NTI: A Lesson in DCF Management

Northern Tier Energy (NTI) – a variable distribution refining MLP – released 2Q13 results yesterday, with the key number being distributable cash flow (DCF) of $63MM, or $0.68/unit.


While the distribution declined 45% from 1Q13, the result was better-than-expected considering the collapse in the 3-2-1 crack (see chart below) and the fact that throughput was down 35% QoQ due to a planned turnaround at the Company’s lone refinery in St. Paul, MN.


This was a nice result for the General Partner (GP), and, coincidentally (or not), NTI announced after yesterday’s close that the GP (indirectly owned by ACON Refining, TPG, and NTI’s CEO) would sell another 11.5MM units (plus a 1.75MM underwriter’s option) to the public.  So far in 2013, the GP has sold 37MM units (including the deal announced yesterday), ~61% of its stake as of YE12 and ~40% of the total units out.


In our view, NTI may have played some games in the quarter to boost the distribution above what it otherwise would have been.


First, NTI did not take a reserve for turnaround expenses in the quarter.  NTI adds back actual turnaround expenses to DCF, but typically deducts a reserve for it each quarter so that there are not large, spurious declines in DCF owing to turnarounds (this makes sense if NTI is actually consistent with this process).  In each of 3Q12, 4Q12, and 1Q13 NTI deducted $10.0MM from DCF to reserve for turnaround expenses.  This quarter NTI reserved $0.0.  As a result, NTI is currently under-reserved for turnaround expenses by $18.1MM, having reserved $30.0MM but spent $48.1MM in the quarters since coming public.


On the conference call, management noted that they will again begin reserving for turnaround expenses in 3Q13.


The second curious item in the quarter is that capital expenditures deducted from DCF ("maintenance" and "regulatory" capex) came in at $13.5MM, 37% below the guidance of $21.3MM.  This was not a “beat.”  These capital expenditures were pushed out into future periods (or possibly considered expansion capex?).  Capital expenditures not deducted from DCF ("expansion" capex) came in at $28.9MM, $11.1MM above the guidance of $17.8MM.  In short, total capex was above guidance, the capex deducted from DCF was below guidance, and the capex not deducted from DCF was way above guidance.  That's a little suspect, in our view. 


These two items alone increased DCF in 2Q13 by ~$17.8MM ($0.19/unit), or 28%.


We were wondering yesterday why NTI would do this – after all, it is a variable distribution MLP (it shouldn’t be trying to smooth DCF).  But the announcement of the GP selling after yesterday’s close has given us a clue...


We think that NTI has now set itself up for even worse 2H13, beyond the collapse in refining margin (see chart), due to these moves to boost the distribution in 2Q13.  The maintenance and regulatory capital projects got pushed back and the Company will again be reserving for turnaround expenses to make up the delta between what’s been reserved for and what’s been spent ($18.1MM).  The manufactured DCF gains in 2Q13 will be DCF losses in future periods.


NTI: A Lesson in DCF Management - nti crack  


Kevin Kaiser

Senior Analyst

Bridgewater: When Good Ideas Go Bad

(Editor's note: Hedgeye Jedi Christian Drake from our Macro Team offers some thought-provoking observations regarding Bridgewater's issues with its All Weather fund (see Bloomberg story "Dalio Patched All Weather’s Rate Risk as U.S. Bonds Fell" for additional background)).

When good ideas go bad……

Bridgewater: When Good Ideas Go Bad - Stormy Weather Saguaro Cactus

If you hold a canonical 60/40 portfolio of stock/bonds, the risk adjusted exposure to bonds is not 40% - it's something less than that given that bond volatility/risk is lower than that of equities.  If however, you lever up the bond portfolio you can magnify fixed income returns, equalize equity & fixed income risk, and increase risk adjusted portfolio returns.  This is the basic idea of Risk Parity (ie. Bridgewater) and risk parity style funds


Risk Parity is a cool idea – it is an especially cool idea when you are levering up exposure to an asset class in the midst of a 35-year bull run. 


“All Weather” strategies, however, suddenly see only rain when fixed income goes convex and cross-asset class correlations tighten (ie. you are levered long falling bond prices and stocks & commodities are declining as well) such as what happened in June post the Taper announcement.  Risk-parity strategies got smoked on both an absolute & relative basis.


Decades long Queen Mary based correlation strategies need to be re-thunk &/or remixed when queen mary starts her secular journey the other way.   


AQRIX/ABRYX are the lead risk parity mutual funds and a Risk Parity ETF is waiting in queue for SEC approval – keep an eye out for that as a short candidate if we move towards getting a repeat of June. 


…Just some thoughts as them there #Rates keep arisin’


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Volatility Lives!

“Does man live from inside out or from outside in?”

-Erich Maria Remarque


I just got back from Thunder Bay and have that quote underlined in a post WWI German inflation novel that one of our clients in London gave me – The Black Obelisk. When I read it, I immediately thought of Global Macro investing legend, Ray Dalio.


Dalio’s signature quote about risk management is also a question: “What is the truth?” And whether it’s his, pardon the pun, All-Weather Fund’s issues, or performance problems most of us have faced over the course of our careers, there’s one thing that tends to answer all the questions we never knew we should have asked – it’s called volatility.


The number one thing that has created draw-down risk in every major hedge fund strategy since the beginning of time has been, and will continue to be, volatility. If your strategy assumes the wrong volatility parameters, you are assuming risks that you do not understand. On a percentage basis, did the biggest q/q change in 50 years in Treasury yields matter? Big time.


Back to the Global Macro Grind


Slides 15, 16 and 17 of our current #RatesRising Global Macro Theme deck outlined how massive outflows from Fixed Income related securities plays out:


1.   Quantitative Signal (Slide 15) – we show what we coined “The Waterfall” of rate risk as 10yr US Treasury Yields broke out across all three of our core risk management durations (TRADE, TREND, and TAIL – with the TAIL risk line = 1.92%)


2.   Causal Factor (Slide 16) – we show how unconventional Fed policy exacerbated a bond bubble (Fed Balance Sheet vs 10yr Yield over the last 10 years = R-square of 0.795)


3.   Correlation Factor (Slide 17) – we show that on a % basis, the most recent rate of change in the 10 year US Treasury Yield (quarter-over-quarter) was the largest in the last 50 years


Call us lucky or call us right. The truth is that we cut our asset allocation to Fixed Income to 0% for the aforementioned reasons alongside many more that were driving a regime change in terms of how our model values growth versus slow growth allocations.


When we were bearish on growth (until November of 2012) we were long US Treasuries; when our views on the slope of growth changed from slowing to stabilizing, we started to move to the dark side (in bonds).


#Process review:

  1. We get the market signal
  2. We do the long-cycle research to find asymmetric (phase change) risks
  3. We wait for the market to tell us when causal factors (expectations changes) drive correlation risk

This is no victory lap. I just feel that it’s important to show people what it is that we do in a transparent, open, and accountable forum of debate. The only all-weather protection against volatility ripping is getting out, before it rips.


Throughout the last 9 months (as US growth went from slowing to stabilizing to accelerating) markets have provided us plenty of opportunity to get into growth related asset classes and out of slow growth ones. August to-date is no different:


1.   Utilities (XLU) are the most overvalued slice of the slow-growth equity pie (with hyper-overvalued securities like MLPs within this Sector Style Risk). XLU is down -1.38% for August to-date (versus SPY +0.5%)


2.   Tech (XLK) and Basic Materials (XLB) are up the most for August to-date at +2.11% and +2.45% respectively. Both are traditionally considered “growth” sectors but for very different reasons. AAPL is not CAT.


There’s a lot of risk in assuming that long-cycle cyclicals (like mining related stocks) are in the right spot from a “growth” investor’s perspective. Then there’s GARP (“growth at a reasonable price”) where mining stocks might look “cheap” too. Just don’t forget that the Mining Capex Cycle was a decade long bubble. The risk here is grounded in the volatility of the underlying commodities.


Where could we be wrong? Our research on something like Caterpillar (CAT) has been bearish, but now the market signal is stress testing our conviction in maintaining that position. If CAT were to close above my long-term TAIL risk line of $88.67 and hold that level on some real volume, my risk management process stops me out of the position.


Do I live my market life from looking inside our portfolio of ideas or from the outside looking in? The truth is that I do both. It’s a learning process. Whenever I ignore the outside, top-down, macro market signals, I will be reminded that volatility lives on the other side of my position’s underlying assumptions. And not in a good way.


Our immediate-term Risk Ranges are now:


UST 10yr 2.64-2.75%


VIX 11.61-13.68

USD 80.92-82.18  

Gold 1

Copper 3.23-3.39


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Volatility Lives! - Utilities Yield Spread


Volatility Lives! - z. vp

Zero Resistance

This note was originally published at 8am on July 31, 2013 for Hedgeye subscribers.

“Through years of experience I have found that air offers less resistance than dirt.”

-Jack Nicklaus


I was playing in a golf match at the Newport Country Club in Rhode Island yesterday and, in the final pairing of the day, found myself playing against our all-star Energy analyst (and former Princeton Hockey Captain) Kevin Kaiser.


He hit a tee-shot on a 240 yard par 3 (into the wind on the ocean side of the course) that appeared to have zero resistance until it was in the hole. #Ace


As his playing partner (former NHL’er , Jeff Hamilton) and I walked down the fairway towards the hole, Hammy said “you guys are one-down.” I had zero resistance to that comment too.


Back to the Global Macro Grind


What if the stock market had zero resistance? That would be cool. I’ve never seen it before, but that doesn’t mean it can’t happen. What is resistance for a market price after it hits an all-time high anyway?


Higher-lows and higher-highs for market prices are bullish. Higher-lows and higher-all-time-highs, are really bullish. And no matter what fairway of life you are walking down into today’s month-end, that’s what the US stock market continues to signal in our model.


Plenty of pundits who were shorting the market since March said you “sell in May and go away.” Then they changed that to June. Now I guess they’ll just have to push that out to August, because here’s what the score card reads on the last day of July:

  1. SP500 (SPY) = +4.96%
  2. US Healthcare Stocks (XLV) = +7.12%
  3. US Financial Stocks (XLF) = +5.32%

In other words, if you weren’t long stocks for all of July, you’ll either need a hole-in-one today, or to just go on CNBC and place your own ball in the hole (after the Herbalife thing, Ackman had to resort to something; pitching a massive long position at month-end).


As stocks continue to make higher-lows and higher-highs, the “value” buyer’s game gets tougher. Combine that perpetual waiting (to buy the dip that doesn’t come) with a massive tail-wind called fund-flows into equities, and playing into that wind gets tougher.


Why does consensus continue to chunk dirt into this epic rally?

  1. #CYA – lots of people who blew up buying the 2007 top are simply not allowed to buyem this high
  2. Sentiment continues to be long of fear, when fear itself in Equities (VIX) continues to crash
  3. The potentially generational fund flow shift out of bonds and into stocks still doesn’t have consensus buy in

If you look at this morning’s II Bull/Bear Spread, it’s more of the same on that front:

  1. Bulls in the survey dropped back below 50% last week to 48.4%
  2. People who admitted to still being bearish remained at 19.6%
  3. The Bull/Bear Spread = +2880 basis points to the bull side

I’m not trying to suggest that after the Russell 2000 and SP500 are up +22.9% and +18.2% YTD that everyone is bearish. I’m not telling you to chase and buy the market on green days either. I’m just reminding you that less than ½ of the players out there are bullish!


And when month-end and YTD performance is in the hole like this, time becomes the bull’s bff…


Let’s go back to the point I made about fear crashing for a minute:

  1. VIX crashed (again) in July (its -20.6% for the month-to-date)
  2. VIX is still crashing YTD at -25.6%
  3. VIX, on a 3yr basis, is -43.0%

That’s a lot of baggage for a dirty ball to carry. And I think, more than anything, else – that’s the point. There’s a lot of mental baggage out there on this course. Consensus bears have been buying 25-30 the thunder and lightning VIX rain protection all year, when it’s been a clear and sunny path toward an implied VIX of 10-12.


Never underestimate the behavioral side to this game. It’s a lot like golf – and, as the great Bobby Jones once said, “Golf is a game that is played on a five-inch course – the distance between your ears.”


Our immediate-term Risk Ranges are now as follows:


10yr 2.57-2.71%

SPX 1683-1699

Nikkei 13505-14422

VIX 11.99-13.89

USD 81.43-82.59

Gold 1273-1361


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Zero Resistance - 2


Zero Resistance - Virtual Portfolio


Client Talking Points


#RatesRising and #DebDeflation remain two of our team's Top-3 Global Macro Themes here in the third quarter of 2013. And they are both playing out as a) U.S. economic data delivers sequential #GrowthAccelerating in July and b) Jackson Hole gets discounted as a hawkish event. The UST 10-year yield is now 2.70%. It's a nice step up of higher-lows and higher-highs. We are now up +13 basis points month over month.


No, utilities do not like #RatesRIsing. Neither do these over-owned and sketchy Master Limited Partnerships (MLPs). Of course, I'm referring to these shady, yield-chasing securities that make a buck and payout 4 bucks in “dividends” (see Linn Energy ticker: LINE). Utilities (XLU) are already down -1.4% for August to-date vs the S&P 500 which is up +0.4%. Utilities (XLU) was the first U.S. Sector to snap my immediate-term TRADE line yesterday.


With QQQs chasing year-to-date highs yesterday, now the S&P 500, Russell, and Nasdaq are taking turns shocking bears to the upside. The bottom line right now is that everything growth (High Beta, High Short Interest, etc) continues to rip higher as slow growth (see XLU, Bonds, etc) continues to be the dogs that consensus has wanted SPY to be for about the last 8 months. Sorry bears, there's no resistance to all-time highs of 1714. 

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

WWW is one of the best managed and most consistent companies in retail. We’re rarely fans of acquisitions, but the recent addition of Sperry, Saucony, Keds and Stride Rite (known as PLG) gives WWW a multi-year platform from which to grow. We think that the prevailing bearish view is very backward looking and leaves out a big piece of the WWW story, which is that integration of these brands into the WWW portfolio will allow the former PLG group to achieve what it could not under its former owner (most notably – international growth, and leverage a more diverse selling infrastructure in the US). Furthermore it will grow without needing to add the capital we’d otherwise expect as a stand-alone company – especially given WWW’s consolidation from four divisions into three -- which improves asset turns and financial returns.


Gaming, Leisure & Lodging sector head Todd Jordan says Melco International Entertainment stands to benefit from a major new European casino rollout.  An MPEL controlling entity, Melco International Development, is eyeing participation in a US$1 billion gaming project in Barcelona.  The new project, to be called “BCN World,” will start with a single resort with 1,100 hotel beds, a casino, and a theater.  Longer term, the objective is for BCN World to have six resorts.  The first property is scheduled to open for business in 2016. 


Health Care sector head Tom Tobin has identified a number of tailwinds in the near and longer term that act as tailwinds to the hospital industry, and HCA in particular. This includes: Utilization, Maternity Trends as well as Pent-Up Demand and Acuity. The demographic shift towards more health care – driven by a gradually improving economy, improving employment trends, and accelerating new household formation and births – is a meaningful Macro factor and likely to lead to improving revenue and volume trends moving forward.  Near-term market mayhem should not hamper this  trend, even if it means slightly higher borrowing costs for hospitals down the road. 

Three for the Road


TREASURIES: monster move in 10yr #RatesRising yesterday sees yield hold 2.70% this morning @KeithMcCullough


”Luck is a dividend of sweat. The more you sweat, the luckier you get.” - Ray Kroc


Europe's recession? Over. GDP across the 17-nation eurozone grew by 0.3% in Q2, according to official estimates released Wednesday. That's the first time the region has grown since Q3 of 2011, and compares with a decline of 0.3% in Q1 of 2013.

Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.52%
  • SHORT SIGNALS 78.67%