Oct 4th, 2015
MLP Market Post
After the dust settled on the craziest week of MLP price action since late 2008, the Alerian MLP Index finished the week up 3.9%, breaking a four week losing streak.
Each day of the week saw the index move more than 3.5%. It opened with two 5%+ decline days; only the third time ever the index has fallen 5%+ on consecutive days. That was followed by the best day ever for the index that didn’t happen in Fall 2008, and the third best day of all-time overall. MLPs followed through on that bounce with two consecutive top-30 all-time days. The index finished the week 17.0% higher than Tuesday’s close, but remains 35.6% (on total return basis) below the August 2014 peak.
The rally was concentrated among the larger MLPs, perhaps an indication of short covering for the few large MLPs that can be shorted. Big cap MLPs EPD (+8.9%), PAA (+13.0%), and MMP (+8.9%) fall into that category. The Alerian MLP Equal Weight Index trailed the cap-weighted Alerian MLP Index by 180 basis points this week. Smaller MLPs participated on the downside along with large caps, but have some catching up to do if the rally continues.
MLPs outperformed utilities and the S&P 500, which both had strong weeks, helped by Friday’s huge positive reversal after the weaker than expected jobs report pushed stocks lower on the open. The U.S. 10-year rate closed below 2%, down 17 basis points on the week.
MLP businesses are sustainable, but is the MLP rally sustainable?
Everyone is hesitant to call the bottom, because it’s been a losing proposition the last year (see below for the head fakes the index has thrown). However, none of the lower lows this year had the volume and extremes of this week’s action, which was very similar to the action we saw in late 2008 when MLPs hit their ultimate bottom. But even after the ultimate bottom in November 2008, MLPs remained volatile for several months before starting their sustained recovery in March 2009.
The post I published earlier this week was well received both here and at Barron’s where it ran on Thursday. Thanks to everyone who read the post, and thanks for all the positive feedback. There were a number of readers who initiated the post by asking for a response. It seems like the original negative post on MLPs did incite real market moving fear among individual MLP investors, evidenced by the number of buy side firms with responses of their own, likely the result of many inquiries to them as well.
It is interesting how easily conviction can wane when faced with sharply declining stock prices. The questions I heard from individuals early in the week carried with them a heavy dose of fear: “Oh, I know that guy doesn’t know what he’s talking about…but is he right? How many of my MLPs are going to be able to keep paying distributions?”
The MLP collapse over the last year hasn’t been driven by blogs (in either direction, as much as we’d love to take credit for the back half of the week). Its been driven by uncertainty around 3 important factors that drive an MLP’s ability to grow distributions:
- Return on capital
- Returns for existing and under construction assets in an environment of slowing activity have been in question, gaining momentum with the contract restructuring WPZ and CHK announced in early September.
- Capital opportunities
- Concerns over capital deployment opportunities have been stoked by PAA management and by mainstream articles about over-piping in certain areas.
- Cost to deploy that capital
- USAC and AMID’s challenging equity raises early in September made it clear that capital access will be challenged for MLPs for some time.
The length of the commodity selloff has brought us here. In a v-shaped commodity price recovery (sort of what it looked like through 6/30 this year), there would have been concerns in the short term over returns on capital based on commodity exposure, and names with exposure to that would get sold off (upstream, oilfield services, processing MLPs). But the other two factors (capital opportunities and cost of capital) generally would have remained benign, and the correction would have been shallower.
MLPs will find it challenging to grow if the current environment persist, but the rally this week is a sign that the market overshot to the downside in trying to reflect those challenges in stock prices.
It seems so long ago after the mid-week recovery, but let’s revisit September quickly and tally up where we stand at the end of three quarters. MLPs finished September down 15.3%, the 3rd worst month ever (behind September and November 2008). This was the 5th straight negative month for MLPs, tied for the longest streak ever (set earlier this year). The other 5 month losing streak (-16.3% total return) was mild in comparison with the current one (-31.1%). MLPs finished 3Q down 22.1%, the worst quarter ever for the index. At the end of September, MLPs were down 30.7% for 2015 (but by Friday down just 25.4%).
Looking forward, October has been one of the most consistently positive of all months for MLPs over the years, due to the tailwind ahead of 3Q distribution payments. Given how fat MLP yields have grown in the recent slaughter, I expect some of the October buying we’ve already seen is in anticipation of that next quarterly payout.
Winners & Losers
There was significant disparity among the top and bottom performers this week. JPEP bounced back from last week’s appearance in the bottom five to claim the top spot. RRMS and SHLX, both dropdown growth vehicles rebounded from significant recent underperformance to make the top five. The bottom five consisted of MLPs with non-traditional assets with the only common thread being coal MLPs FELP and CNXC. HCLP showed up in the bottom five for the second week in a row as frac sand fundamentals continue to deteriorate.
VLP joined the top five performers for the YTD period replacing FGP while the bottom five names remained unchanged, although HCLP took over the bottom spot from LINE.
General Partner Holding Companies
GPs underperformed MLPs this week and didn’t get the bounce some MLPs had. EXH was the top performing GP this week on no news. Among the bottom five, CPGX and EQGP made the list two consecutive weeks while AHGP was down perhaps in sympathy with weakness in coal MLPs.
News of the (MLP) World
MLP distribution announcements for 3Q have already started. EPD’s distribution announcement and continued insider support were likely a factor in its positive performance this week. Some mild capital markets activity was announced. We also got the formal announcement of a new MLP joining Energy Transfer’s flying circus of MLPs, bringing the total number of tickers for the Energy Transfer complex to 6. After the wild ride for the market, this blockbuster deal is almost an afterthought.
- NuStar Energy (NS) filed equity distribution agreement to sell up to $500mm of common units at the market (filing)
- VTTI Energy (VTTI) priced of $245mm of senior notes of varying maturities (10 year weighted average) for average coupon of 3.9% (press release)
- Enbridge Energy (EEP) priced of $1.6bn senior notes, including:
- $500mm of 4.375% senior notes due 2020
- $500mm of 5.875% senior notes due 2025
- $600mm of 7.375% senior notes due 2045
M&A / Growth Projects
- Kinder Morgan (KMI) announced additional commitments for Northeast Direct natural gas pipeline development (press release)
- Energy Transfer Equity (ETE) and Williams Companies (WMB) announced merger agreement (press release)
- No change to the value of the deal, as priced in ETE units, but ETE added some cash to the deal
- Large cost and commercial synergies expected by ETE, but limited details on those synergies was announced
- Enterprise Products (EPD) announced quarterly distribution of $0.385, an increase of 1.3% quarter over quarter, or 5.5% year over year (press release)
- 45th consecutive distribution increase, has increased distribution every quarter since the middle of 2004
- Additionally, the Duncan family, through ownership of EPCO, EPD’s G.P., has agreed to purchase $50mm EPD units through the company’s distribution reinvestment program
- This brings the total to $200mm invested by EPCO in EPD through the reinvestment program so far this year
- TOO announced 4% distribution increase
- This is TOO’s first distribution increase in 7 quarters
Sep 29th, 2015
MLP Market Post
We are compelled to respond to the sky-is-falling scenario outlined a few days ago by Valuentum Securities. The market may or may not be responding to the “MLPs may not survive” sensationalism. Hard to pin 5%+ consecutive down days on one article. But maybe because he starts it with “Warren Buffet…” If Warren said it, it must be true, right? We think not, and want to point out what is and is not true.
Midstream MLP Business Model Will Endure
At CBRE Clarion, we have a long history in real asset investing and this is not the first time we have heard such “wisdom” from market participants (mostly hedge funds). There was a time when the retail mall was going to end as internet retailing would take over the world. Many a stock owner is glad they didn’t sell their Simon Property Group shares at $26/share in 2009 (now $182). No Simon didn’t go out of business, despite the much heralded loss of capital access (sound familiar!) and of course death of demand due to internet sales taking mall demand. Malls thrived in the new world and capital markets opened for real estate companies allowing them to grow their businesses.
MLPs own real, tangible assets, just like REITs. The business is capital intensive, and to grow, you do need access to capital. Capital market are not always open, and currently the equity markets are closed for MLPs. And debt may be more expensive than it was 6 months ago. But, capital markets do not close indefinitely, either. MLPs, like regional malls, are not going out of business because they own irreplaceable assets, supported by long-term contracts and the U.S. is the lowest cost energy producer in the world (take that internet shopping!).
MLPs Can Fund Existing Dividends!
The MLP model has been one of a positive relationship between its investors and the company. Investors buy MLPs in the expectation of a return of that investment in the form of distributions and future growth in that distribution. MLPs are not required to make ANY distributions to their investors, unlike REITs which are mandated by the IRS to pay out a fixed percentage of net income. The distribution by MLPs is an elective. But, it also benefits the GP of the MLP as they typically have IDRs (Incentive Distribution Rights) tied to the level of the distribution. Growing the distribution above certain targets creates incentive cash flow for the GP.
We estimate that the current coverage ratio of dividends across our midstream MLP universe is 1.18x. Moreover, the universe of midstream MLP carries a distribution yield of 8.3% (yes, that starts with an EIGHT!). The current distribution is covered by cash flow. Cash flow that is adjusted (meaning deductions) for IDR payments to the GP and maintenance capital expenditures. So, in fact, MLPs cover their dividend with cash flow, and have cash available for capital investments.
The author confuses the capital requirements that will generate future cash flow generation with on-going free cash flow. Capital spending for growth projects is optional and companies can choose not to invest in uncommitted projects. Moreover, projects that are committed are typically contracted out at a level that more than adequately covers the cost of capital. In any event, an assumption of no capital access would mean no future capital spending. But in that scenario, MLPs would still cover their current distributions and an investor would collect a very healthy yield!
Upstream MLPs are the Exception, not the Norm
MLPs can be formed to serve a wide variety of services along the value chain in energy resources. The majority of MLPs are midstream-focused, providing transportation, storage and processing services. The universe of MLPs is 94% midstream. Midstream MLPs own tangible assets (pipelines, storage facilities, processing plants) with contracts based on fees for the services these assets provide.
A much smaller subset of the universe (Upstream MLPs) is exposed to exploration and production. These MLPs are severely challenged in this sustained low oil price environment as their cash flows are directly tied to the price of oil. The author attempts to link an Upstream MLP that has suspended its dividend to all MLPs. He should have pointed to the fact that all Upstream MLPs have severely cut or suspended their dividends. But, his generalization of all MLPs being potentially subject to dividend cuts is way off the mark.
Warren Buffet has a solid legacy for a reason. Perhaps we should consider one of his other famous quotes: “Be fearful when others are greedy and greedy only when others are fearful”. MLPs are down over 43% the past 12 months and yield over 8%. We see tremendous fear and, while we know it is hard, recommend investors to think of being greedy and not succumb to the panic.
As to the specific claims of the blog post referenced above, let’s run through a few of them.
Claim: MLPs are reliant on the capital markets to support ongoing distributions at current levels
MLPs are reliant on the capital markets for growth of distributions, but not ongoing distributions. In some cases, MLPs may choose to borrow to pay distributions in a seasonally low quarter, or may choose to ride out a period before growth projects come online with less than 1.0x coverage, but those are meant to be temporary, and in any event are not representative of the 1.0x+ coverage universe of MLPs currently.
Claim: Free cash flow less all capital spending is the appropriate way to evaluate ongoing operations of MLPs. When looked at through that lens, MLPs are not sustainable.
Not true, as mentioned above, if capital programs were put on hold, MLPs would be able to sustain existing distributions. See 2008-2009.
Claim: “Most midstream MLPs will have to make difficult decision to either cut distributions or suspend growth plans altogether. This would completely negate forever the distribution-based equity pricing framework that brokerage houses use.”
If MLPs are forced to suspend growth of distributions, how would that “negate forever the distribution-based equity pricing framework”? The market will just back up the yield to reflect no growth. That no-growth MLP yield has generally been between 7-10% over the last 10 years. Many MLPs are now trading much higher on this recent over-correction. But just because the market slaps a 15% yield on you, that doesn’t mean you have to cut the distribution so you are only yielding 10%. At 12/31/2008, MarkWest (MWE) yielded 32.1% and Targa Resources (NGLS) yielded 26.7%. Neither one reduced distributions through 2009, and each were up more than 200% over the next 12 months. MWE recently felt it would be better able to fund its backlog of growth with a strong sponsor like Marathon. Other MLPs may choose the consolidation path as well, but that’s to fund ongoing growth more easily and to protect valuable franchises and footprints, not to sustain current distributions.
Claim: ETE and WMB deal at much lower valuation that previously means that if the environment continues to deteriorate, leading participants to become desperate in the face of adverse conditions.
In the current environment, certain MLPs will have trouble living up to distribution growth targets set prior to the commodity collapse, this is true. And some may seek to consolidate to be able to better defend market share in key regions. But, there are real commercial synergies in this deal and there is real value to being bigger in the current environment, and that’s driving these deals. WPZ was not going to have to reduce distributions, but it was going to have trouble growing as fast as previously guided. WMB management saw the opportunity to get some value for the GP IDRs, which earlier this year it was willing to collapse entirely.
Sep 27th, 2015
MLP Market Post
MLPs fell for the fourth week in a row, with this week’s 5.9% decline the worst of the streak so far. The broad market was weak (S&P 500 -1.2%), struggling to find footing after the Fed’s announcement last Thursday, while utilities outperformed.
Oil futures finished the week up 2.1%, but were again volatile around the weekly inventory report. Oil was stronger late in the week, but MLPs stayed down. MLP investors have been hoping for a decoupling of oil prices and MLP prices, but were probably expecting it to occur when oil prices were flat for some time period and MLPs were up. Not just yet.
With just 3 days left, the Alerian MLP Index has produced -19.4% total return in 3Q. If that holds, it would be the 2nd worst quarter in the history of the MLP sector (4Q 2008 was -20.3%). It’s clear now the current MLP decline has just one comparable: 2007-2008.
From last year’s peak to today, the MLP Index total return has been -37.8% over 392 days. On 7/15/07, the index peaked and saw a 50.6% total return decline over the next 497 days to 11/21/08. The index bounced 11.3% the next day and produced 87.0% total return the next 12 months from the bottom. To get that 11.3% bounce in the index, there was a final washout 2 days prior when the MLP Index declined 10.8% in a single day. It should be noted that the S&P 500 was down 6.7% on that big washout day. The broad market hasn’t been strong lately, but it’s not in total panic like it was back then, which makes the MLP action lately all the more frustrating.
With school back in session, weekends are quickly filling up with kids’ birthday parties. It got me thinking about bouncy castles. I set up a bouncy castle for my nephew’s party this year. It’s a simple process: hook the castle up to the fan and plug the fan in. The castle slowly inflates, and if you get inside, you can hear the air leaking out from small holes along the surface of the castle. As long as the fan is pumping air in, it stays inflated, even as air dissipates from the surface.
When the party’s over, shut off the fan, and the castle slowly deflates. When it gets about halfway down, to get the rest of the air out, it helps to jump on it and squeeze out the remaining air.
The party for MLPs ended around this time last year, and the sector has been slowly deflating ever since. But air (funds) continued to flow for a while, allowing MLPs to access the capital markets without much friction. Since June 30th, however, oil’s decline and more vocal concerns about growth prospects for the sector have teamed up to jump on the sector, joined by uncertainty from Yellen last week. At this point, after a horrible September (to cap a horrible quarter and 12 months), it feels like we’ve gotten almost all the air out of the sector.
Winners & Losers
Down 24.7% this week, SMLP led the MLP losers (not counting variable distribution MLP EMES, which was down 42%). The reported unconfirmed rumor of SMLP’s sponsor sale efforts caught the market by surprise. There were amazingly only 4 positive MLPs this week, led by CMLP.
Drop-down growth MLPs have struggled of late, but none more so than CPPL, which made it two straight weeks in the bottom five, dropping like a rock early in the week.
HCLP joined the bottom 5 for the year. VLP announced an accretive drop-down acquisition with no equity needs, and it dropped out of the top 5. FGP climbed into the top 5 for the first time this year. The list of MLPs with positive returns this year is declining rapidly, and there is now just one MLP with more than double-digit returns.
General Partner Holding Companies
All GP holding companies declined this week, and the median underperformed the MLP Index. CPPL’s sponsor CPGX dropped almost as much as it’s MLP, down 14.5% and near the bottom for the second straight week. WMB and ETE performance fell in the middle of the chart below, which is appropriate given the holding pattern their potential merger is in.
News of the (MLP) World
The last few months, we’ve seen more buyback programs than at-the-market equity programs announced, and the results have generally been positive for the MLPs involved. Two more were announced this week. There was 1 actual M&A transaction this week, from a supportive sponsor. There were also 2 reports of rumors related to MLP M&A. No equity offerings, no PIPEs, no debt offerings. But you can be sure bankers are busy behind the scenes, hopefully efforting fixes for broken MLPs.
- Dominion Midstream (DM) announced that its sponsor, Dominion, has initiated a program to buy back up to $50mm of DM units over the next 12 months (press release)
- This is one of several recent buybacks announced, although this is the first of the class of 2014 drop-down MLPs to institute such a program
- DM units were slow to react to the announcement, but did finish the next trading session up 4.1%
- CST Brands, sponsor of CrossAmerica Partners (CAPL), announced program to buy back up to $50mm worth of CAPL units (press release)
- CAPL units were up 5.0% on the day the program was announced
M&A / Growth Projects
- Valero Energy Partners (VLP) announced $465mm drop-down acquisition of Corpus Christi Terminal assets (press release)
- Sponsor Valero Energy Corp (VLO) will help finance the acquisition with a $395mm subordinated loan agreement with VLP and by taking back $70mm worth of VLP equity
- The acquisition price represents a 9.3x EBITDA multiple, based on next year’s EBITDA of approximately $50mm, backed by a 10-year terminaling agreement with VLO
- VLP reiterated distribution growth guidance of 25%+
- According to a Bloomberg report citing people familiar with the matter, Energy Capital Partners, the private equity sponsor of Summit Midstream (SMLP) is rumored to be seeking buyer for its midstream assets and stake in SMLP (Bloomberg)
- SMLP would not comment on the speculation, choosing not to add credibility to what they view as a rumor
- The market reacted violently to the rumor, sending the stock down 28.3% in two days following the report
- The market appears to be worried that SMLP will end up as an “orphan MLP” with no remaining drop down acquisitions to drive growth
- The orphan MLP scenario has not played out well in the past (see El Paso Pipeline Partners and QEP Midstream Partners)
- SMLP was already down more than 50% in the last 12 months prior to the downdraft this week
- We have heard the risk of SMLP becoming an orphan MLP from other investors over the last year, and management specifically addressed that question in the past, so even if this were true, this should not have been 28.3% type of news for the market
- SMLP bounced Friday, but still quite a bit of damage done and the market is ascribing no further growth for SMLP or the potential for a positive outcome if such a sale were to happen
- There are potential positive scenarios for SMLP if they are indeed seeking a sale
- Given the MLP IPO market appears closed, it’s quite possible that a potential acquirer would place a premium on buying assets where there is an existing MLP in place (like Devon did with ENLK)
- On the other hand, there is no shortage of existing MLPs that could be thought of as shell MLPs for a good sponsor, so that in and of itself is not a value driver (just ask CMLP)
- In any event, Energy Capital is not happy this week, having lost around $160mm in value this week and $1.0bn from 52-week high last week
- According to a Reuters report, the board of Williams (WMB) will vote on a revised offer from Energy Transfer Equity (ETE) as early as this week (Reuters)
- The report indicated that the offer could include a cash component of around 15%, up from an all equity offer originally