Northern Tier Energy LP (NYSE:NTI)
Investment Synopsis:
The small number –three– of refinery MLPs provide a unique way to invest in the downstream portion of the energy sector. These three partnerships all operate with full cash flow payout through their variable distribution policies. Profits for a refiner can be highly variable, with both input costs and product prices set in the open market. Refining continues to be highly profitable in the current low crude price environment, but this can and mostly likely will fluctuate in the future. As a longer term position, Northern Tier Energy is the most attractive of the three refining MLPs.
IPO Date: July 26, 2012
- Market Cap: $2.25 billion
- Annual adjusted EBITDA: $431 million (TTM through Q2 2015)
- GP/Sponsor: Western Refining Inc. (NYSE:WNR)
Distribution Facts
- Current yield: 17.9% – variable
- TTM distributions/unit: $3.76
- Historic quarterly distribution/unit range: $0.31 – $1.48
Business Operations
Northern Tier’s refining business consists of a 97,800 barrels per day refinery located in St. Paul Park, Minnesota. The refinery’s complexity allows it to process a variety of light, heavy, sweet and sour crudes into refined products. The St. Paul Park refinery is one of only two in Minnesota and one of four in the upper Great Plains region. The refinery has access to heavy Canadian crude through direct connection with the Minnesota Pipeline (NTI owns a 17% interest in the pipeline) and Northern Tier operates its own fleet of tanker trucks to source North Dakota crude directly from the Bakken production area. The refinery has the flexibility to run the most cost advantaged mix of heavy Canadian and light sweet North Dakota crude. The refinery produces a broad slate of refined products including gasoline, diesel, jet fuel and asphalt. About 85% of the output is higher value light refined products such as gasoline and distillates (diesel and jet fuel).
Northern Tier also owns a retail business of 165 convenience stores under the SuperAmerica brand and supports 89 franchised SuperAmerica stores. The SuperAmerica chain retails about 60% of the gasoline and diesel produced by the refinery. The partnership also has a contract with Marathon to supply almost all of the gasoline and diesel requirements for the independently-owned and operated Marathon branded convenience stores in the refinery’s distribution area.
Since its IPO, Northern Tier has been active in upgrading and adding to the St. Paul Park refinery capacity. At the time of the July 2012 IPO, the refinery had an 80,000 bpd capacity. The throughput capacity has been upgraded by almost 20% and individual components have been upgraded to give Northern Tier more flexibility to select the most cost effective crude oil sources. In November 2013, Western Refining, Inc. (NYSE: WNR) acquired the general partner interest and 39% of the NTI LP units. The Northern Tier partnership agreement does not have IDR payments to the general partner.
Growth Prospects
Refinery profits are primarily dependent on the difference between the cost of crude oil and the realized prices for refined products, primarily gasoline and distillates. A crack spread calculates the profit per barrel of oil using published market prices for crude and fuels. For example, I track a 3-2-1 crack spread using the NYMEX spot prices for WTI crude and New York Harbor unleaded gas and ultra low sulphur diesel fuel. With the 3-2-1, the spread is the difference between two barrels of gasoline plus one barrel of diesel fuel minus three barrels of crude oil. Refiners use different crack spread benchmarks based on their regional prices. Northern Tier uses a couple of Group 3 Benchmark Crack Spreads, 3-2-1 and 6-3-2-1 (the extra 1 is heating fuel or kerosene) as its benchmarks.
Gross margin per barrel is the gross profit margin actually realized by a refiner. Out of the gross margin, we subtract refinery operation expenses and G&A expenses to get EBITDA.The gross margin generated by Northern Tier has consistently matched or exceeded its benchmark crack spreads. NTI has also generated higher margins than the other two refining MLPs. In a recent four quarter period, NTI reported an average margin of $18.38 per barrel compared to $13.36 from CVR Refining LP (NYSE:CVRR) and $16.49 reported by Alon USA Partners (NYSE:ALDW). Direct operating expenses for Northern Tier have ranged from $4.20 to $4.80 per barrel. The high gross margins generated by Northern Tier have allowed the company to pay very attractive quarterly distributions.
Northern Tier’s combination of price-advantaged crude sourcing and a relatively closed off selling market should allow the company to be more profitable than most refining companies. This means, that while distributions will vary from quarter to quarter, NTI can remain profitable even if the average margins across the refining sector squeeze down to breakeven, or even go negative. The current low crude price environment is very profitable for refiners. Lower energy prices boost demand for fuels, so gasoline and other fuels prices have not dropped as much as the decline in crude oil.
Northern Tier has been more aggressive than its peers on capital spending to increase its throughput capacity and efficiency. Planned upgrades will add another 4,000 bpd of capacity and increase the operating margin. These capex spending plans are forecast to produce upward of 50% annual returns on the capital spent. NTI’s relationship with Western Refining also has the potential to pay future benefits to investors. Western owns and operates two refineries in Texas and New Mexico. WNR also controls Western Refining Logistics LP (NYSE:WNRL), a two year old moderate to fast growth midstream MLP. The management teams of the three companies continue to evaluate asset sales between the different entities that would boost returns for investors. For example, NTI could raise capital to invest in the refinery by selling its Minnesota Pipeline stake to WNRL. I expect Northern Tier to continue to find ways to grow both refining margins and total refining capacity.
The primary risk for investors in NTI are unfavorable energy prices in the form of expensive crude oil balanced against market fuels prices that do not allow a refinery to run profitably. Also, with the variable distribution policy, quarterly payouts can fluctuate significantly as well as unit prices based on the changing distributions. Historically, NTI has traded between $19 and over $31 per unit. The current $24 is in the middle of the range, and is actually quite low compared to recent distribution amounts. The 2015 third quarter is on track to produce what may be record distributable cash flow for NTI. After that, we are out of the summer driving season so it is not possible to give an accurate cash flow forecast for Q4 and later.
Recommendation: Buy NTI below $25 per unit and plan to accumulate more units if the price drops further into the low $20’s. This is an investment that will do best if units are accumulated over time, taking advantage of low prices when spreads narrow and collecting big distributions when times are good.