Week Thoughts: Spotlight on Revenant MLPs, No Longer the Big Short

MLPs continued last week’s rally, but with a little less fortitude this week.  Monday, Wednesday and Friday were up, Tuesday and Thursday were down.  Overall, MLPs finished +3.8%.  Earnings drove wide disparity among individual MLP returns.  Oil prices forcefully breaking back above $30/bbl helped lift the tide.  Major themes this week were: (1) sponsor support in the form of low multiple drop-downs, (2) increasing disclosure on counterparty risk and leverage concerns, and (3) the impact of declining volumes on G&P MLPs (and on diversified names like ETP).

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Oil futures settled at $32.90 (up 11% for the week) and popped above $34/bbl in early Friday trading, before sputtering into the close.  Propane prices continue to rise despite weak domestic demand, driven by accelerating exports.  Natural gas prices remain at multi-year lows, and seem to be in a race to the bottom with the 10-year interest rate.

Epic Comeback or Another Head Fake?

Because of Leap Year, MLPs have one final shot at a positive February on Monday.  If MLPs gain 1.87%, February will go down as a positive total return month.  That would be an amazing intra-month reversal from being down 19% for February a few weeks ago.

In 2015, February was one of just 3 positive months for MLPs.  We still haven’t seen back-to-back positive months for MLPs since June 2014.  If February did somehow finish positive, it would set up the possibility of follow through in March that would perhaps encourage some additional fund flows that have hesitated because of the intense volatility to start the year.

There are clear headwinds facing MLPs as we enter March, with producer customer concerns, pending rulings in bankruptcy cases with midstream contract implications that may see negative outcomes, and there is always the looming specter of oil prices.  Despite those headwinds, two positive weeks in a row has MLP sentiment thawing a bit.

Capital Markets Stirring from Hibernation

The equity capital markets seem to be wide open to all energy companies, except MLPs.  This week, there were large E&P public offerings, distressed energy special purpose acquisition companies (SPACs) doing IPOs, a yieldco offering, and a monster equity deal from Canadian midstream company Enbridge (ENB). ENB’s $2.0bn offering traded very well after pricing at a 5.7% discount. No MLP (or no investment bank) has attempted a public offering since November, and even the 3 deals in November were only for high quality and high valuation MLPs.

Given the positive reaction to the deck-clearing equity deal from ENB this week, I expect at least one brave MLP to try an offering in March.  The first deal will likely come from a high-quality MLP seeking capital to fund an announced drop-down acquisition, rather than just to reduce debt.  Historically, equity deals to fund debt pay downs aren’t welcome in the MLP sector.

In this new era, however, an MLP with a sub-10% yield and leverage that’s creeping up may want to try an equity offering to remove leverage overhang altogether.  We may see a deal like that attempted, and we may see it trade well in the aftermarket, just because of where we are in the MLP cycle and the intense focus on leverage these days.

Poll Question Review

Last week, there were 17 investment grade MLPs (8 just one notch above junk) and we asked how many there would be by the end of 2016.  The most popular answer (with 50% of the vote) was 2-8 investment grade MLPs by the end of the year, implying that all the nearly-junk rated MLPs would eventually be downgraded this year.  I voted for more than 8, because I believe several of the barely- investment grade MLPs are not at risk of a downgrade in 2016.

This week, Moody’s downgraded one of those MLPs (ENLK) to junk status.  Now there are 16 investment grade MLPs.  On the positive side, WPZ was taken off credit watch by S&P 500 with no change to its rating, despite its exposure to Chesapeake.

Poll Question: Valuation

Despite all the discussion about focusing on cash flows over distributions following the KMI dividend cut, MLPs are still valued by a large percentage of the MLP investors based on yield.  MLPs with healthy balance sheets and high coverage still trade at lower multiples than a similar MLP with a low distribution coverage ratio (i.e. a higher payout).  The yield focus needs to change if MLPs are going to transition to a lower payout model over time.  This week’s poll question seeks to get an idea of what valuation method you gravitate towards.

What is the best way to assess MLP valuation?

  • Price / Distributable Cash Flow per Unit (44%)
  • Enterprise Value / (EBITDA or EBITDA less IDR Payment) (39%)
  • Distribution Discount Model (11%)
  • Yield (6%)

Total Voters: 234

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Winners & Losers

DKL results were weaker than expectations, but affirmation of 15% distribution growth and the potential to acquire its sponsor’s retail business helped DKL beat all other MLPs this week.  WES’s supportive drop down acquisition helped WES bounce back in a big way.  CCLP and RMP earnings helped those names outperform.  SMLP led all MLPs to the downside with much of the selling coming on the day prior to its large drop down transaction and earnings release that stopped the bleeding Friday.  CEQP was down on weak earnings and no resolution on the distribution given its ongoing strategic alternatives review, which is now entering year 3 or 4.

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NRP, AMID and MEP made it two straight weeks on the bottom 5 list.  Smaller G&P MLPs in general saw negative producer outlooks in certain basins pressure their stock prices.

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Year to date, CNNX popped into the top 5 after a strong showing this week.  On the downside, CEQP joined the bottom 5 and MEP took over the bottom spot.

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General Partner Holding Companies

General partners outperformed MLPs this week, on average.  WGP popped on the drop down to WES announced with earnings on Thursday. SEMG rallied even as RRMS’s unit price declined Friday.  ETE and WMB lagged other GPs on weaker results from ETP.  TEGP and EQGP made it two straight weeks in the top 5.

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News of the (MLP) World

Equity help arrived for producer customers of MLPs, and that should continue to improve sentiment towards MLPs. If producer customers have access to capital, they have access to (a) paying MLPs and (b) continuing to pull resources out of the ground to be flowed through MLP infrastructure.  But the news of the week was the decisive action taken by WES and SMLP to stabilize their businesses and their unit prices.

MLP Financing

  • Enbridge (ENB) priced $2.0bn bought deal equity offering (press release)
    • Priced at 5.7% discount, finished the day above the prior day’s closing price, more than erasing the discount
  • Magellan Midstream (MMP) priced $650mm of 5.0% senior notes due 2026 (press release)
    • Offering was upsized from original $500mm size, a positive sign for other investment grade MLPs

Growth Projects / M&A

  • Western Gas (WES) announced $750mm drop-down of Eagle Ford gathering assets at supportive 5.8x EBITDA multiple (press release)
    • 75% of the revenue is backed by minimum volume commitments, and given the production trend in the area, the MVC level might be hit in the next few years, raising the purchase multiple a bit, but it remains an accretive transaction
    • APC has proven once again to be the most supportive sponsor in the business, even if feels like they are running out of bullets
    • WES gave distribution growth guidance for 2016, building 10% distribution growth this year on top of 15% growth in 2015 that was only achieved with the help of an acquisition WES hasn’t paid for yet
    • APC / WES management is savvy enough to know that the market still cares about distributions and confirmation of slowing growth has been a recipe for disaster of late (see MPLX and PAA)
    • A healthy WES and WGP are critical to APC as potential liquidity tools via further monetization of assets and units owned by APC
  • Summit Midstream (SMLP) announced drop down of remaining assets at Summit Investments for $1.2bn estimated value (press release)
    • SMLP will pay $360mm up front and will pay the rest in 2020 (either in units or cash) based on a 6.5x multiple of 2018/2019 average EBITDA
    • Assets include substantial gathering & processing assets in the Utica shale and Bakken Shale
    • SMLP has now pulled all the levers they have, but this transaction should allow the MLP and its current distribution to survive any commodity price environment for at least a few years
  • Williams Partners (WPZ) is seeking to sell Canadian midstream assets (Dow Jones)
    • According to sources, WPZ has hired two investment banks to launch a sell-side process that could fetch as much as $1bn
    • WPZ previously announced plans to sell at least $1bn of assets this year to fill its 2016 capex funding gap

Other

  • Cheniere Energy (LNG/CQP) loads and ships first LNG shipment, marking landmark first LNG shipment from U.S. lower 48 (Houston Chronicle)
  • Moody’s completed ratings reviews of several producers and one MLP, and downgraded ENLK to Ba2 (high yield) from Baa3 (investment grade), citing DVN customer concentration, Barnett Shale exposure, and inherent risks associated with high payout MLP model (press release)
Category MLP Market Post