NuStar Holdings: Execution Risk In Acquisition Of Navigator Energy Services
The equity markets have been on an absolute tear since the election last fall.
For existing investors, this has been welcome. Swelling account balances and rising net worths have made many investors a great deal richer since the results of the November election were announced.
However, a red-hot stock market poses many problems for investors that are looking to buy more stocks.
Valuation matters, and finding attractively-valued stocks in today’s market is difficult.
Cheap stocks can often be found by looking for companies whose stocks have experienced a meaningful drawdown. NuStar Holdings (NSH) is an example of this. The company’s stock has declined from ~$30 to ~$24 since the beginning of February.
Lower stock prices mean higher dividend yields. NuStar’s dividend yield is currently ~9%, making it a member of the elite and selective group of stocks with 5%+ dividend yields.
As with any high dividend stock, NuStar should be thoroughly investigated to ensure that its dividend payout is sustainable in nature.
This article will analyze the investment prospects of NuStar Holdings in detail.
Business Overview
NuStar Holdings is a publicly traded limited liability company whose primary asset is an ownership stake in NuStar Energy L.P. (NS), a publicly-traded master limited partnership.
More specifically, NuStar Holdings owns the general partner of NuStar Energy along with 11% of the partnership’s outstanding common units.
NuStar Holdings also owns 100% of NuStar Energy’s incentive distribution rights (IDRs). IDRs give the general partner (NuStar Holdings) an increasing proportion of the partnership’s cash flows as it grows, which encourages the entities to drive growth at the partnership level.
Additional details about the corporate structure of NuStar Holdings can be seen below.
Source: NuStar Presentation at the May 2017 MLP Investor Conference, slide 4
Interestingly, 21.0% of NuStar Holdings is owned by William E. Greehey, who is the Chairman of both NuStar Energy and NuStar Holdings.
Mr. Greehey’s 21% stake is worth more than $200 million at today’s prices, which means that the Chairman’s interests are definitely aligned with those of his shareholders.
High levels of insider ownership are a key sign of a shareholder-friendly stock and this ownership should be welcomed by NuStar’s investors.
The Underlying MLP
To understand NuStar Holdings, it is imperative to understand NuStar Energy.
NuStar Energy is a midstream oil & gas MLP with a market capitalization of $4.2 billion.
Founded in 2001, NuStar reports in three segments: Storage, Pipeline, and Fuels Marketing. NuStar operates 8,700 miles of pipeline along with 79 terminals and storage facilities.
NuStar has been undergoing a significant business transformation in the past 5 years or so. Namely, the company has been reducing its exposure to the fuels marketing business and focusing on its larger pipeline and storage segments. This can be seen below.
Source: NuStar Presentation at the May 2017 MLP Investor Conference, slide 8
Today, pipelines and storage each represent about one-half of NuStar Energy’s total business as measured by EBITDA.
Current Events
On April 11, NuStar Energy (not NuStar Holdings) announced the acquisition of Navigator Energy Services LLC, a crude oil transportation, gathering, and storage company located in the heart of the Permian Basin.
While this transaction occurred at the partnership level and not at the level of NuStar Holdings, it is still relevant to NSH shareholders because it is essentially a holding company for NS LP and GP units.
The financial markets reacted negatively to this acquisition as many viewed the price tag of $1.475 billion to be excessive. Additional market pessimism was seen on April 18, when NuStar issued 14.4 million common units to fund the transaction.
Despite the market’s concerns, NuStar’s CEO remains confident that the assets were a worthwhile purchase. The acquisition closed on May 4.
Further details about Navigator Energy Services LLC can be seen below.
Source: NuStar Presentation at the May 2017 MLPseenestor Conference, slide 16
The primary reason why NuStar Energy acquired Navigator Energy Services LLC was for its exposure to the Permian Basin.
Currently, the Permian Basin represents approximately 40% of all U.S. onshore rig activity. NuStar Energy has been shopping for exposure to this geography for some time now.
Source: NuStar Presentation at the May 2017 MLP Investor Conference, slide 14
As mentioned, NuStar Energy completed an equity offering to help finance the Navigator Energy Services transaction. This complimented an additional offering of debt in the form of 5.625% 10-year senior notes due April 28, 2027.
Details about the capital markets financing used in the Navigator acquisition can be seen below.
Source: NuStar Presentation at the May 2017 MLP Investor Conference, slide 20
Importantly, NuStar Holdings has agreed to waive its incentive distribution right (IDR) payments temporarily to help ensure a seamless transition.
The IDR waiver will last a period of 10 quarters from the date of the acquisition’s close (May 4) and is capped at $22 million in aggregate.
Source: NuStar Presentation at the May 2017 MLP Investor Conference, slide 19
The most important takeaway from this transaction is its impact on NuStar Energy’s distribution coverage ratio.
More specifically, the dilution associated with NuStar’s acquisition of Navigator Energy Services LLC has reduced the MLP’s distribution coverage ratio to a level lower than we’d like: 0.87x in the quarter. Absent the impact of this dilution, the MLP would have reported a distribution coverage ratio of 1.06x in the quarter.
Accordingly, the safety of this company’s distribution is highly dependent on the success of the Navigator Energy Services business post-acquisition, and since the performance of NuStar Holdings and NuStar Energy are highly interrelated, this should be closely monitored by the shareholders of either corporate entity.
Growth Prospects
The same transaction that has reduced NuStar’s distribution coverage is expected to drive much of the MLP’s future growth. This will translate into growth for NuStar Holdings once the IDR payments resume 10 quarters after transaction close.
Navigator’s Permian presence combined with NuStar’s existing footprint in the Eagle Ford basin gives exposure to two of the most prolific oil geographies in the United States.
If executed as planned, the acquisition presents considerable upside for NuStar’s investors.
Competitive Advantage & Recession Performance
NuStar Holding’s competitive advantage comes from having a sizeable stake in NuStar Energy as well as owning 100% of the incentive distribution rights.
NuStar Holding’s distribution was adequately covered in the most recent quarter, as the company reported a distribution coverage ratio of 1.08.
However, many have concerns about the sustainability of the company’s dividend once IDR payments are suspended. Absent IDR payments, NuStar Holdings reported a distribution coverage ratio of .54 in the most recent quarter. It is unclear how the company will continue its current dividend payments once IDR payments are suspended.
At the master limited partnership level, NuStar Energy typically reports a distribution coverage ratio above 1.0, meaning its dividend adequately covered by distributable cash flow. This can be seen below.
Source: NuStar Presentation at the May 2017 MLP Investor Conference, slide 12
All said, there is a substantial amount of uncertainty with regard to future dividends once IDR payments are suspended.
Accordingly, investors should exercise caution before buying this stock.
Valuation & Expected Total Returns
Assessing the valuation of a company like NuStar Holdings is different from a traditional corporation because NuStar incurs significant non-cash depreciation and amortization charges that artificially impair the company’s earnings-per-share.
Thus, instead of using the traditional price-to-earnings valuation metric, an easier alternative is to compare the MLP’s current dividend yield to its historical dividend yield.
NuStar Holdings currently pays a quarterly dividend of $0.545 per unit which yields 9.0% on the company’s current stock price of $24.00.
The company’s current dividend yield is compared to its long-term historical average in the diagram below.
Source: YCharts
NuStar’s current dividend yield of 9.0% is well above its long-term historical average of 6.9%. Thus, the company appears undervalued, likely due to concerns about the future of the company after the Navigator acquisition.
Investors have a solid chance of achieving double-digit total returns if the company can successfully execute the acquisition of Navigator Energy Services LLC without experiencing a dividend cut.
Final Thoughts
NuStar Holdings and NuStar Energy are in the midst of an acquisition that will provide the two entities with significant exposure to the attractive Permian Basin oil sand geography.
However, financial data leaves much to be desired with regards to the sustainability of NuStar Holding’s distributions.
Accordingly, this stock should be avoided for investors looking to generate reliable dividend income.
For investors looking for MLPs with similarly high yields but much superior dividend coverage, the following articles may be helpful:
Disclosure: Sure Dividend is published as an information service. It includes opinions as to buying, selling and holding various stocks and other securities.
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