Of all the energy pipeline master limited partnerships (MLPs) out there, NuStar Energy (NYSE:NS) would not have been the one I'd have picked to outperform in the third quarter. The company was diving headlong into a new crude oil opportunity in the Permian Basin, which is completely disconnected from the vast majority of its other operations.
And yet, those Permian investments seem to have paid off for NuStar in Q3 -- the company delivered double-digit percentage increases in both revenue and net income. Here's why investors may want to pay attention to NuStar.
The raw numbers
|Metric||Q3 2018||Q3 2017||YOY change|
|Revenue||$490.4 million||$440.6 million||11.3%|
|Net Income||$48.1 million||$38.6 million||24.6%|
|Earnings Per Unit (adjusted)||$0.13||$1.39||(90.6%)|
|Distributable Cash Flow||$88.5 million||$80.2 million||10.3%|
|Distribution Coverage Ratio||1.38x||0.66x||N/A|
A few of these numbers need to be put in context for proper consideration -- particularly the earnings per unit metric ("units" are the MLP equivalent to shares), and why it decreased by so much, despite the increases in revenue, net income, and distributable cash flow.
First of all, as you can see on the chart, those earnings of $0.13 per unit are adjusted. The unadjusted figure was a $3.49 per unit loss, which was attributable to a one-time noncash charge of $377 million related to its recent merger with NuStar GP Holdings. As a noncash charge, it didn't affect distributable cash flow or net income.
But the main reason that even the upwardly adjusted number was so low compared to the prior year is that the company issued a huge quantity of new shares in conjunction with the merger, lifting the number outstanding by nearly 15%. More shares mean less earnings per share. The company also cut its distribution to help shore up its balance sheet, which is why its coverage -- the degree to which it can pay its distribution using cash from operations -- is so high today, when it was so lousy a year ago.
What happened with NuStar this quarter
Basically, the Permian Basin happened.
NuStar's crude oil throughput volumes increased by 34.5% over the prior-year quarter, thanks largely to the company's new crude oil gathering system in the Permian, which is on track to be moving between 360,000 and 380,000 barrels per day by the end of the calendar year. By comparison, the company's refined products and ammonia pipelines -- which make up the vast majority of its pipeline network -- only moved 567,320 bpd during the quarter.
Interestingly, hardly any time was spent on the company's earnings call discussing items other than the Permian Basin, NuStar's Corpus Christi marine terminal, and how the company was trying to connect the one to the other using third-party infrastructure. Currently, long-haul pipeline access from the Permian is constrained, so NuStar has constructed a large truck loading platform at its rail terminal there to facilitate shipping Permian crude by train. The company has also re-activated the train offloading operation at its St. James, Louisiana, terminal.
But one of the more promising pieces of news was that NuStar has entered into an agreement with commodity trader Trafigura to connect its South Texas crude pipeline system -- which in turn connects to its Corpus Christi terminal -- to Plains All American Pipeline's Cactus II Pipeline, which is slated for completion in Q3 2019. Securing some of the limited pipeline capacity out of the Permian is wise, as competition for it is likely to be fierce.
As part of NuStar's refocus on the Permian, it announced it was selling off noncore assets in Europe for $270 million, and using the proceeds to pay down debt. This will reduce the company's leverage from 4.7 times EBITDA to around 4.2 times EBITDA, which should further please the rating agencies.
What management had to say
In a press release, CEO Brad Barron spoke in glowing terms about the company's performance and its new Permian-focused strategy:
I am very pleased with our third quarter results, as they reflect the positive impact of the hard work we have done this year to create a more simplified corporate structure, which provides even greater transparency in our governance, eliminate the Incentive Distribution Rights, strengthen our coverage, minimize equity needs and lower leverage.
Because of these efforts, NuStar is positioned to participate in the burgeoning opportunities that the Permian Basin's production growth is driving, within the basin and further afield, for MLPs with world-class assets in the right locations. Our new export project for Trafigura exemplifies this strength.
A lot has happened with NuStar since the start of 2017, including a merger, its decision to eliminate IDRs, its purchase of Permian assets, and its debt restructuring. While I still have concerns about how well those Permian assets integrate with the rest of its portfolio, and competition for scarce third-party Permian connections remains an issue, I can't deny that NuStar seems to be making some savvy moves to reinvent itself.
Investors will want to keep a close eye on NuStar to make sure all of this activity isn't just creating flash-in-the-pan results, but can be converted into sustained outperformance.