Published in Seeking Alpha August 15, 2013
Calumet (CLMT $29.68) recently declined 20% from its recent high of $36.6 due to weak earnings and now yields 9.2%. The temporary nature of the factors relating to the miss is the basis for our optimism. The quarterly earnings disappointment is due to several one-time or ephemeral factors. As dividend growth returns to Calumet in future quarters, buyers of this dip will be rewarded with 20% sized annual returns. Our view is supported by the August 8th purchase of 3500 shares by Calumet Board of Director, James S. Carter, at $29.39. More importantly, in spite of the quarter’s negative adjusted distributable cash flow, the company announced its twelfth consecutive quarterly distribution increase– $0.685, a 16.1% increase over last year’s distribution.
The primary reason for the earnings miss was a planned turnaround at its Superior, Wisconsin refinery. This 45 day turnaround led to lost revenues and approximately $30 million in expensed costs. The next one time item was sudden spike in RIN (Renewable Identification Number) expenses from $0.2 million last year to $15 million in the current quarter. RINs are now required under EPA mandate and their prices have risen from as low as two cents a year ago to over $1 per gallon. We believe that this unusual spike will be met with some regulatory relief in the future. A third temporary factor was the $20 collapse in the WTI to Brent, and other related spreads, which negatively impacted margins. The WTI to Brent forward curve points to the spread reverting to the $6-8 range in 2014-16. Two large pipeline fills and a large refinery feed stock shift have temporarily created unusual demand for WTI. Since Calumet had only hedged about one third of its fuel products’ production, the spread contractions adversely impacted operating profits. Fourthly, Calumet’s specialty products segment also saw price weakness which will be relieved as planned price increases take hold.
Most importantly, we expect that Calumet’s significant capital expansion program which should lead to incremental annual EBITDA upon completion in the $200-260 million range. In the next 24 months, $420 million in capital expenditures for the Montana refinery expansion, the North Dakota greenfield refinery, and three other projects, will lead to the creation of additional distributable cash flow and drive higher distribution growth. In 2014 and 2015, the $420 million in capital expenditures will drive an incremental $200 million in annual EBITDA drive higher distributions. The combination of a 9% yield and distribution growth in the teens will lead to 20% total returns for the company over the next three years.
Tesoro Logistics (TLLP, $52.28) recently declined 23% off its recent high of $68.09 on May 29th for two reasons. First was the likely competitive interest in the July 23rd new issue of Phillips 66 Partners, LP (PSXP, $32.74)another high growth logistics company from a top quality general partner with significant assets to push down to its MLP. With the recent concerns surrounding Benanke’s commentary on an expected taper of the Federal Reserve’s $85 billion a month of US Treasuries and mortgages, interest rate sensitive issues like MLPs came under pressure and hurt Tesoro Logistics. The Fed’s anticipated policy shift has led to a sharp rise in the long end of the treasury market with yields rising from 1.6% on the ten year US Treasury to 2.7%. This has clipped prices of all yield vehicles with the longest duration assets experiencing the sharpest declines. High growth low yielding MLPs like Tesoro Logistics are the longest duration assets among MLPs and will decline more than shorter duration MLPs like Chesapeake Granite Wash Trust (CHKR, $14.09), an MLP income trust hybrid, in a rising rate environment.
Tesoro Logistics currently has several large projects in the process of being pushed down to its parent. Tesoro Logistics has long term fee based contracts on most of its assets and does not take title to any hydrocarbons. Consequently, the visibility of its distribution prospects is first rate and comparable to that of pipelines. Tesoro Logistics now yields 3.9% and is expected to grow its distribution by 20%, according to Brian Zarahn, CFA of Barclay’s, and street estimates in the high teens. The combination of the near 4% current distribution yield and the 20% distribution prospects lead us to expect a 20% total returns or more over the next 12 months, depending in part on interest rates.
Over the next few years, we anticipate higher interest rates as the taper is unwound and the global economy improves. When rates rise, MLP performance will likely moderate to single digit performance, or worse. However, history has shown repeatedly that when performance does wane, subsequent years are some of the most powerful on record for MLPs. We feel it is unwise to attempt to time interest rate moves or MLP investments. Alternatively, we advocate picking up the best MLP investments opportunistically so that one has a first rate MLP portfolio when the interest environment becomes bullish. Additionally, anyone investing over $100,000 should buy MLPs directly and avoiding paying the corporate tax at the mutual fund or ETF level as the cash flows you will receive may needlessly pay Federal Taxes that can be deferred for many years, if ever.
The data and information presented is for informational purposes only, and is not offered as a basis for trading in securities. Potential investors should conduct their own independent investigation before making any investment or business decisions with respect to CLMT, TLLP, PSXP, and CHKR or other securities presented on this or our website. The data being presented was obtained from sources believed to be accurate, but Income Growth Advisors, LLC and its affiliates cannot and does not guarantee the accuracy of these sources. Income Growth Advisors, LLC and its affiliates may have positions in CLMT, TLLP, PSXP, and CHKR or other securities presented on this or our website. The data being presented was obtained from sources believed to be accurate, but Income Growth Advisors, LLC and its affiliates cannot and does not guarantee the accuracy of these sources. Income Growth Advisors, LLC and its affiliates may have positions in CLMT, TLLP, PSXP, and CHKR and may trade in and out of CLMT, TLLP, PSXP, and CHKR without informing anyone.