Is Northern Tier A Pipeline to Profits?
The largest business by far (over 90% of revenue) is refining. The company owns and operates the St. Paul Park Refinery in St. Paul, Minnesota. With a capacity of 74,000 bpd, it is considered a "mid-size" refinery.
The second business is equity ownership in two pipelines. NTI has a 17% interest in the Minnesota Pipeline, a 455,000 bpd system that transports crude from Western Canada and North Dakota to a hub in Clearbrook, Minnesota, and then to the St. Paul Park Refinery. Historically, a vast majority of Northern's crude has come via this pipeline. In June, NTI also announced that they had entered a second agreement to take an equity interest in the High Prarie Pipeline, a 150,000 bpd system to transport crude from McKenzie County, North Dakota (the heart of the Bakken Shale drilling operations) to the hub in Clearbrook. However, Enbridge (ENB), who runs the Clearbrook terminal, refused connection and the status of the project is unclear.
The third and final business is retail. Northern Tier owns and operates 166 SuperAmerica convenience stores in Minnesota/Wisconsin/South Dakota, and franchises an additional 67. These are your typical gas station / convenience store setups, selling snacks, tobacco products, drinks, etc.
Northern Tier is best analyzed as being a refiner. MagicDiligence has already gone in-depth on the fortuitous conditions for midwestern refineries, and those interested in learning more should check that article out, as the same applies for Northern Tier. In a nutshell, WTI crude produced from U.S. fields has been far cheaper than Brent crude from overseas, but gasoline prices have been relatively stable, leading to far greater profitability for midwestern U.S. refineries over the past year or so. How long those conditions last is anyone's guess, but at some point it is likely that the Brent-WTI spread will shrink to more historical levels.
Northern Tier is a recent IPO, going public at the end of July at $14. Only 17.7% of the company was floated to the public - the rest is owned by private equity firms ACON and TPG. It's important to note also that this is a limited partnership (LP) - it exists primarily to make cash distributions to the unit-holders. Quarterly (dividend) distributions are paid out based on free cash flow for the quarter, and NTI has no plans to "smooth" them out - the amount of payout each quarter will fluctuate. Based on published projections by the company, the estimation for the next 12 months is for about $2.34/unit in distributions, or roughly an 11% yield. However, their first distribution came in at $1.48/unit, far above the projection of $1.01. So there is certainly significant upside in those projections.
There is a lot to like about Northern Tier. The location is hugely advantageous. There is only one other refinery in Minnesota, it has a direct pipeline, and is geographically close to both Western Canada and the Bakken Shale, two areas enjoying massive crude production increases over the past several years. These location advantages and the pipeline assets have led to cheap transport costs, as NTI purchases its crude at an average of $1.56/barrel lower than the NYMEX price. And, despite actions to shrink it, the WTI-Brent spread still stands at one of its highest levels ever!
The retail strategy also fits well. A vast majority (83%) of refined products were sold directly to the SuperAmerica chain and 90 Marathon-branded stores. This helps protect the business against unpredictable fluctuations in the wholesale market. All-in-all, it is a well-thought out business model.
Still, refining is such a tough business to predict. Historical operating margins are in the low single-digit percentage range. Northern's recent levels are an unsustainable 19%. Even though I think the firm's advantages give it a better base profitability level than competitors, I don't see anything above 5% as sustainable over the long term. My price target on the stock is about $27. NTI might be a decent choice for income investors to grab a few nice payouts, but I would look elsewhere for my next MFI pick.
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