Keith Schaefer has come up in questions and discussions here at Stock Gumshoe quite a few times in recent weeks, but this pitch of his that a few folks asked about lends itself to a quick answer — and it’s an interesting space in the markets right now — so I thought we’d get you a speedy answer and something to think about this afternoon.
The email ad I got carried the headline, “The Obvious Trade That The Entire Market Has Missed” … and, well, that’s pretty much irresistible. The market misses lots of stuff, of course, and I do too, but we do so hate to miss out on the obvious.
And, of course, it doesn’t hurt that this one pays a nice, fat dividend. Mmmm, dividends.
The basic premise from Schaefer is that Canadian oil production is about to pick up again, creating even more supply going into the Western Canada/Bakken bottleneck of oversupply and driving down crude prices in that area… and that he has a company that benefits because their input cost is based on Bakken crude oil prices but they can sell their output at prices that are driven by (much more expensive) Brent Crude.
Here’s some of the ad:
“There is a lot of attention on how much additional oil production that Iran might be able to bring back online in the coming year…well, that same 500,000 barrels of oil per day (bopd) increase is coming this quarter–from Canada.
“In fact, we could be talking about a production increase of almost 600,000 bopd….
“This spring, refinery maintenance and wildfires in western Canada choked out roughly 400,000 bopd of production that was heading to the US refinery system. But that’s mostly under control now…..
“That’s the #1 reason why US oil inventories are up in the middle of the summer this year–when they’re normally down.
“Most of this Canadian production flows to US refineries via the Midwest–right beside the Bakken. Canadian and Bakken oil prices will now go back to competing for refinery and pipeline space.
“It’s a race to the bottom for regional oil prices–just like 2012.”
So who benefits? Some clues…
“The wider the Brent and Canadian oil differentials get from Brent, the more money this company makes….
“Over the next three to six months this company’s profits are going to explode….
“It is a sound company that I owned back in 2012 as it made its First Big Run, from $14-$33…
“… this company is already sporting a double digit dividend yield….
“… if I’m right and those Canadian and Bakken differentials really start blowing out–getting BIG–the market will rush into this stock in a hurry.”
So who is it? This is almost certainly Northern Tier Energy (NTI), which Schaefer did indeed like several years ago, in the second half of 2012 when it was booming after a pretty tepid IPO at $14 up to the low-$30s in March of 2013.
Northern Tier is mostly a single-refinery MLP, which means they have considerably more “lumpiness” in their earnings than larger, more diversified refining companies like Marathon or Philips or Valero — but they do benefit from the fact that their one refinery, at St. Paul Park in Minnesota, is connected (by their own short pipeline) to Enbridge pipelines that come in from North Dakota and Alberta.
They report next Tuesday, so the numbers are getting a bit stale at this point, but according to a recent investor presentation their gross margins in the first quarter were better than any other independent refinery — and for all of 2014, they were in third place behind only Tesoro’s (TSO) El Paso refinery and Western Refining’s (WNR) North Dakota refinery. Presumably that’s because of lower crude prices in North Dakota and West Texas helped to improve margins for those two, though I haven’t looked at the details. Past studies have indicated that the price of Brent Crude (the international seaborne price) means more for US gasoline prices than does the price of West Texas Intermediate (WTI — the price that settles in Cushing, OK), so larger WTI/Brent spreads have generally been good for domestic refiners (except for those on the Coasts who might depend on imported crude), but apparently some refiners, including Northern Tier, have been doing even a bit better than that partly due to the luck of geography and the difficulty (and cost) of moving massive amounts of Canadian and Bakken crude down to the Gulf Coast while some pipeline routes can’t take on more capacity.
And this publicly traded partnership (it’s a MLP, not a corporation, so you would have some additional tax reporting and recordkeeping obligations) does indeed have a high yield — though it’s not necessarily a “steady grower” of a yield, it’s highly variable based on their performance in any given quarter. Variable yields are almost always higher (meaning the stock generally trades cheaper than peers, all else being equal), probably because investors have a preference for steady, predictable and growing yields. Over the past eight quarters, the distribution has averaged 66 cents — which would mean a yield of about 10.5% at the current price — but it has moved around a lot, the lowest quarterly payout was 31 cents and the highest was $1.08 during those two years.
Like many refiners, Northern Tier also both operates and franchises a chain of gas station/convenience stores, in their case it’s under the SuperAmerica name and they’re almost all in the Twin Cities metro area — that chain of gas stations consumes about half of the gasoline sold by Northern Tier, so they are to some degree vertically integrated.
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And unlike most refiners, they carry very little debt — it’s not a big company, and they do have some debt, but it looks quite manageable. They also have tended to keep their dividend pretty well covered over the past year or so, which I guess is a benefit of having a variable dividend, if you’re paying out too much you can cut it back a bit without anyone being terribly shocked. They are a a Master Limited Partnership, so it wouldn’t be surprising if they paid out more in cash distributions than they earned in profits (most MLPs do, using non-cash items like depreciation to boost the yield and give investors some tax-deferral through return of equity — distributions paid out in excess of income aren’t taxed, they just reduce your cost basis), but for the last few quarters they’ve been paying out less than 100% of profits. Partly that’s because of capitalized costs for turnarounds and expansion investments, but it’s a fairly promising indicator especially for a MLP that is trying to grow.
Western Refining owns the general partner of NTI, they took control from some private equity investors in late 2013 and also own a large stake in the limited partnership — I’m not sure why they wouldn’t take the whole thing over, but maybe it works out better for them this way.
Refiners in general have been a popular place to be over the past nine months, as folks look for respite from the crashing oil price by investing in the companies who actually benefit from falling oil prices — so most of the big refiners have risen nicely over the past year, while Northern Tier has pretty much been flat (they’ve had a total return of 12% over the past 12 months, but that’s all from the dividend)… though they have done better than fellow refining MLP CVR Refining (CVRR), which should also have a prime location (in Cushing) and is down more than 10%.
And beyond that, you’re on your own — it’s an interesting little company that’s actually being pretty aggressive about sourcing cheaper crude from the Bakken, they’ve got some ambitions of growing either organically or through acquisitions and could probably buy a small refiner pretty easily given their low debt levels, and they have paid out a nice (though unstable) yield over the last couple years. You can see their most recent investor presentation here, but they report next week so numbers could certainly change quickly.
Sound like the kind of investment that would interest you? Let us know what you think with a comment below.
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