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Hinds Howard

Principal, Associate Portfolio Manager, Infrastructure

Week Thoughts: Mariner Makes Midstream Mixed

Midstream stocks were mixed across categories, with Canadian midstream outperformance offset by MLP weakness, but overall finished positive for the week, helped by broad market strength and income stock strength.  Performance divergence among midstream categories has gapped out, and appears to be at least partially driven by tax loss selling, where YTD losers are being sold.

Fabled MLP Divergence Continues

After 8 straight negative days, MLPs traded up on Friday, but still finished the week negative for an 8th straight week.  8 negative weeks is officially the longest streak of futility in the history of the MLP sector.  All of this is made worse by the strength of the broad equity market and oil prices in recent weeks that normally would support MLP prices at least on the margin. 

But, the magnitude of the selloff across those 8 weeks is not historic at just 12.5%.  There have been many other worse 8 week stretches in terms of value destruction, including less than 2 years ago when 8 weeks ending March 2018 produced -19.6% total return.  The worst ever total return over 8 weeks ended in October 2008, produced -38.2% total return. 

The selloff has also been muted beyond MLPs.  MLPs have been bad, even some of the more prominent ones like PAA, ET, and MPLX.  But the sector overall hasn’t been that bad.  U.S. and Canadian midstream stocks have traded better, leading to wide spread in performance for the three midstream indexes, as shown below. 

For years now, at this website, I have explained the very large technical headwinds being faced by very large fund vehicles and asset managers that have built their products and businesses on midstream remaining a sector.  As the universe of stocks continues to shrink, the money in motion picking up steam.

MLPs have been steadily going down over a prolonged period of time.  15 negative weeks in the last 18 has never happened before.  It is a slow, orderly bleed of MLPs into midstream, infrastructure or broad equities.  That’s why the carnage hasn’t been as bad as other periods in history that were more volatile and dramatic (like 4Q last year, for example), without the capitulation, just relentless selling.

Midstream’s Three Little Pigs

This week, Disney Plus dominated the entertainment industry when it launched and grabbed 10 million subscribers in 24 hours.  One of the best parts about the new service is exploring the classic cartoons by decade.  One of the most successful of these cartoons of all time was the 1933 Silly Symphony version of the classic fable the Three Little Pigs.  The film won an Oscar for best animated short film of 1933 and spawned several sequels (and may have inspired the 1992 hit single by Green Jelly where the band tells the story while playing guitars with heavy distortion).

If we re-imagined the fable with the three segments of the midstream sector (MLPs, U.S. corporations, Canadian corporations) each representing one of the pigs, MLPs would have the house of straw.

The wind (funds flow) is blowing away from MLPs, but its not the sudden and forceful blow like the wind from the big bad wolf’s lungs in the Three Little Pigs, or like we experienced in 4Q of 2018.  It continues to be more of a steady wind that’s peeling off pieces of straw slowly over time from the first little pig’s house.  

U.S. midstream corporations are the second little pig in this scenario, and Canadian midstream corporations are the third little pig, comfortable in their house of bricks, built over time by not having IDRs, by limiting the number of competing firms, by nurturing a loyal investor base, and by structuring contracts to avoid much exposure to changes in volumes.

Resolving IDRs

Another week, another dilutive IDR elimination transaction announced.  Only a few relevant IDR situations left to be resolved.  SHLX is the biggest remaining MLP with IDRs.  DKL, SUN, CNXM, and CQP are less relevant given their smaller size, but are paying significant cash to their IDRs today.   Others like TCP ENBL, GLP, MMLP and NGL aren’t being impacted by IDRs, but they remain there should distributions grow in the future. 

In terms of investable, meaningful MLPs (i.e. 1% or larger weights in the AMUS), all that’s left is SHLX and TCP.  Royal Dutch Shell appears to have done the math and realized that growing distributions for as long as possible is going to yield a higher overall purchase price for the IDRs than rushing to get a good multiple before comparable multiples (like DCP and NBLX at less than 10x) come through.  Smart. 

The IDR elimination process is nearing an end, setting up simpler strategic M&A potential and setting up future accretion once the near-term dilution works itself through.  But working through dilution requires cash flows to not decline in order to avoid eventual distribution re-assessments after the fact that make IDR multiples in hindsight much more egregious (like PAA’s IDR elimination and several other subsequent ones).  ENLC is facing such a predicament at the moment, the nuances of which were captured by Liam Denning from Bloomberg this week.

Winners & Losers

MLPs

TGP and BPMP reported results this week and led all MLPs in performance.  CEQP rallied back on some CHK relief related to Haynesville acreage sale.  ET made the bottom 5 this week, as the market was given another reason to be skeptical of ET’s ability to develop infrastructure in the Northeast. 

CEQP went from bottom 5 last week to top 5 this week.  EQM and GLOP repeated in the bottom 5.   Big weeks for TGP and CAPL helped push them into the top 5 of the YTD leaderboard, replacing SPH and SRLP.  ARLP dug its way out of the bottom 5, replaced by WES.

Midstream Corporations

Among midstream corporations, WMB traded near the top of the group.  WMB seemed to trade well Friday after NBLX announced strategic transactions that probably make it less likely for WMB to acquire NBLX (it was reported WMB was among the potential buyers a few months back).  In addition, WMB benefitted from marginally positive CHK news.  On the downside, the four worst YTD performers (AM, ETRN, ALTM, ENLC) were hammered this week, maybe an indication of tax loss selling now that the last distributions of the year have been paid.

Each one of the bottom 5 performers this week was in the bottom 5 last week.  OKE and LNG repeated in the top 5.  On the YTD leaderboard, KMI and OKE continue to battle for top YTD return.

Canadian Midstream

Every single Canadian midstream stock was positive as the divergence in performance continues.  No real news this week, but the biggest Canadian midstream have upcoming analyst days, with TRP’s happening this week.  It should be an opportunity for TRP to update the market on its growth outlook from here now that its major asset sale de-leveraging program has worked itself through.  Growth is 8-10% through 2021 for now, but investors will want a peek at what to expect beyond 2021.  FID for Keystone XL is probably downplayed and seen as more of a post-2020 election event.

The three top performing names last week repeated as the top performers this week.  Enbridge’s comeback continues, and its YTD return in U.S. dollars is now above 30%.  TRP has lagged recently, but is still well ahead overall.

News of the (Midstream) World

Friday’s NBLX news made up for an otherwise quiet week of actual transaction news.  We did get a positive datapoint from the debt capital markets, which seem wide open to midstream issuers after a TRGP upsized offering priced this week. 

Capital Markets

  • Noble Midstream (NBLX) announced 12.1mm unit private placement that raised $250mm to help fund its transaction with Noble Energy (NBL) (press release)
  • Targa Resources (TRGP) priced $1.0bn offering of 5.50% senior notes due 2030 at par (press release)
    • Offering upsized from $750mm
  • Inter Pipeline (IPL-CA) priced an offering of $700mm of 6.625% fixed-to-floating subordinated notes due 2079 (press release)

Growth Projects / M&A 

  • Noble Midstream (NBLX) announced combination large drop-down acquisition from sponsor Noble Energy (NBL) and IDR elimination transaction for combined value of $1.6bn (press release)
    • NBL will receive $670mm in cash and 38.5mm of newly issued common units valued at $930mm
    • NBL will own 63% of NBLX units following the close of the transaction
    • Total transaction including IDRs implies valuation of 8x 2020 EBITDA
  • Magellan Midstream (MMP) announced a supplemental open season for the expansion of the western leg of its refined petroleum products pipeline system in Texas (press release)
    • MMP is expanding capacity to 175,000 bpd from 100,000 bpd
    • MMP is also building a new refined products terminal in Midland, TX
  • Calumet Specialty Products (CLMT) announced sale of San Antonio refinery to Starlight Relativity Acquisition Company (press release)
    • CLMT will receive $63mm price for the asset, plus net working capital and inventories
    • NuStar Energy had sold CLMT the refinery in early 2013 for approximately $100mm

Other

  • The FBI has started a corruption investigation into how permits were issued on Energy Transfer’s (ET) Mariner East project in Pennsylvania and whether Gov. Tom Wolf and his administration applied pressure to environmental protection staff to approve permits (Dallas Morning News)
    • A spokeswoman for ET said no one at ET has not been contracted by the FBI about Mariner East