Blueknight Energy Partners, L.P. (BKEP)

[mgland]

Not good. they need to address the uncertainty.....
https://seekingalpha.com/article/4245393-blueknight-common-distribution-elimination-coming

Blueknight: Common Distribution Elimination Coming?
Feb. 28, 2019 4:06 PM ET|
66 comments
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About: Blueknight Energy Partners (BKEP), BKEPP, Includes: AMR, BPL, I, II, III, SEMG
Michael Boyd
Michael Boyd
Long/short equity, contrarian, medium-term horizon, mid-cap
Marketplace
Industrial Insights
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Summary

Blueknight has long been (in my view) a poor play.

Recent news on the termination of the Cimarron Pipeline, as well as structural concerns for Alta Mesa, mean bad news.

The company will owe money for a stranded asset that will never generate money.

Without Cimarron, already relaxed covenants are at risk of violation in 2020. The payout on the common should be cut to zero.

The preferreds are likely covered from asphalt earnings, but the market might still react negatively to 2019 results.

This idea was discussed in more depth with members of my private investing community, Industrial Insights. Start your free trial today »

Wondering why the unit prices of Blueknight Energy Partners (NASDAQ:BKEP) has gotten blown out of the water recently? You might not be alone. News coverage has been pretty bare, and without understanding the asset base and checking SEC filings, one might be left scratching their head. I've been recommending against a position in the firm for quite some time internally within my Marketplace service, holding a Sell rating for more than a year. Given the lack of coverage on the negative drivers on the firm, I wanted to bring a quick update public so that investors can make a rational decision on what is going on here.
Asset Overview, The Major Problem That Hit Blueknight

Established in 2007 in Oklahoma City, Blueknight Energy Partners has had an interesting history. Originally called SemGroup Energy Partners, the company was once part of what is now SemGroup (SEMG) but was itself acquired by Vitol in 2009. That marriage lasted for some time until Ergon bought out the existing general partner ("GP") in 2016, an entity that at the time was owned 50/50 by Charlesbank Capital Partners and Vitol Holdings. Members might recognize the Vitol name; they operate the global VTTI joint venture ("JV") with Buckeye Partners (BPL).

Blueknight Energy Partners is perhaps best known for its asphalt operations. Even after recent sales and rolling back up assets to the general partner ("GP"), the company still operates the largest independently owned asphalt terminal network in the United States. My quibbles with the firm have never been with these assets - it lies with its crude oil operations.

Blueknight operates a crude oil terminalling business at Cushing with 6.6mm barrels of storage. Elsewhere, the company's attempts at operating pipelines, primarily the Oklahoma Pipeline assets and what was the potential eventual dropdown of the Cimarron Express Pipeline ("Cimarron"), have not been major contributors to earnings. However, they have held significant weight for Blueknight in the future. The implicit goal with these pipelines is to drive oil flow into Blueknight-owned Cushing storage tanks, and this vertical integration is necessary to do that. Additionally, the company recently ramped up its marketing business (where it buys crude and sells it) in April of 2018, a move that drew questions from me on whether third party volumes could be maintained.

Cushing has not been the place to be, particularly for storage owners that are reliant on trading volumes and cannot attract E&P customers. The once-great storage hub has been losing its importance as producers focus on gulf export. In my view, it is structurally overbuilt, and utilization had plunged to as low as 25% recently before recovering somewhat. Cimarron was supposed to be a way for Blueknight to combat this. However, I had this to say in September of last year:

Despite Permian bottlenecks and wider differentials, most operators continue to focus on the Permian despite more expensive acreage. Alta Mesa Resources (AMR), the JV partner in Cimarron, is stating that it is bucking this low growth trend. The company is guiding to exit 2018 with 40kboe/d of production, doubling 2017 production. That might be a bit too aggressive; most players in Anadarko have not been doing a great job executing on meeting production targets in recent quarters.

We now have seen this overly aggressive estimates come to pass. Alta Mesa Resources released this statement as part of its Q4 earnings release:

Kingfisher Midstream has made the decision to suspend future investments in Cimarron Express Pipeline, LLC ("Cimarron Express"). The anticipated volumes from the currently dedicated acreage, and the resultant project economics, do not support additional investment in Cimarron Express at this time.

Cimarron is dead in the water, and it likely sends a very negative signal on Anadarko volumes into Cushing elsewhere. But the bad news doesn't stop there. The JV has already spent $30mm on the pipeline project, and without dedicated acreage, the asset is near worthless. Recall that the JV got next to no interest in a prior run open season, and it is unlikely to do so now. This means that money spent to date on construction has essentially been lit on fire. Blueknight stated this in an 8-K filing (no press release):

Ergon has the right to require BKEP to purchase one hundred percent (100%) of the authorized and outstanding member interests of Devco for the Purchase Price (the "Put") at any time beginning the earlier of (I) eighteen (18) months from the formation of the joint venture company to build the pipeline, (II) six (6) months after completion of the pipeline, or (III) the event of dissolution of the Cimarron Express joint venture.

As of December 31, 2018, Cimarron Express had spent approximately $30 million on the pipeline project. Both BKEP and Ergon are currently evaluating the status of the investment in Cimarron Express. To the extent the Put is exercised in the future, BKEP would be responsible for 50% of the total amount spent by the pipeline project plus interest at 9% per annum. BKEP anticipates the principal cost of the Put could be reduced by $4 million to $7 million upon the sale of the assets of the Cimarron Express joint venture, for a total net cost to Blueknight of $8 million to $11 million plus interest.

Long story short, Ergon can dump Cimarron's problems on the MLP. Sound like pocket change? Not really for a company that has a $61mm market cap. That payout represents more than an entire year's worth of distributable cash flow after payments on the preferreds, perhaps worse if there are no takers for stranded pipeline assets with no demand. Additionally, without Cimarron, it seems unlikely that the firm will be able to get their coverage up over 1x, setting the stage for yet another dividend cut in 2019.

In my view, EBITDA will come in at $58mm in 2019, allowing for just $13mm in distributable cash flow ("DCF") to the common stock ($14mm interest, $6mm maintenance, $25mm preferred payouts). The coverage is barely there on a distribution that was cut less than one year ago.

Making matter worse, leverage has to be below 4.75x in a little over one year on the recently amended credit agreement. Assuming they roll $12mm in debt into the credit facility to pay for the put option, leverage will be 4.9x at year end. If lenders balk at yet another relaxation in the covenants, the company will be in dire straits. The smart decision here would be to cut the common distribution to zero and get to work on delevering the balance sheet with every dollar that they can. Sending more assets back upstream to the GP just unwinds operational leverage.
Takeaway

Blueknight is in dire straits. Leverage is too high, and there is now no real path to delevering the balance sheet with free cash flow. It will not grow its way out of its problems. The crude operations have been absolutely dismal and in stark contrast to the asphalt operations, which have seen expanding margins in recent years.

If you own the preferred (BKEPP), I get it. There is coverage even when assuming everything excluding asphalt is junk. Yet I think sentiment there might get dragged down with the negative news likely coming on the common stock. A distribution cut and focus on delevering would be positive for the preferred, but would also emphasize how close the preferred payouts are to being impacted. Those are a toss-up play to me.