Fighting the Utilities Bear

09/17/2008 12:00 am EST


Roger Conrad

Chief Analyst/Managing Partner, Capitalist Times

Roger Conrad, editor of Utility Forecaster, says bear markets “stress test” utilities, and he finds one he thinks will pass.

Even regulated utilities can take a whacking in a bear market. In fact, the major sector averages have tumbled at least 10% from highs to lows 16 times since World War II. The average drop was a little more than 20% over 14 months, and it was followed by a bottom-to-top recovery of 67.4%.

Declines were far more severe when sector fundamentals were threatened, as was the case in the great 2001-02 collapse. In contrast, declines were relatively mild and short-lived when the selling was based on macroeconomic factors such as rising interest rates.

In retrospect, the current utility bear market began in mid-summer 2007. Thus far, it’s carried sector averages down more than 16%, with most of the damage coming since the first of the year.

Over the past 13 months, companies have faced the triple threat of weakening economic growth, rising raw material costs, and tight credit conditions. As long as the bear market lasts, companies will be continually stress tested. As long as underlying businesses hold up, however, a powerful recovery is inevitable. That doesn’t mean there weren’t nail-biters this quarter, particularly in stocks where expectation of disaster has pushed down prices.

Like all US limited partnerships, NuStar Energy LP (NYSE: NS) units had a rough 13 months. But blockbuster second-quarter results signal better times ahead. The big push came from newly acquired asphalt operations, now 30% of cash flow. Refining margins hit $9.00 a barrel and are expected to jump to $10 to $15 in the third quarter.

Supplies continue to tighten as rivals shift capacity to process heavy oil into light oil products. Meanwhile, 85% is purchased by governments for US roads, more than a third of which are in need of repair. NuStar’s pipeline throughput dipped on conservation due to higher energy prices.

That was offset by tariff increases, and the LP stayed on schedule to complete $400 million in fee-generating energy storage projects by next month, adding $20 million in operating income. Storage is typically contracted out for three to ten years, and management has also identified a next phase of growth.

Second-quarter earnings were hit by a $1.10 per share hedging loss. The good news is that will be recovered when the products are sold. Excluding hedging, second-quarter distributable cash flow covered the payout by a 1.73-to-1 margin, signaling an increase ahead.

NuStar’s plans are aggressive, and the weakness of municipal governments could hit asphalt demand next year. But priced at barely book value, 6.6x distributable cash flow, and yielding nearly 9%, the risk is priced in. Buy NuStar Energy LP. (It closed Tuesday below $46—Editor.)

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