Dividend Roulette With Refinery MLPs

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Dividend Roulette With Refinery MLPs

By Martin Hutchinson, Global Markets Analyst

Upstream master limited partnerships (MLPs) have been generally devastated by the decline in oil and gas prices that began in the third quarter of 2014.

Some bankruptcies have occurred, and distributions – the MLP equivalent to corporate dividends and the reason most investors bought these companies – have been slashed.

However, one segment of the energy MLP universe has gone from strength to strength: companies whose principal assets are oil refineries.

These downstream MLPs offer yields well into the double digits, plus all the excitement of a quarterly earnings roller coaster.

While oil prices remain low, they’re an excellent investment – provided you don’t need to sleep at night.

A Refined Opportunity

According to the U.S. Energy Information Administration, U.S. oil refinery capacity has increased 14.8% since 1985, less than half of the 35% population increase during that period.

Although refiners have added capacity and several small refineries have been built recently, the last major U.S. refinery to come on stream was completed in 1977.

Additionally, environmental and legal harassments make it unlikely that refiners will add significant capacity in the near future.

Meanwhile, oil prices are down 50% in the last year, and demand for crude oil and refined products has risen by around 5%, with a further upward trend likely as consumers drive more and also shift to more gas-guzzling vehicles.

On top of all that, three more factors – the United States’ increasing self-sufficiency in crude oil, the lack of refined products available for import, and increasing overseas demand for products refined in the United States and Canada – have all put further pressure on U.S. refineries.

In total, these factors have produced a tightness in U.S. refinery utilization that’s not likely to diminish until or unless oil prices return to $100-per-barrel levels.

Accordingly, margins in the refining business are likely to remain elevated, and capacity utilization is likely to remain close to 100%.

That means refinery MLPs should earn good returns, which they’ll be forced to distribute.

Best of all, the market hasn’t fully adjusted to this new reality, which makes the yields available on refinery MLP stocks truly juicy.

High Risk, High Reward

There are four refinery MLPs, three of which appear attractive for investors.

1. Northern Tier Energy LP (NTI) gives you a truly spectacular current yield of 17.7%, based on the last four quarters of distributions – though that’s not quite covered by earnings over that same period.

However, in the third quarter, Northern Tier earned $1.11 and will go ex-distribution on November 12 on a $1.04 distribution, to be paid on November 25. That’s very satisfactory indeed.

Northern Tier went public only in 2012, and quarterly distributions since then have fluctuated from $0.31 to $1.48 – the classic profile of a refinery MLP. Right now, Northern Tier is selling at 5.1 times book value, with negative tangible net worth, and in the past year its stock price has increased by 5%, adding just a bit extra to that incredible yield.

2. CVR Refining LP (CVRR) is a large refiner in Coffeyville, Kansas, whose shares currently yield 17.8%, based on the last four quarters of distributions. Earnings didn’t quite cover the distribution over that period, though the company did cover in the second quarter.

In the third quarter of 2015, CVR Refining earned $0.94 per share compared with a $1.01 distribution, which has just gone ex-distribution and will be paid on November 16.

Unlike Northern Tier, CVR Refining’s stock price has declined 6% in the past year, though even net of that decline its return is attractive. It also has the additional advantage of a positive net worth, and it trades at 2.1 times book value.

3. Alon USA Partners LP (ALDW), which owns a 73,000 barrel-per-day refinery in Big Spring, Texas, currently yields 16.9%, though its distribution isn’t quite covered by earnings.

Most recently, it announced third-quarter earnings of $0.86 per unit, and it will distribute $0.98 per unit, which goes ex-distribution on November 16 and pays on November 25.

Alon has a positive tangible net worth (barely), sells at an eye-watering 8.3 times book value, and its share price has risen 36% in the last 12 months, nice indeed but suggesting it may drop back a bit.

4. Finally, Calumet Specialty Products Partners LP (CLMT) is the least attractive of the four. Although it has the broadest base of refined petroleum products, this doesn’t seem to lead to much profitability, even when oil prices are weak, as at present.

Indeed, it managed to report a loss in the third quarter, a period when oil prices had sunk to new lows. Its quarterly distribution is $0.685, giving it a yield of 10.3% at current prices. However, that’s not much good to us in the long run, since the company made a loss over the last four quarters.

What’s more, the stock price is down 6% in the last 12 months, negating much of the benefit of the distribution, and it sells at 2.4 times book value, with a negative tangible net worth. I frankly don’t understand why Calumet Specialty’s broader range of products prevents it from being as profitable as its peers, so I’d suggest avoiding it for now.

At the end of the day, these are risky stocks, but I can’t see why the environment shouldn’t continue to favor them for some time.

Plus, the 16% to 18% yields on the first three are not to be missed. They’re like finding $100 bills in the street.

But go small, however tempting they may be.

Good investing,

Martin Hutchinson

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By Martin Hutchinson