USD Partners: 7% Dividend With Upside Potential
- USD's reported income loss last year was only on paper, due to an asset write-down.
- Their cash from operations remained in line with its pre-pandemic level and is improving this year.
- Rail transportation will remain important into the foreseeable future, due to its convenience, reliability, and speed.
- Given the improving economic outlook and increasing transportation costs, I expect USDP's revenue and profit to increase. A dividend increase will follow.
- I expect 20-40% upside with 7% dividend along with it.
USD Partners (NYSE:USDP) is a fee-based partnership that acquires, develops, and operates midstream infrastructure and logistics for crude oil, biofuels, and other energy commodities. I believe that USDP presents a great investment opportunity for an investor seeking a solid dividend yield coupled with growth potential because:
- Their profitability is well above the industry average, and the current valuation is too low.
- The tailwind from increasing transportation fees will boost their revenue and profit.
- USDP generates ample cash from operations and it is improving, which should easily support the current dividend and future increases.
Strong profitability and attractive valuation
USDP is a very profitable partnership shown by various metrics. Their EBIT margin (25.51%), EBITDA margin (42.85%), and Net Income margin (20.94%) are well above the sector median. Additionally, their business model generates a safe and reliable profit. USDP does not take any ownership of the commodities that they are transporting, but instead charges the customer fees to use their transportation and terminal service. This business model protects them from exposure to commodity price fluctuations.
The reported income loss in 2020 was not an actual operating loss, but instead was a paper loss. It was largely caused by a goodwill impairment loss of $35 M shown below. Their cash flow remained in line with the pre-pandemic level. This reported loss and dividend cut pushed stock price down to ~30% of its pre-pandemic level, a point from which it hasn't yet recovered (TTM P/E is at 6.70). When they increase their dividend in the near future, I expect the stock price and valuation to recover to its pre-pandemic level. A section of the SEC filing is given below to show the "goodwill impairment loss" last year.
Source: SEC filing
Supply chain disruption and rising transportation fees
The ongoing supply chain disruption is affecting every part of the economy, and causing problems for most companies. However, companies in the transportation business are experiencing a huge tailwind from the disruption due to rising transportation fees (shown below). This tailwind is boosting USDP's revenue (9% increase) and operating cash flow (20% increase) as well. I don't expect the supply chain disruption to last into the long term, but, in the meantime, USDP can utilize the extra cash to strengthen their balance sheet (they did reduce their long term debt last year and this year) or increase their dividend payment. The average trend of commodity goods rail tariffs is shown below.
Source: American Farm Bureau Federation
Strong cash generation from operations, and high chance of dividend increases in near future
Thanks to their fee-based business model, USDP generates very reliable cash flow from operations and has minimal exposure to fluctuations in commodity prices. Even when oil price dropped during the pandemic (and briefly touched a negative value), their cash from operation remained in line with the pre-pandemic level ($45.8 M in 2020 vs. $45.1 M in 2018). Recently, receiving a boost from increasing transportation fees, USDP's cash flow has sharply increased ($45.8 M in 2020 to $55.4 M TTM). I therefore expect them to increase the dividend to pre-pandemic levels soon. They have already announced a dividend increase of 2% for the next payment, but I expect subsequent increases as well. The cash from operations trend is shown below.
Intrinsic Value Estimation
I used DCF model to estimate the intrinsic value of USDP. For the base case, I utilized TTM dividend cash distribution ($12.6 M total distribution) and current WACC of 6.8% as the discount rate, assuming perpetual payment at the same rate. For the bullish and very bullish case, I assumed a total dividend distribution of $16 M and $20 M, respectively, using the same WACC and perpetual payment assumption. The dividend payment of $16 M and $20 M is well below the pre-pandemic distribution level ($40 M), but higher than the current level. Given the improving economic outlook, I believe the company will be able to handle this dividend increase.
The estimation revealed that the USDP presents an opportunity with a great combination of stock appreciation (20-40%) and nice dividend yields (7%). As mentioned previously, I believe USDP can maintain or increase their dividend payments due to their strong cash generation and the tailwind from transportation fee increases, and this will translate into appreciation of stock price accordingly.
Stock Price Appreciation Potential
Very Bullish Case
The assumptions and data used for the price target estimation are summarized below:
- WACC: 6.8%
- Current Dividend Payment: $12.6 M
- Current Stock Price: $6.55 (10/30/2021)
- Tax rate: 30%
In the short term, labor shortage is hitting all segments of the economy, and this may negatively impact USDP's business by increasing labor costs and make it difficult to maintain adequate staff. However, as vaccination rates rise and the economy opens up, I expect that the labor shortage challenge will diminish. Also, the USDP should be able to pass the cost to their customers since they provide a service which is essential to their customers' business.
In the longer term, as people become increasingly concerned about climate change and the environmental impact of fossil fuels, there are concerns around the viability and sustainability of any business associated with oil and gas. However, petroleum has many different usages other than fuel (e.g. plastics, base chemicals, etc.), so I expect the business activity associated with petroleum to stay in the foreseeable future. Also, USDP owns valuable assets (railroad, terminals, and storage), and these can be used for other freight besides crude oil. Therefore, I expect USDP's future to be safe regardless of crude oil demand. The following diagram shows the importance of the railroad infrastructure to the U.S. economy.
Source: American Farm Bureau Federation
I believe USDP presents a great investment opportunity. Given the increasing transportation fees, their revenue and profit should increase substantially in the near future, and this should translate into an increasing dividend payment. I expect them to return the dividend payment to its pre-pandemic level soon. Labor shortage or weaknesses in petroleum demand may present short-term challenges to USDP, but I expect them to mitigate these risks effectively. I believe the current stock price represents 20-40% upside alongside a 7% dividend yield.
This article was written by
Analyst’s Disclosure: I/we have a beneficial long position in the shares of USDP either through stock ownership, options, or other derivatives. 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.
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