistics L.P., 7.625% Fixed-to-Floating Rate Subordinated Notes due 1/15/2043 (NSS) which you seem to reference are categorized from an accounting standpoint as Debt Obligations (as per the SEC filings) and thus sit on the Liability side of the balance sheet. The Series A preferred shares are Partners’ equity and are issued via the standard 5 year non call feature and priced as such. The Sub Notes will not be called because the company has no benefit from doing that + they were issued as variable rate bonds to begin with - ie on pricing date you price cash-flows to maturity (2043) and you benefit from the capital structure subordination (upon an event of bankruptcy Sub Notes rank above preferred shares and common equity) - thus the more advantageous pricing. hope this helps.

[Preferred Stock Trader]

@Binary Tree Analytics NSS was not issued as a variable rate to begin with. It was issued as fixed-to-floating just like NS-A but hit its floating rate date earlier than NS-A. And it is much more to NS's benefit to call NSS as it would show up as reducing their leverage. Calling NS-A would not reduced their reported leverage. In fact, if they floated debt to raise money to call NS-A, it would increase leverage by adding to balanced sheet liabilities. The last thing NS wants to do is increase their leverage needlessly. I don't mean to be critical as I see you are a new author and I think you tried to do an interesting article. But all authors can learn from the comments. I encourage you to keep writing and learning.

[Binary Tree Analytics]

@Preferred Stock Trader hi - thank you for your comments. my feedback:

i) in all their SEC filings the company describes the 2043 Notes as "Variable-Rate-Debt" - please reference the Q1 2021 Form 10-Q (pg 30, "Item 3.Quantitative and Qualitative Disclosures About Market Risk")

ii) In respect to the 2043 Notes - these are not included in the debt / ebitda metric that the company reports b/c they follow the Revolver covenant and calculations (a fairly standard market practice in the MLP space). As a reference point please see pg 39 of the May Management Preso (investor.nustarenergy.com/...). Also in my article above i detail the company's methodology for coming up w/ their debt/Ebitda number as per the Revolver covenant

iii) the article is not of the opinion that NS.PA will be taken out by debt, but is talking about the ability of the company to refinance NS.PA via new 5-year non call preferred shares

[petergo007]

NSS ?

[Binary Tree Analytics]

@petergo007 hi Peter - thank you for the comment. kindly see the above explanation given to the "Preferred Stock Trader" user.