NuStar Energy L.P.'s (NYSE:NS) reported slightly weaker results than expected at its last conference. But, on the other side, strong energy demands with its steady price increase, leave investors considering balancing acts to further understand NuStar's rewards vs. risks.
Management opened the results interestingly with this comment, "We closed out 2021 with a debt-to-EBITDA at 3.99x, a strong improvement from the 4.24x at the end of 2020. with $885 million available on our $1 billion unsecured revolving credit facility." The company wanted investors to understand its laser focused on the balance sheet.
They continued stating that the business supported complete funding of its entire cash requirements during 2021 with a similar commitment for 2022.
On the performance side, crude pipeline throughputs measurably increased YoY. Regarding the important Permian Basin, "Our systems volumes averaged around 516,000 barrels per day for the fourth quarter of '21, a new record, up 3% over third quarter of '21 and up 23% over the fourth quarter of 2020. Our system's average barrels per day in 2021 was over 10% higher than 2020's average, and we exited 2021 more than 100,000 barrels per day over our 2020 exit, which is impressive."
Other important factors reported follow: DCF for the 4th quarter equaled 1.43x and debt fell 11% to $3.2 billion.
For the coming year, management stated, 'We currently expect to generate full year 2022 EBITDA in the range of $700 million to $750 million, the midpoint of which represents a 6% growth over 2021 when adjusted for the sale of the Eastern U.S. terminals and other items." With EBITDA for 2021 equaled $705 million, at the mid-point of guidance, the company expects an increase of 3% YoY. See our quandary note below.
NuStar's business continues operating at impressive rates. The quandary exists primarily with the coming negative changes in the $600 million worth of Series D preferred stock.
Four days after NuStar reported, Wells Fargo's analyst Michael Blum downgraded the stock from a buy to a hold lowering the price target to $17 down from $20. Stating his reasoning, "We expect NuStar's capital allocation priority will be towards reducing leverage for the next few years," analyst Michael Blum wrote, meaning the stock "could lag behind peers with better balance sheets and FCF generation as it relates to capital return."
Blum also added that the 4th EBITDA reported at $169 million was below the market consensus of $176 million.
On the 14th of February, the company announced the sell of its Nova Scotia Terminal for $60 million with plans to employ the proceeds toward its $130M-$150M strategic capital 2022 plans.
A positive business, Permian Basin assets, looks promising going forward. For the next year, management remarked, "Looking ahead, we're encouraged by what we're hearing and seeing from our producers as well as the crude price outlook, and we expect to exit 2022 between 560,000 to 570,000 barrels per day or about 10% above our 2021 exit."
The company holds other key technologies and assets in the ammonia transportation. It is working with existing and possible new customers for future opportunities with green ammonia, renewable electricity and efficient transportation of hydrogen. Details about these opportunities will be forth coming later in the year. A lot is at stake with this report.
NuStar also competes in California for transportation and storage of renewable diesel and other renewable products.
Yet, the quandary begins with changes coming with its preferred stocks. The company issued four sets for preferred stock some years ago. Included in the issue were Series A, B, C and D. The interest rate on Series D units jump steeply in 2023, while that preferred issuance also becomes redeemable.
On the four different series, the company pays a significant amount of cash quarterly. For the first three series, the cost per year equals $65 million. Series A turned variable in December of 2021; B turns variable in June of 2022; Series C turns variable in December 2022. New costs associated with these units consist of a fixed amount plus a LIBOR rate adjustment. For at least the near future, the actual rates won't change much from the fixed to variable status. The penalty is with the Series D.
The company paid $65 million a year for the Series D, but in 2023, the costs increase to $81 million or 11% of the total adjusted EBITDA. At the last conference management noted, "And we're particularly focused on addressing the Series Ds that come due in 2023 - so not due but they become redeemable in 2023."
With the inclusion of Series preferred units into the debt structure, debt jumps jumps from $3.2 billion to $3.8 billion increasing the leverage to 5 based on the high end of this years EBITDA forecast. Management understands the serious natural of the coming issue and is laser-focused on addressing it. Management firmly committed to managing (reducing) spending and increasing EBITDA as its primarily means to control leverage. During the call when asked about a leverage target, abruptly, management stated we don't have one. Not a good answer for either investors or analysts. But again, "And we're particularly focused on addressing the Series Ds that come due in 2023."
A look at the debt structure in the next slide shows that the company has nothing due until 2025 plus an almost billion dollar revolver. A note, the interest rate on the revolver is 3.1%.
A couple of approaches come to mind in studying solutions to the company's debt circumstances. One approach, NuStar may convert the $600 Series D into revolver debt dropping the interest payment from $81 million to $18 million, a savings of $63 million a year. Most likely this approach would be short-term.
Before we discuss the others, it is important to remember that management must wait at least a year before they can recall the shares. In the meantime, cash can be accrued. In calendar year 2022, the company plans to spend $150 million on capital with $60 million already in hand from the most recent sell. It pays out $120 million in its preferred shares a year, $230 million in debt interest and approximately $180 million in distributions for common units. The total cash expenses equals $600-$650 million a year. A possible excess cash generation of $100-$150 million exists. When the Series D preferred are called, the company could do the recall using $450 from its revolver, approximately half of the remaining balance, and the cash generated between now and then.
With the preferred extinguished, the company could issue more bonds increasing the leverage toward 4.5-5 or it could issue new common shares and pay a distribution. At $15 per share issue, an increase of 25% would occur. The total additional cash at $0.40 per quarter, the yearly cash expense equals $48 million or $33 million less than the floating rate Series D yearly rate. The problem with this approach is that each distribution increase costs the additional cash from the added shares.
Another solution exchanges through the issuance of new bonds at a fair rate of 9% costing the company $40 million. The negative side of this becomes the significantly higher leverage at least 4.5, something the company would be required to reduce in time.
A mix of the two approaches could be employed. Again, it is important to note that the company has options and the business in humming.
A note: our own quandary. In gathering information for this section, we found a few disconnects. The company claims a leverage at 3.99. We found debt from the slide equaled $3.15 billion, debt stated in place equaled $3.2 billion, yet the leverage ratio of 4 suggests debt equals approximately $2.8 billion ($700 million in EBITDA for 2021.). Something is amiss.
We included below a stock chart for NuStar created through TradeStation Security software.
In essences, the market values NuStar with a high yield between 9%-11% ranging it between $14-$18. The market senses the negative magnitude of the situation and is pricing it likewise.
With the price stuck in a range, our strategy includes selling in the money options. For us, this equates to options with a strike price of $15 out 3-9 month. Why? We can add a point or two in profit to the already high yielding investment without a significant risk of losing the stock and still collect the distribution.
NuStar isn't without risk, not a business risk, but rather balance sheet risk. We don't view this with a belief concerning bankruptcy. It concerns stock price. For those who might suspect another distribution cut, we don't see that either. Each $0.10 per quarter adds only $45 million a year, or so little. What we see is a trapped investment which offers a nice income return for those willing to think outside the box. With NuStar entering into or expanding its presence into several future growth markets, we believe that entering at an advantage prices, this could be a valuable long-term investment for those seeking income.
We aren't the first author on Seeking Alpha to point out this quandary. We hope we have added meaningful understanding to already outstanding work.
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Disclosure: I/we have a beneficial long position in the shares of NS 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.