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Under the Microscope: Aggressive MLP Portfolio

By Elliott H. Gue on Jan. 27, 2015

NuStar GP Holdings LLC (NYSE: NSH)

After an extended period of weakness and some dubious investment decisions by its former management team, NuStar Energy LP (NYSE: NS) generated enough cash flow to cover its second- and third-quarter distributions, increasing our confidence in the MLP’s turnaround story.

As part of its strategic shift, NuStar Energy has divested its interest in cyclical businesses in favor of organic expansion projects at its South Texas pipeline system, which supports customers in the prolific Eagle Ford Shale.

This turnaround effort involved the divestment of the MLP’s ownership interest in the San Antonio refinery and its exit from the much-maligned asphalt business.

In late 2012, NuStar Energy accelerated its growth opportunities in the Eagle Ford Shale with the $325 million acquisition of crude-oil and NGL pipelines and related storage and gathering assets from privately held TexStar Midstream Services LP.

The MLP in the second quarter completed the first expansion to its South Texas pipeline system, bringing the capacity to 135,000 barrels per day. Management expects to complete the second phase, which will increase the capacity to 200,000 barrels per day, in the second quarter of 2015.

NuStar Energy also more than tripled the capacity of its docks in Corpus Christi, enabling customers to move crude-oil volumes across the Gulf of Mexico to refineries in Louisiana.

This valuable asset also puts the company in pole position to take advantage of potential condensate exports. (See Condensate Conundrum.) In fact, management noted that the firm has started to work on modifications to its pipeline that would segregate minimally processed condensate from other volumes and has invested in building associated storage infrastructure.

We also like the MLP’s agreement with Occidental Petroleum Corp (NYSE: OXY) to reactivate and reverse an idled pipeline that will transport NGLs to the oil and gas company’s propane export facility in Ingleside, Texas. NuStar Energy expects this project to come onstream in the second quarter of 2015.

The anchor shipper has booked about two-thirds of the capacity on this pipeline, with the remainder likely used as part of NuStar Energy’s joint venture with an affiliate of Petróleos Mexicanos (Pemex) that will develop pipelines and storage capacity that will facilitate the flow of US-produced propane and butane from Houston and Corpus Christi into Northern Mexico.

The two partners would jointly fund the construction of these assets, with NuStar Energy overseeing the construction process and the operation of this infrastructure.

Management indicated that this project, tentatively slated to come onstream in 2016, would reduce the cost of transporting these hydrocarbons to Mexico; today, our neighbor to the South receives US propane and butane volumes primarily via seaborne vessels.

NuStar Energy deserves credit for leveraging its existing footprint and expertise to ink one of the first joint-venture agreements between US and Mexican energy companies.

At recent industry conferences, NuStar Energy has provided more color on the organic growth opportunities afforded by its existing asset base, including the potential to loop some of the pipelines in its South Texas system to boost capacity.

Management also reported conversations with customers to move barrels from the Permian Basin through Corpus Christi to avoid the congested Houston Ship Channel. However, a proposed pipeline running from Colorado’s Niobrara Shale to Cushing, Oklahoma, has been crowded out by competitors’ projects.

We like NuStar Energy’s foothold in the Eagle Ford Shale, a high-quality oil-producing basin that benefits from its proximity to the Gulf Coast. The severe downdraft in crude-oil prices, intensifying competition for projects and the MLP’s relatively high cost of equity capital could present a challenge to future growth.

That being said, NuStar Energy’s pipeline segment has minimal direct exposure to commodity prices, and demand for storage should improve with the oil market’s recent reversion to contango, a situation where prices for immediate delivery are lower than those for future delivery.

NuStar GP Holdings LLC, which owns a 2 percent general partner interest in NuStar Energy and 12.9 percent of the MLP’s outstanding common units, sports a distribution yield of about 7.2 percent–easily one of the highest among pure-play general partners.

Buying the general partner gives us exposure to NuStar Energy’s turnaround story–and any premium in a potential takeover.

Plains All American Pipeline LP (NYSE: PAA) is on the hunt for an acquisition after its general partner, Plains GP Holdings LLC (NYSE: PAGP), went public.

And investors shouldn’t overlook the potential for NuStar Energy’s former general partner, Valero Energy Corp (NYSE: VLO), or Valero Energy Partners LP (NYSE: VLP) to get in on the action; the independent refiner remains one of NuStar Energy’s key customers, while Valero Energy Partners boasts one of the lowest costs of equity capital in the MLP space.

And even if a takeover offer never materializes, NuStar Energy has clearly turned the corner in its turnaround story and continues to move closer to resuming distribution growth—a major upside catalyst.

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