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NuStar Energy Upgraded to Neutral

NS VLO

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We have upgraded our recommendation on NuStar Energy L.P. (NS - Analyst Report) – owner/operator of crude oil and refined products pipelines and storage facilities – to Neutral from Underperform, reflecting a balanced risk/reward profile.

San Antonio, Texas-based NuStar – which was spun off from the U.S. refiner Valero Energy Corp. (VLO - Analyst Report) in 2006 – engages in the transportation and storage of crude oil as well as refined products in the U.S., the Netherlands Antilles, Canada, Mexico, and the U.K. The partnership is one of the largest asphalt refiners and marketers in the U.S. and the second largest independent liquids terminal operator in the nation.

We like NuStar for its diversified asset base and robust distribution-growth prospects. A strong pipeline of organic growth projects and contribution from acquisitions provide the partnership with an above peer-group average distribution coverage ratio.

NuStar has a track record for consistent distribution growth – its current quarterly distribution of $1.095 per unit ($4.38 per unit annualized) is up approximately 120% over its distribution rate of $0.5011 per unit ($2.00 per unit annualized) at the time of its IPO in 2001.

Furthermore, the majority of NuStar’s business is derived from an attractive set of fee-based storage and transportation assets that support the U.S. and international energy infrastructure.

Over the last few years, the partnership has consolidated its business through a combination of organic efforts and accretive acquisitions. We also welcome NuStar’s announcement to sell a 50% stake in its volatile asphalt operations.

However, we believe these positives are already reflected in its current valuation, so there is not much upside from the current price level.

NuStar recently reported grim second-quarter 2012 results, with earnings per unit (EPU) of 6 cents that came significantly lower than the Zacks Consensus Estimate of 52 cents. Comparing year over year, reported result declined heavily from the adjusted profit of $1.34. The underperformance was mainly on account of losses in its asphalt and fuel marketing segment (which contribute roughly half of total profits).

We also remain concerned about NuStar’s high debt levels, which leave the partnership vulnerable to an extended downturn. As of June 30, 2012, NuStar had debt (including current portion) of more than $2.6 billion, representing a debt-to-capitalization ratio of 52.0%.

Given these concerns, we see NuStar units performing in line with the broader market. Our new long-term Neutral recommendation is supported by a Zacks #3 Rank (short-term Hold rating).

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