TEXT-S&P cuts NuStar Energy rating to 'BB+'
Overview -- U.S. midstream energy company NuStar Energy L.P.'s credit profile has weakened due to continued poor results in the asphalt-refining business and a trading loss in the fuels-marketing segment. As a result, financial leverage will be significantly higher than our previous estimates, requiring NuStar to obtain an amendment to its debt to EBITDA covenant for the second and third quarters of 2012. -- NuStar also announced that it has entered into an agreement with an affiliate of Lindsay Goldberg LLC to sell a 50% interest in its asphalt-refining assets for $175 million in cash plus working capital. -- We are lowering the ratings on NuStar and its operating subsidiaries to 'BB+' from 'BBB-'. The outlook is stable. -- The stable outlook reflects our view that the partnership will likely reduce leverage, have sufficient liquidity, and focus on expanding its core transportation and storage segments during the next 12 to 18 months. Rating Action On July 6, 2012, Standard & Poor's Ratings Services lowered its ratings on San Antonio-based midstream energy company NuStar Energy Partners L.P., including the corporate credit rating, to 'BB+' from 'BBB-' and revised the outlook to stable. Our issue-level rating on NuStar's senior unsecured notes is 'BB+' (the same as the corporate credit rating). We are assigning a recovery rating of '3', which indicates our expectation for average (50% to 70%) recovery if a payment default occurs. Rationale The downgrade reflects that NuStar's financial risk profile will be considerably weaker than we previously expected due to losses in its asphalt-refining and fuels-marketing segments, which requires covenant relief in the second and third quarters of 2012. NuStar's financial performance for the quarter ended June 30, 2012 will be very weak, hurt by poor results in the asphalt refining business and a trading loss. The partnership's asphalt operations will generate negative EBITDA and the fuels-marketing segment will generate a loss because the partnership did not hedge its heavy fuel oil and bunker fuel inventories for about two months even as commodity prices sharply declined. Consequently, NuStar was going to breach its debt to EBITDA covenant of 5.5x as of June 30, 2012 and 5x as of Sept. 30, 2012 were it not for an amendment to its credit facility by its lenders. NuStar's decision not to hedge its inventory when it historically used hedges in the past raises concerns about NuStar's financial policies, and, together with the potential breach of financial covenants, is inconsistent with an investment-grade credit profile, in our opinion. NuStar indicates that its entire fuel oil inventory is fully hedged as of May 25, 2012 and the partnership intends to remain fully hedged in the future. We view NuStar's announcement that it plans to form a joint venture with an affiliate of private equity firm Lindsay Goldberg (not rated) to own and operate NuStar's asphalt refining assets as a positive step in improving NuStar's overall credit profile, because it should reduce future cash flow volatility and the need for large working capital investment. We believe that the partnership can also use expected cash proceeds of $400 million to $500 million to reduce debt or help fund capital spending. However, this view is tempered by the fact that NuStar will still have significant ties and obligations to the joint venture. NuStar will provide an unsecured, seven-year, $250 million credit facility to fund working capital as well as offer initial guarantees and credit support of up to $150 million. We also expect NuStar to continue to be the counterparty to the supply contract with Petroleos de Venezuela S.A. (PDVSA), which supplies the bulk of crude oil to NuStar's asphalt refineries. We are revising NuStar's financial risk profile to "aggressive" from "significant" due to our expectations for higher leverage in 2012 and 2013 compared with our previous expectations. Under our base-case forecast, we assume that NuStar receives no EBITDA from the asphalt segment in 2012 and minimal distributions in 2013 while providing working capital support to the new joint venture of $100 million to $150 million (depending on commodity prices). We have also reduced our 2012 EBITDA assumption in the fuels-marketing segment to about $35 million from our previous forecast of between $50 million and $60 million, and continue to view the San Antonio refinery as break-even in 2012. Our EBITDA projection for the transportation and storage segments will be about $40 million to $50 million higher in 2012 due to the completion of organic projects such as NuStar's St. James terminal expansion and various crude transportation projects in the Eagle Ford crude and gas-gathering area. We assume total 2012 EBITDA will be about $460 million and total debt to EBITDA will be about 5.5x compared with our previous estimates of 5x. For 2013, we forecast total debt to EBITDA to be in the high 4x area, above our previous forecast of about 4.5x. Due to NuStar's weak operating performance, we expect distribution coverage to be below 1x in 2012. In our view, coverage could remain weak through 2013, given the cash flow lag related to many of the growth projects in the partnership's transportation and storage segments. The partnership's core transportation and storage segments continue to generate the bulk of overall cash flow (about 80%). These largely fee-based businesses generate stable cash flow and support our business risk assessment of "satisfactory" under our criteria. At the same time, the large growth projects in these segments will keep the balance sheet somewhat stretched through 2013, in our view. Liquidity We consider NuStar's liquidity "adequate" under our liquidity criteria. We project that sources divided by uses will be about 1.2x during the next 12 months. Our assumptions for the partnership's sources of cash include about $350 million of funds from operations, $450 million of net proceeds pro forma for the asphalt joint venture, and about $700 million of unused capacity available under its $1.5 billion bank facility that matures in May 2017. Key uses include about $475 million of capital expenditures (related to maintenance and growth), $134 million of long-term debt maturities, and distributions of about $360 million. A key assumption in our liquidity analysis is that we would expect NuStar to scale down its capital spending if sources of liquidity became constrained. On June 29, 2012, NuStar obtained a covenant waiver from its bank group and revised its maximum debt to EBITDA covenant to 6.5x and 6x for the second and third quarters of 2012, respectively (5.5x and 5x previously). Based on these revised covenant levels, we believe the leverage covenant will continue to limit the amount NuStar can currently borrow under its $1.5 billion revolving credit facility. As of March 31, 2012, the partnership's credit facility had a maximum debt to EBITDA covenant of 5x, compared with NuStar's ratio of 4.6x. Recovery analysis See our recovery report on Nustar Energy L.P. to be published following this report on RatingsDirect. Outlook The outlook on NuStar is stable, and reflects our view that the partnership will reduce debt to EBITDA to about 4.75x by 2013 from more than 5x in 2012 and have sufficient liquidity to fund its growth initiatives during the next 12 to 18 months. We could lower the rating if NuStar exhibits a more aggressive financial strategy in managing its businesses, such that there is a renewed focus on segments with a higher degree of business risk and more volatile cash flows, or if NuStar cannot reduce leverage below 5x. A higher rating, currently not under consideration, is possible over time if we see management embrace more conservative financial policies and demonstrate that it can consistently maintain leverage in the low-4x area. Related Criteria And Research -- Key Credit Factors: Criteria For Rating The Global Midstream Energy Industry, April 18, 2012 -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 Ratings List Ratings Lowered To From NuStar Energy L.P. Corporate Credit Rating BB+/Stable/-- BBB-/Negative/-- Senior Unsecured BB+ BBB- New Rating Recovery Rating 3