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On Jul 12, 2013, we downgraded San Antonio-based publicly traded partnership NuStar Energy L.P. (NS - Analyst Report) to Underperform from Neutral. Our new investment thesis is supported by a Zacks Rank #5 (Strong Sell).

Why the Downgrade?

Though we welcome the partnership’s 50% stake sale in its volatile asphalt operations, NuStar’s high debt levels and exposure to volatile commodity prices will be a drag on its near to medium term outlook. We are also concerned by the inherent seasonality of the road construction business.

Detailed Analysis

NuStar’s exposure to asphalt business exposes it to volatility in commodity prices. Coupled with the inherent seasonality of the road construction business, this increases the partnership’s risk profile. As such, NuStar – that was spun off from the U.S. refiner Valero Energy Corp. (VLO - Analyst Report) in 2006 – is not a pristine midstream master limited partnership (MLP) focused entirely on fee-based and relatively low risk infrastructure assets.

Over the last few years, NuStar has consolidated its business through a combination of organic efforts and accretive acquisitions. We believe the higher operating expenses associated with this expanded asset base may lead to reduced returns going forward.

A key risk to our recommendation remains the outlook for petroleum products expenditure. We expect lower customer spending on fuels such as gasoline, aviation fuel and diesel (on the back of commodity-price and credit market weakness), which would lead to less transportation volumes for pipeline operators.

Finally, we remain concerned about NuStar’s high debt levels, which leave the partnership vulnerable to an extended downturn. As of Mar 31, 2013, NuStar had debt (including current portion) of $2.4 billion, representing a debt-to-capitalization ratio of around 49%.

Stocks That Warrant a Look

While we expect NuStar to perform below its peers and industry levels in the coming months and see little reason for investors to own the stock, one can look at Delek Logistics Partners L.P. (DKL - Snapshot Report) and Rose Rock Midstream L.P. (RRMS - Snapshot Report) as good buying opportunities. These energy pipeline partnerships – sporting a Zacks Rank #1 (Strong Buy) – have solid secular growth stories with potential to rise significantly from current levels.
 

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