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Hinds Howard

Principal, Associate Portfolio Manager, Infrastructure

Week Thoughts: Market Suspended, MLPs Canceled

What a week.  The oil price collapse dragged MLPs and midstream stocks down again this week.  The group finished down a staggering 30%, which leaves YTD returns in less than 3 months at negative 40-50%.   The S&P 500 broke a few records and entered into bear market territory officially, which didn’t help midstream. 

Pain was everywhere, as investors sought liquidity where available, in a rush to the exits as we all prepare to shelter in place for a few weeks after a stunning round of postponements, suspensions and cancelations across America this week, for the greater good.  

The market’s cancellation of MLPs and MLP products this week was no less stunning, but like some of what’s known as “cancel culture”, it felt extreme.  Midstream is more oversold than it has ever been, in desperate need of hope, maybe even a pep talk.

In the 2013 film Pacific Rim that made more than $400mm at the box office, the world was threatened by giant monsters called Kaiju that would emerge from cracks in the ocean floor.  Countries from around the world banded together to create giant robots to fight the Kaiju and trained “pilots” to operate the giant robots.  At the end of the film, Idris Elba’s character Marshal Stacker Pentecost gave a rousing speech that ended with the line, “Today, we are canceling the apocalypse!”

It remains to be seen what will save the midstream space from its worst single year return ever, but there will be survivors of this latest challenge to the existence of midstream companies.  The show must go on.  Having invested through a few cycles (including 2008), this time around the companies are in better financial shape than in the past (no IDRs, lower payout ratios), but with very daunting technical, political and fundamental headwinds that continue to relentlessly frustrate investors.

Rewriting the Record Book

Later this week, we’ll post an update to the universe with some further thoughts on the technical challenges of the sector.  Before I share some summary thoughts on why this week’s action was so bad and what to expect from midstream in the future, I wanted to catalogue the record-breaking volatility this week. 

  • Monday was the worst day ever by a wide margin for MLPs and midstream stocks
  • Over the course of 5 trading days, we had 3 of the 6 worst days for MLPs ever
  • TC Energy (TRP) at -21.9% had their worst day ever on Thursday in more than 30 years of history I have access to via Factset
    • TRP followed up with its best ever day on Friday
  • Enterprise (EPD) had its two worst days ever on Monday (-18.6%) and Thursday (-17.1%)

  • It was the worst week ever for MLPs and midstream, and that followed two other top 10 worst weeks ever for MLPs, making it a safe bet that this is the worst 3 weeks in the history of the sector.

  • On Friday there was some relief, particularly in the final few minutes of trading, good enough for the best day ever for Midstream (AMNA) and the 7th best day ever for MLPs.

Frequent Questions This Week

Below I’ll share some of the more frequent questions I received this week, along with some quick thoughts on each.

Why has the selloff been so large and so quick? 

  • Two big reasons: Limited liquidity beyond the top 5 names, and blueprint from last time oil prices collapsed (we’ve seen this movie before)

Why are MLPs so correlated to oil prices when they have little direct commodity price exposure?

  • MLPs are correlated to oil prices, especially with the shift in the industry to where the large natural gas pipeline systems reside outside of major MLP indexes.
  • Some of the selling was clearly technical in nature, the result of forced selling from levered closed end funds and redemptions.
  • But the fundamental outlook has changed dramatically in the last week – less production, counterparty risk, less need for future midstream infrastructure and lower returns on those projects.

Can you breakout what part of the sell-off was from oil prices vs. equity markets vs. company specific issues?

  • The massive selloff this month has been the combination of oil prices, weak equity markets and technical pressure from levered MLP exposure
    • There was an announcement Monday that certain MLP-focused closed end funds were going to eliminate their leverage (had been around 39%) resulting in significant forced selling
    • There will be continued pressure from redemptions among open end funds and pressure on long-only midstream managers to sell
  • It is difficult to break the different factors down, but we are not surprised to see midstream trade this poorly after a 45% decline in oil prices to start the year and a negative broader equity market.

If oil prices remain low at $30-35 for the next 2-3 years, what is the impact on MLP fundamentals?

  • We expect oil prices to remain low for an extended period and it will be very detrimental to the MLP and midstream sector.
  • Oil at below $45-50/bbl means the U.S. cannot grow production, so it will peak and decline, reducing the volumes through existing infrastructure, reducing returns on projects being developed today, and will lead to lower rates as the over-piped sector competes for scarce volumes.
  • The upstream-oriented companies will be hit hardest, likely leading to bankruptcies and increasing counterparty risk.
  • Integrated midstream players with significant demand pull and export capabilities will hold up better but still face risks of declining production and lower demand.
  • Most of these integrated companies exist outside the MLP structure, in Canadian midstream corporations and in U.S. midstream corporations.

What are the key factors that would lead to cuts in dividends?

  • We expect more dividend cuts, including from companies that have already cut their dividend.
  • There will be more distribution and dividends cuts beyond the 115 cuts we have seen since 2014.
  • Cuts are driven by the need to reduce leverage or to maintain certain leverage levels as mandated by ratings agencies or by debt covenants.

 

Winners & Losers

MLPs

The least bad name in the MLP space was SRLP, which was only down 9% Monday and recovered the rest of the week, benefitting from being under owned by MLP fund products and ETFs.  Other relative winners included SMLP, which rallied 91% Friday after dropping 30% on both Monday and Thursday.  The losers this week were each down more than 50%.  The worst three were G&P names likely to be impacted by reduced oil-directed drilling in the Permian & DJ (NBLX) and Bakken (CEQP and OMP).  PBFX (downstream-oriented subsidiary of a refinery operator) was a bit confusing to land among the bottom 5, but it has a small float and was likely crushed on a forced sell down from a larger investor.

SRLP, TCP and CINR repeated in the top 5 week-over-week.  NBLX repeated in the bottom 5.  SMLP went from bottom 5 to top 5.  On the YTD leaderboard, each of the top 5 best performers is down 15% or more, and each of the bottom 5 are down 70%, including DCP and CEQP, fresh names on the bottom 5.

Midstream Corporations

Median return among U.S. corporations was -24%, better than the AMNA and AMZ, which was weighed down by weakness among large cap names like OKE and EPD.  WMB was the big relative winner among midstream corporations this week.  Lower oil prices likely mean better outlook for natural gas supply and demand, to the benefit of northeast producers and WMB’s pipelines.  Other natural gas names ETRN and LNG were also strong performers. 

Among the bottom 5, TRGP and ENLC aren’t a surprise to see.  OKE was the outlier after outperforming and executing at a high level through the 5-year downturn, only to be sold hard on oil prices that make the Bakken challenged long term.

RTLR, ENLC and TRGP repeated in the bottom 5 this week.  On the YTD leaderboard, TGE leads the group, but appears to be pricing in some uncertainty as to whether its buyout will close.  Each of the top 5 is down more than 25% this year.  WMB climbed into the top 5, replacing OKE.  

Canadian Midstream

Canadian midstream was not quite as stable as usual this week.  As you’d expect, the largest names held up best, with ENB and TRP outperforming by a wide margin the rest of the group.  Pembina down more than 40% in a week has to be a shock to its investor base and those who favor their team’s generally conservative management of the business.

ENB and TRP repeated as the top performers week over week.  IPL and KEY were the bottom 2 performers this week.  On the YTD leaderboard, those two sets are at the top and bottom as well.

News of the (Midstream) World

Very little news this week, and minimal communication in general from midstream companies in general.  It wasn’t until Wednesday that OKE and NBLX announced reduced capex plans for 2020.

Capital Markets

  • None.

Growth Projects / M&A

  • TC Energy (TRP) signed letter of intent to acquire Pioneer Pipeline from Tidewater Midstream and TransAlta for $255mm (press release)

Other

  • Insider purchases by KMI, ET, LNG, OKE, WES, DCP, PAA management and directors