Where the Rubber Meets the Road

NustarAs soon as President elect Obama began to float his ideas of economic stimulus by means of public works among other proposals, many savvy investors began to seek out investments that would benefit from such a plan. The details of Mr. Obama’s stimulus measures are still being debated, but there is little doubt that public works and massive infrastructure spending will be one major platform. It was soon after such pronouncements that we wrote a blog on the potential of construction materials firm Vulcan Materials (VMC) in Stock! Are You Out of Your Vulcan Mind? and since that time the stock has vaulted up by more than a third. Vulcan is not alone in its stellar performance of late as many of the so called “Obama infrastructure plays” have enjoyed quite a bit of momentum.

One of my esteemed colleagues here at Ockham called to my attention an interesting NPR report. The story detailed one of the more volatile commodities that is sure to be a major part of the proposed stimuli: asphalt. Most if not all major road upcoming projects will be made of asphalt with the state of New Jersey alone accounting for potentially $300 million worth of “shovel ready” paving projects on tap according to NJDOT. There is a growing concern that a shortage of the petroleum based product is an inevitability.

Obviously, for a petroleum derivative, the price of crude has great influence over the asphalt prices. Asphalt is made from the heavy stuff near the bottom of a barrel of crude, so as crude becomes more valuable, producers make every effort to squeeze as much as possible out of the barrel. However, with the increased demand for asphalt it may be beneficial for producers to put more emphasis on asphalt. Ben Teplitz, an industry analyst says this decision makes financial sense as well:

“The last time I checked, it did not pay to make gasoline, but it paid to make asphalt. The difference was over $13 a barrel.”

Yet, as crude and asphalt prices have declined many producers have shifted away from asphalt. The exception is NuStar Energy (NS) a San Antonio based Limited Partnership, which in March 2008 purchased CITGO’s asphalt refining operations and assets for around $450 million. Mike Pesce Vice President of refining explains the bustling potential for asphalt when these infrastructure projects begin:

“The U.S. overall has a net shortage of around 20,000 barrels a day of asphalt. If these projects come in as we’re seeing them come in, you’re looking at a potential of extra demand in the United States of around 250,000 barrels a day.”

There is no doubt that we see great potential in proposed public works projects from the Obama administration, and NuStar may be one of the very best companies to own. NuStar has experienced some explosive sales growth in the last few years. In 2001, the company was bringing in just a shade under $100 million in revenue. By fiscal 2005, that revenue number had ballooned up to $660 million. Now, in 2009 the company is projecting more than $3 billion in sales. So, it is not surprising that our historical study comparing current price-to-sales of .79x to the historical range of 2.3x to 3.1x, makes the company look extremely undervalued. Similarly, price-to-cash earnings show that the company is undervalued compared to historical norms, but it is less drastic than the revenue metric.

However, a few words of caution are in order, first NuStar has undertaken quite a bit of debt in order to finance this rapid expansion. This is certainly okay as long as the company can continue to grow, but in these times of unsure credit markets it is certainly worthy of mention. Furthermore, the company is banking on the proposed infrastructure spending by the government, but President-elect Obama’s spending appears to be taking quite a bit of heat right now as the federal deficit is said to be staggering for the year ahead. The Congressional Budget Office has said that the federal deficit could amount to 8.3% of GDP, far outpacing the post WWII high of 6.4% during the Reagan Administration. The proposed stimulus of $675-$775 billion could face increased resistance from house members, especially Republicans, if the economic prospects continue to worsen. As Rep. John M. Spratt, Jr (D-S.C.) puts it:

“I keep telling them to defer judgment: Don’t do anything permanent now. Otherwise, how do you get rid of a deficit of this magnitude?”

In addition, to what is becoming an increasingly gray area of government stimulus, NuStar is up 36% in the last 6 weeks. So, it is yet another of the “Obama infrastructure plays” that many were looking to as a great long term buy, but has now appreciated so rapidly that it is tempting to take that return off the table. 36% return is a wonderful return for a 18 or 24 month investment, in this economy it is not wise to let that opportunity slide. After all, by all indications we are in a serious recession which has already lasted 13 months, and many pundits think the worst may be yet to come. While NuStar and others could certainly get a great boost by the many projects that could come on-line in the later half of this year, it seems that investors may be able to pick up these shares after the next downturn at even more attractive valuations.

About Ockham Research 645 Articles

Ockham Research is an independent equity research provider based in Atlanta, Georgia. Security analysis at Ockham Research is based upon the principle known as Ockham's Razor, named for the 14th- century Franciscan friar, William of Ockham. The principle states that a useful theory should utilize as few elements as possible, because efficiency is valuable. In this spirit, our goal is to make the investing environment as simple and understandable as possible, yet no simpler than is necessary.

We utilize this straightforward approach to value over 5500 securities, with key emphasis given to the study of individual securities' price-to-sales, price-to-cash earnings and other historical valuation ranges. Our long term value investing methodology is powered by the teachings of Ben Graham and it has proven to be very adept at identifying stock prices that are out of line with fundamental factors.

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