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REAL ESTATE SERVICES
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Hinds Howard

Principal, Associate Portfolio Manager, Infrastructure

Week Thoughts: Midstream Canceled Again

The S&P 500 closed negative for a 4th straight week, while midstream had its worst week since June in what has been a brutal September so far.  MLPs were much worse than the broader midstream indexes.  In a declining stock market, energy stocks (including midstream ones) aren’t likely to see much interest.  It may not feel fair, but that’s how it’s been going this year.

Historic Apathy

Month to date, the MLP Index is down 15.3%.  That is the same return MLPs had in September 2015, but not as bad as September 2008 (-17.2%) and it is not the worst month this year (March was -47.2%).  YTD MLP total return is -47.2%, the worst performance at this point in a year ever for MLPs.

Month to date, AMNA is down 9.7%, significantly better than its 15.3% decline in September 2015, and would be just the third worst month of the year (behind February -9.8% and March -39.3%).  At -35.6% year to date, AMNA’s performance is the worst ever to this point in a year. 

Why Does Midstream Keep Going Down?

Global hydrocarbon demand concerns impacting terminal value for pipeline assets is maybe a reason to cite as to why energy stocks underperformed this week.  The California Governor’s order that internal combustion engine vehicles will no longer be sold in California after 2035 may have played a role this week, for sure.

But demand concerns and terminal value concerns should have been priced in well in advance of this week.  There just isn’t a large enough group of folks who don’t already own midstream or energy stocks that are eager to buy them.  Not buying energy stocks seems rational even at depressed prices based on the laundry list of headwinds the remainder of 2020, including:

  • Election with energy policy impacts
  • Tax loss selling into year-end
  • Uncertain recovery of demand for transportation fuels from COVID-19 after the initial bounce
  • Whether or not OPEC will continue support the oil market
  • Institutions rotating into more ESG friendly asset classes (and away from poor performing ones)

I probably missed a few, maybe closed-end fund deleveraging, hedge fund down-grossing or unwinding, but those are the big ones.  These known unknowns are enough to keep potential funds from flowing into midstream stocks.

They Aren’t Making These Anymore

The regulatory environment for pipeline development was challenged before the fundamental environment became challenged.  It would be virtually impossible to rebuild many of the pipelines that exist today.  Midstream bulls will argue that there is scarcity value in these irreplaceable assets.

Similarly, in the film industry, there are many movies that probably could not be made in today’s culture. Many examples of such films were made in the late 1970s and early 1980s, like “Bad News Bears”, “Blazing Saddles”, “Silver Streak”, “Soul Man”, and the one I saw more than any of these: “The Toy” (1982).

The Toy was directed by Richard Donner (of Goonies, Superman and Lethal Weapon Fame) and was released on the same weekend as 48 Hours.  Richard Pryor starred as a reporter who gets hired by a very rich man to be the live-in toy for his son who is home from military school for a week.  The plot is ludicrous and uncomfortable throughout.

The film is also terrible and earned a 9% score on Rotten Tomatoes.  Somehow it made $48mm of early 1980s dollars at the box office, and somehow, I have seen it several times, I because guess we had a VHS copy in my house in the 1990s.  The point is that just because The Toy couldn’t be made today, does that necessarily mean it has value? 

There are quality midstream assets that could not be built today that are critical to the functioning of the economy.  Other assets that could not be built today should not have been built and are not critical.  The market is painting with a broad brush at the moment, marking down all fossil fuel-related assets.  There is value in the irreplaceable and critical infrastructure in this sector, but the catalyst for that value to be appreciated remains elusive for now.

 

Winners & Losers

MLPs

The power of the renewable thematic in the broader market was on display this week.  SPH announced a small investment into a renewable fuel technology firm in a press release last week, and the stock has dramatically outperformed the rest of the sector since and was a major outlier this week. 

The bottom 5 was dominated by several names that just continue to be sold hard after an already brutal year so far.  PAA was the worst performing stock, on no news, but also on clearly no buyers. 

SPH repeated in the top 5, OMP and CQP went from bottom 5 to top 5.  On the YTD chart, EVA continues to lead, DKL dropped down a spot, but no other changes in the top 5.  PAA dropped a spot in the bottom 5 after an abysmal week.

Midstream Corporations

Midstream corporations held up better than MLPs, especially cap-weighted, with LNG, WMB and KMI all materially beating index averages this week.  Natural gas focused names were clearly better than oil or NGL names this week. 

LNG, WMB and TRGP repeated among the better performers in this group, while OKE went from top to near the bottom.  YTD, WMB fell back a bit, but still has some cushion as the top performer.  At the bottom of the group, TRGP climbed 2 spots, but it still down 64% inclusive of dividends.

Canadian Midstream

Canada was also a relatively safe place to hang out this week, as you’d expect, with ENB and TRP outperforming the rest of their group and their U.S. peers.  IPL had the biggest news of the week, but that wasn’t enough to avoid a sell-off inline with its current leverage and asset profile in a big risk-off energy decline week.

IPL and GEI went from best to worst performing week over week.  Pembina and Keyera were again weak.  On the YTD leaderboard, TRP reclaimed the top spot from GEI.  The group at the bottom remains tightly bunched, with little separation of YTD performance among Pembina, Keyera and Inter Pipeline.  It feels like these trends will continue until earnings or some other catalyst can spark some divergence among those three.

News of the (Midstream) World

News flow continues to be very light, although there was a sizable asset sale and some management turnover in Canada.

Capital Markets

  • Global Partners (GLP) announced private placement of $350mm of 6.875% senior notes due 2029 (press release)

M&A / Growth Projects

  • Inter Pipeline (IPL-CA) announced sale of majority of its European storage assets to CLH Group for C$715mm (press release)
    • These assets represented 2/3rds of IPL’s 2019 European storage EBITDA and the sale price represented 10x that EBITDA

Other

  • TC Energy (TRP-CA) announced retirement of CEO Russ Girling effective at year end 2020 (press release)
    • Current COO Francois Poirier will replace Girling