Inflation is no doubt upon us and with that I continue to push towards companies that I believe will be a hedge for my portfolio. If you read my article, Finding Value In 2022: Inflation, Interest Rates, And Research, you will see that one of the highest returning historical sectors during this time is Energy. One of the companies that I noted in that article (Jan. 20th, 2022) was PBF Logistics LP (NYSE:PBFX). This was a company that I labeled a top pick to continue further research on and soon after my breakdown I began to purchase it. This was when the stock sat around $12 per share. Now it sits right around $15 and yet I’m still buying, but why?
PBF Logistics LP, headquartered in Parsippany, New Jersey, is a fee-based, growth-oriented master limited partnership formed by PBF Energy to own or lease, operate, develop and acquire crude oil and refined petroleum products, terminals, pipelines, storage facilities and similar logistics assets. — Taken from PBF Logistics’ website
Fairly simple explanation about the company, one that anyone familiar with an LP will understand. One additional note is that they operate in two segments when reporting revenue: Transportation & Terminaling, and Storage.
For those unfamiliar with moat, it is the ability for a company to maintain their competitive advantage and fend off competition. This is just like the protection of the medieval moats that were found around castles. I primarily like the description and categories of moat found here by Phil Town of Rule 1 Investing. I won’t go into each one here, so I encourage you to read about them if you are unfamiliar.
So what moat does PBFX have?
Just like any LP, PBFX also enjoys a Toll Bridge moat, where most of the crude oil or refined petroleum in the US held by PBF Energy (PBF), the parent company, goes through the transportation of PBFX. For those interested in PBF (you always should be when researching an LP) here’s a quick description from their website about the company:
PBF Energy (“PBF”) is one of the largest independent petroleum refiners and suppliers of unbranded transportation fuels, heating oil, petrochemical feedstocks, lubricants and other petroleum products in the United States. — Taken from PBF Energy website
Increasing Distributable Cash Flow. Of course one of the most important things when you are looking at an LP is the amount of distributable cash flow that they produce and what are the underlying growth metrics. From 2019 through 2021 PBFX has increased their distributable cash flow from $137 million to $195 million, just over a 40% increase! This is also while many companies in the energy sector were getting run over by the pandemic and just looking to survive.
When you take a look deeper into the cash flow metrics within PBFX you will find that free cash flow per share has been increasing since 2019, although both levered and unlevered free cash flow did take a step back in 2021. The good news I see here though, is that after increasing net debt in 2018 and 2019, PBFX has tightened up the ratio between its levered and unlevered cash flow.
Reduction in Debt. There are obvious things that get into the way of providing investors returns in the form of cash flow, and one of these is the interest that is paid on outstanding debt. While I am not trying to say that companies need to be debt-free, I do like to see companies that continue to work to use excess cash to reduce the debt and therefore allow themselves to use cash flow on other things such as growth within the company or growing the cash distribution per unit, or CDPU. This is part of the reason that I really like PBFX. They reduced the CDPU in 2020 to a place that is sustainable and allows them to focus on debt reduction.
As you can see, PBFX has been diligent about reducing the debt and from 2019 to the latest report (4/28/22) have decreased Total Debt from $802 million to $598 million. During that same time, interest payments have decreased from $48.3 million for FY 2019 to $41.5 million in the TTM.
CDPU Yield. If you are with me that the CDPU is sustainable then you will also agree that the current yield of just over 8% is a solid return in a market that may be stagnant as we see rising inflation and rising interest rates. As mentioned above, PBFX recently moved from a CDPU of over $2 in 2019 to a more sustainable $1.20. This places the payout ratio of PBFX at around 50%. While some investors looked at the adjustment as a negative, I see it as a positive as it allows for the additional cash flow to be used to reinforce the strength of the underlying business.
Decreasing YoY Revenue & Gross Profit. As investors that are purchasing shares of an LP there is one thing that should be in mind, increasing cash flow so that our units can make us more money. After watching the revenue and gross profit increase each year from 2015 to 2020, 2021 saw a decrease in both of these metrics, albeit minimal. Even with all this though, a decrease in depreciation and amortization led to a small increase in operating income. In the recent Q1 conference call the PBF Director, Matthew Lucey, said this about the expected full year 2022 revenues:
Thanks, Colin. PBF Logistics operated well in the first quarter. Our operations continue to be driven by the reliability of our assets, and our safety-oriented workforce. In addition to our strong relationship with our sponsor and high percentage of contracted volumes, these are the foundations that provide for our consistent financial performance. We expect partnership full year 2022 revenue to be approximately $320 million to $340 million.
As mentioned on previous calls, the 2022 partnership revenues reflect the lower minimum volume commitments for the East Coast rail facilities, which took effect as of January 1. Revenues in this range are expected to generate EBITDA of approximately $200 million to $210 million. The partnership’s consistent revenues and cash generation provide strong distribution coverage and the ability to continue reducing our net debt. We remain focused on our balance sheet.
— from the PBFX Q1 Earnings Transcript (link here)
While it is encouraging to see a strong partnership with solid contracted minimum, it is important to note that the 2022 revenues are projected to slightly decrease as the new minimum volumes of the East Coast railway take effect.
This is not a reason to panic, but instead a reason to set realistic expectations about when we may see CDPU increases.
Projected Increase in 2022 Cap Ex. Another potential negative when talking about cash flow heading to the unit holders is the amount of capital expenditures that are expected to occur in 2022.
Erik Young, PBF Energy CFO, said this in the 2021 Q4 call:
During the fourth quarter, we spent roughly $1.7 million in total CapEx, including approximately $1.1 million for maintenance. In 2021, total capital expenditures were approximately $8.6 million. For 2022, we currently expect capital expenditures to be approximately $14 million, including $12 million for maintenance and $2 million of regulatory spend. — from the Q4 Earnings transcript (link here)
While an increase of $5.4 million is not seemingly large when we are talking about distributable cash flows of almost $200 million, it still cuts into the amount of cash that can either be paid to unit holders or used to reduce debt. It, like the revenue point, is not a huge negative but instead one to keep in mind while setting expectations.
Debt Maturity. One thing to watch as 2022 plays out for PBFX is the long term debt refinancing. Their current long term debt are actually 2023 notes (shown below).
Refinancing these notes are obviously the most important thing that gets done this year. These notes need a successful refinancing and, while I have no concerns of it getting completed, it will be an interesting watch to see the rate and timeline at which they complete the move, as the current rate sits at 6.875%.
In Q4 of 2021, Erik Young said this:
Consistent with our commentary on the PBF Energy earnings call this morning, our near-term finance efforts are focused on a successful refinancing and long-term credit extension of the revolver and unsecured notes due in 2023. — from the Q4 2021 Earnings Transcript (link here)
Another con that I do not see as a massive limiter of producing returns, but again, is something that should be on the minds of investors.
Now I have my own method of valuing companies, much like those that write these articles. Valuations, no matter how you do them, always take a certain amount of speculation, whether it is organic growth, acquisitions, future debt refinancing, changes to the landscape of the industry, effects of inflation, etc.
When performing estimates of a company’s value like PBFX, I like to look at them in through two different lenses. These lenses include:
- Cash flow per share Valuation with CDPU (5 years)
- Free Cash Flow Valuation (8 years)
Let’s begin with the Cash flow per share valuation. This equation I like to use because it not only looks at the FCF production but also how the market typically values companies in the particular industry. I also use this as my Margin of Safety valuation, due to my fair price you will see at the end.
Looking at the historical values of the Price to Cash Flow of PBFX it is a bit all over the place and the five-year historical average actually comes out to around 12. This seems a bit high to me, and according to gurufocus.com the median for the company is just over 10. This also is where the industry median sits, so I will place it there for the calculations. I also will use a growth rate of 7% which is fairly conservative considering the current environment.
Here is what the calculations looks like:
While this is an overly simplistic way of looking at a company’s valuation, it is one that I have consistently used, and one that has treated me well. As you can see, the fair price (not the price I would purchase PBFX at) sits just above $21 per share. That places PBFX at a significant discount right now.
This isn’t the full picture though.
My second equation is based off of the payback rate of free cash flow, which in my equation is simply operating cash flow minus maintenance capital expenditures combined with growth and discount rates (aka Buffett owner’s earnings). Here is what that looks like on paper.
Looking at the rate of growth of FCF (still keeping it at 7%) and using a 3% discount rate, this calculation may seem rather conservative, especially when we are talking about the current state of the industry. That being said, I would rather miss conservative than aggressive when making predictions about the future.
One thing that you may have noticed that I do different than The Oracle is that I use an 8-year instead of a 10-year calculation. Why is this? Well, I stole this one from Phil Town as well, where he speaks about the payback time that private equity investors expect. He literally wrote a book about this, so instead of me wading through it, I suggest you take a look at his explanation. This, again, leaves me more conservative than most.
Finally, there is one last step, which is how to combine the two calculations. There are a couple of ways to do this. First, I could take a 50/50 split and average the two prices. Second, I could assume that the next 8-10 years of stock price depends more on FCF growth and label it 60/40 in favor of the FCF calculation. Finally, my third choice is to perform the opposite and go 60/40 in favor of a Price/FCF valuation.
Finally, once I determine which one I want to use (I will place all three below for you), I discount the price by 20% to give myself a solid margin of safety. Here are the calculations:
Currently, I have decided to use the FCF Heavy pricing as my baseline. This is purely because, after analyzing the company, I am convinced that the market will continue to undervalue this company until it decreases its total debt load further and shows that it has solid footing in terms of future distribution. This comes more from the total FCF produced and less on a per share basis.
So where do I value the company at? Well currently I value PBFX at $26.68. This currently sits at 80% higher than its current price of $14.80.
My Buy Price
Whenever I am buying, I am looking in a five to ten-year horizon and want to be able to safely see annualized returns of around 15%. Note that I said safely, which will mean that I need to be conservative.
At the time of writing, PBFX has a yield on cost of just above 8%. That places me in a position where my returns need to be about 7-9% to reach or beat my goal.
What does this look like in reality? At current price ($14.80), a 15% annualized return for the next five years places the stock price at about $44.56 WITHOUT distribution payments. Using our calculations above, we see that our estimated 2026 pricing is around $42.78, or an 11% annualized return WITHOUT distribution payments. With payments staying at the current 8% rate (Spoiler alert, it probably will not) then we actually may exceed my goal rate of return.
So what do I do with all this information? The answer is my best. From my view, the current state of PBFX is showing a lot of upside and solid management that is dedicated to not only paying down the debt load but also to increasing distribution per share in the near future. This means that I feel comfortable to buy this closer to the calculated buy price above of just over $21. With current rate of distribution looking safe, even purchasing up to $18-$19 leaves me with a yield on cost of over 6%, which is more than appealing enough for me to continue my purchases.
Buy Price = Add up to $19
On the long-term weekly chart, PBFX currently sits just above support after recently breaking through a spot of resistance. It appears that it is currently consolidating, and is trying to make a decision on whether to move higher or break lower as the current market continues its slide.
The daily chart points at the ability to soon get an answer if there will be an aggressive move upwards by PBFX. Currently sitting just below resistance of $15.08 after bouncing off support in a relatively low volume sell off. The 50 day MA is currently $14.24, and I am sitting and waiting to see the $15 break before continuing to add more.
There has been relatively little going on of late for the PBFX insiders. With zero moves over the last 5 months there is very little to learn here.
PBF Logistics L.P. is a cash printing machine and I will continue to add more to my current position. The management has done a tremendous job in focusing on decreasing the debt load and working to use the FCF towards solidifying the distributions, not only currently but also in the future. The continual wise use of the cash flow points me to a company that I can sleep well at night owning.
We are sitting right now in a shaky market, that will continue to be volatile. This places me in a position where I want nothing less than a company that I know can produce actual monetary returns for the future. This to me is PBFX.
Thanks for reading. Until next time, Happy Investing!