BKEP. This NOV 18 article is a good Synopsis.........
Blueknight Energy Partners: This 16% Yielder Loves Contango
Nov. 14, 2018 4:03 PM ET|
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About: Blueknight Energy Partners (BKEP), Includes: AMR, BKEPP
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Richard Lejeune
Richard Lejeune
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Summary
WTI oil is now in contango after being in backwardation for the past year.
Contango oil creates a windfall for BKEP's struggling Cushing oil storage terminals.
The Cimarron Express pipeline project is on schedule and appears to be a winner.
BKEP offers an attractive 16% yield that will be fully covered in 2019.
BKEP is trading near its 52-week low and substantial capital gains are possible.
This idea was discussed in more depth with members of my private investing community, Panick High Yield Report. Start your free trial today »
It has been a rough year for Blueknight Energy Partners (BKEP). The stock has lost over half its value in 2018. The quarterly dividend was slashed from 14.5 cents to 8 cents in July. Even this reduced dividend was only 92% covered in Q3 2018 which is the strongest seasonal quarter for the company's asphalt terminal business.
What went wrong? The asphalt terminal business has continued to perform well, but 2018 has been a disaster for the company's large Cushing oil storage business. From November 2014 to November 2017 WTI Oil was in contango. Storing oil is very profitable when the expected future price is higher than the current price. Traders can easily lock in profits by buying oil, storing it and reselling it at a later date. BKEP's 7.5 million barrels of Cushing storage tanks were fully leased at very attractive rates during this period of contango.
Unfortunately, WTI Oil moved to a period of extreme backwardation starting in November 2017. Traders do not want to store oil if the expected price in six months is lower than the current price. Some large Cushing tank storage leases came up for renewal and could not be renewed. Oil storage and handling fees dropped. Times were tough for BKEP.
Fortunately, WTI Oil has recently moved back to contango. WTI Oil December 2019 futures are now trading about $1.70 higher than WTI Oil December 2018 futures. On the Q3 2018 earnings conference call, BKEP reported that Q3 2018 was the low point in the storage cycle. Their Cushing storage tanks are now expected to be fully leased in 2019. In fact, 2019 should show improved results in several business areas. Despite these improved prospects, BKEP continues to trade at less than 10 cents from its 52-week low. This article provides the top 10 reasons why investors should consider BKEP and also discusses the major risks.
1. The Cushing oil storage business is nearly fully leased
As reported on the Q3 2018 earnings conference call, the Cushing oil terminals are expected to be fully leased in 2019:
"These contracts taken together represent approximately 90% of our total storage capacity available for contracting. We continue to see strong demand and we now anticipate being fully contracted in 2019."
2. The dividend should be fully covered in 2019
The 15.6% dividend is expected to be fully covered in 2019. As management commented on the Q3 earnings conference call:
"Our current projections has impacted by the improving crude oil storage market conditions that Mark discussed indicate we will steadily delever over the course of the next year. We are targeting to be at or near four times leverage at the end of 2019, as well as to increase our distribution coverage back to above 1.0 times."
3. Balance sheet leverage is declining
Balance sheet leverage is now 5.39X which is perilously close to the maximum allowed limit of 5.5X permitted under the Wells Fargo Credit line. Fortunately, balance sheet leverage is expected to decline to 4X by the end of 2019. This will result from improved performance of the pipeline sector, oil terminal sector and trucking sector. Note that those numbers do not include the impact from the expected Cimarron Express pipeline purchase in Q3 2019.
4. The oil pipeline segment is rebounding
The oil pipeline segment is ramping up due to higher regional oil production and the July restoration of service on a pipeline that had been out of service for several months due to a landslide. As commented on the Q3 earnings conference call:
"Our total November pipeline volumes are expected to be 38,000 barrels per day more than double our volumes at the end of the second quarter. Our crude oil pipeline services segment was cash flow positive in September for the first time in over a year."
5. Asphalt terminals continue to perform well
The asphalt terminating services business generated $17.6 million of operating margin in Q3 2018. This was consistent with expectations. Operating margins for Q3 2017 did decline from $20.5 million in Q3 2017. This decline was due to the sale of three asphalt terminals to Ergon for $90 million to help finance the Cimarron Express purchase in 2019. Note that lower oil prices tend to increase the demand for asphalt. The recent drop in WTI oil pricing is not enough to substantially reduce pipeline volumes and should have a positive impact on the asphalt terminal business.
6. Results are improving at the trucking sector
The trucking sector also should provide improved margins in Q4 and 2019. As noted in the Q3 2018 earnings report:
"The high level of drilling activity in Oklahoma has also led to an increased demand for crude oil trucking services, and volumes increased steadily this year. We are confident the tighter supply and increased demand for trucking services will lead to improved margins in the fourth quarter of this year and in 2019. We expect our crude oil trucking services segment to return to positive cash flow during this period."
7. The Cimarron Express pipeline construction is on track
The Cimarron Express pipeline project is proceeding well. This will connect the STACK play in Oklahoma to BKEP's Cushing oil terminals located about 65 miles away. BKEP is building the pipeline which will initially be 50% owned by Alta Mesa Resurces Inc. (AMR) and Ergon (BKEP's General Partner). BKEP has an option to acquire Ergon's 50% share based on construction costs plus a 9% financing fee. Cimarron Express is expected to be completed in mid 2019. I anticipate that BKEP will exercise its purchase option in Q3 2019.
8. Cimarron Express is expected to be a high return project
Many midstream projects require an eight-year to 10-year payback period. As Chief Executive Officer Mark Hurley notes on the Q3 conference call in response to a question from JPMorgan analyst Josh Golenn:
"Yeah Josh. It is - it's got a payback period of about somewhere between 5 and 6 years."
9. Cimarron Express will make Cushing oil storage less cyclical
BKEP will benefit from the pipeline even in the unlikely event that it decides not to exercise its purchase option. The pipeline will terminate at BKEP's Cushing oil terminals and generate additional revenues there.
10. Small pipeline projects have big advantages
The continuing struggles of the Keytsone XL pipeline illustrate why investors should focus on smaller pipeline projects such as Cimarron Express. Keystone has been a high profile target for environmentalists. It has been delayed for years and will stretch for thousands of miles if construction is ever completed. It requires approval by multiple states as well as the Federal government. Sacred Indian lands and extensive environmental studies have been ongoing issues.
In contrast, the Cimarron Express pipeline faces none of those challenges. It will be a short 65-mile pipeline entirely located in the oil industry friendly state of Oklahoma. There are no environmental lawsuits. There's no need to cross sacred Indian lands. The project is proceeding rapidly and is on budget with an expected completion in mid 2019. There's already substantial dedicated production from AMR to help fill the pipeline and production in the STACK area is increasing.
What are the major risks?
See pages 15-37 of the 10-K annual report for an extensive discussion of risk factors. Here is a brief summary of the major risk factors as I see them. BKEP is smaller and less diversified than many of its larger midstream peers. With a market capitalization of less than $100 million, even modest changes in cash flow can have a large impact on the stock price. BKEP is a partnership and holders will receive a K-1. The asphalt terminal business is the largest business unit for BKEP and has been thriving. The economy is currently booming. However, an economic recession could reduce tax receipts for the municipalities that fund much road paving work.
BKEP has sold assets and has received a more flexible credit line agreement from Wells Fargo & Co. (WFC) to help fund their Cimarron Express purchase option from Ergon. The BKEP purchase option is based on Ergon's costs plus 9% interest compounded annually. The pipeline is currently on budget but the exact cost won't be known until construction is actually completed. Cost over-runs and project delays are possible. WTI Oil has declined recently to trade below $60. The STACK is a low-cost drilling area and this decline is not expected to have a major impact on oil production. If oil were to decline further to $30 or $40 per barrel, that could have a material negative impact on pipeline volumes.
Conclusions
BKEP is trading near its 52-week low and offers a very attractive 16% yield. Mr. Market appears to have totally ignored the pending turnaround in the oil storage business due to contango. Results also are improving for BKEP's pipeline and trucking sectors. The asphalt sector continues to perform well and the Cimarron Express pipeline is an exciting growth project for Q3 2019. BKEP is oversold and offers the potential for significant capital gains. The 16% yield should be fully covered in 2019 and it's nice to collect this hefty yield while waiting for the turn around to progress.
I also previously written about the BlueKnight Energy Partners LP LLC Pfd Units Series A (BKEPP). BKEPP offers an attractive 11.2% yield and is senior to the common stock which makes it a less risky alternative. I cover both BKEP and BKEPP at my Panick High-Yield Report.
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