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Hinds Howard

Principal, Associate Portfolio Manager, Infrastructure

Week Thoughts: Midstream Captures More Downside

The slow bleed in midstream continued this week.  MLPs again lagged broader the Midstream Index (AMNA), because of Canadian midstream and a few large U.S. corporations.  Higher commodity prices and strong broader equity market trading weren’t enough to get midstream moving higher, as midstream-specific concerns over producer counterparty risk and slowing growth trumped the market’s positivity. 

Interest rates also spiked, which hurt yield-based equities like utilities and REITs, and probably didn’t help midstream, either.  It was another week when it felt like midstream can only capture downside in the market.  Oil prices up, stock market up on less concerns of global growth, but midstream sells off, because reasons that change from week to week.

This week the MLP Index was down more than 1% each day for 3 straight days this week, which was the first time since January that has happened.  It has only happened 18 other times in the last 10 years, 15 of those 18 times (or 83%) the AMZ was positive 30 days later.  In those 15 times when AMZ was positive, average return was 8.6%.  Overall average return across all 18 times has been 6.6%.  Based on that very small sample size, chances are MLPs trade better at some point in the next 30 days.

Dark Days

Daylight savings is behind us, which means we have darkness before 5pm here on the East Coast.  As noted above, its been dark days for MLPs for a while now.  Since the MLP Index peaked in July, MLPs have produced -15% total return (inclusive of 2 quarters of distributions).  

This was the 7th negative week for the MLP Index IN A ROW, which only happened 1 other time in 24 years (March/April 2012 was the last time).   Also, this will be 14th negative week of last 17, just 3 positive weeks in 4 months!  Never before have MLPs been negative 14 of 17 weeks. 

Taking a step back, this prolonged and ongoing midstream weakness is due to a brutal combination of technical and fundamental forces.  Technical headwinds (as discussed here ad nauseum) from big slow institutional capital exiting MLPs while retail investors are throwing in the towel and selling to lock in tax losses after one more distribution payment.  Fundamental headwinds from (investor-imposed) producer discipline driving down outlooks for those less diverse and more upstream-oriented midstream operators.

Earnings played out like you’d expect, with slowing activity hitting certain G&P names hard, but other more integrated businesses holding up better, and visibility into demand pull projects driving some of the big players to continue to spend in 2020 rather than return capital. 

Time and consolidation are the catalysts to look forward to.  With time, perhaps it’s the switchover to a fresh calendar year or maybe a few days into the new year, the institutional moves being made work through the system and fund flow balance can be restored.  Beyond time, it would seem that consolidation and culling the herd of smaller MLPs with questionable assets, business strategies and payout ratios.  That’s already been happening, but the sector would still be better off with fewer stronger players that could reasonably expect to have pricing power with their customers.

Winners & Losers

The three best-performing MLPs this week all reported results that were well-received.  DCP also announced a transaction to eliminate its IDRs at a reasonable (although still dilutive) price.  On the downside, EQM sold off on lingering uncertainty over future contract re-negotiations, the Mountain Valley Pipeline project and the distribution.  CEQP was hammered on the market’s draconian view of the impact of significant customer CHK’s financial challenges.  WES’s results and prospects were not well received.

NRP went from top 5 last week to bottom 5 this week.  EQM repeated in the bottom 5.  One the YTD leaderboard, USAC overtook BPL (which is no longer trading) for the overall lead.  NS’s big week helped it reach 50%+ total return for the year.  On the downside, EQM joined NRP and SMLP in the negative 30% group at the bottom of the sector.

Midstream Corporations

OKE’s legendary resilience within the midstream universe was on display this week, when it traded basically flat while the rest of the group was negative.  Cheniere and TRGP also outperformed, Cheniere perhaps on positive global trade sentiment and TRGP on strong results and a more restrained capital deployment tone. 

On the downside, ETRN results and distribution policy raised more questions than answers and the stock sunk lower.  ENLC posted weak results and the CEO’s observations and action plan did little to quell concerns over development halting in Oklahoma.

TRGP repeated in the top 5, while ETRN and AM repeated near the bottom of the group.  On the YTD leaderboard, KMI dropped into second place overall, replaced by OKE.  No changes among the order of the bottom 5, but each was lower week over week.

Canadian Midstream

Gibson, Keyera and Enbridge posted strong results this week, and (because both trade in Canada) they saw their stock prices go up as a result.  Inter Pipeline did not fare as well, but at least one investor was frustrated enough with the stock performance to ask on the quarterly call why Inter Pipeline didn’t pursue that $30/share offer that was reportedly made (IPL closed the week at $21.75).  TC Energy was also an underperformer on the week on no news.

On the YTD leaderboard, ENB hopped another name this week to climb into 4th place in the group, well off the pace of the top 3: TRP, GEI and KEY.

News of the (Midstream) World

First capital markets action in a few weeks was a financial sponsor selling at multi-year low price, so that wasn’t well-received.  Combined with a dilutive IDR elimination transaction, the transaction news didn’t provide huge confidence boost to the market in an already challenging market for MLPs.  There are still 18 MLPs with IDRs out there, with the top 5 biggest percentage IDR takes remaining, in order, are: SHLX, DKL, CNXM, SUN, and NBLX.

Capital Markets

  • Antero Midstream (AM) announced a secondary offering of 26.0mm shares owned by Warburg Pincus and Yorktown Partners funds resulting in gross proceeds of $171mm for the holders (press release)
    • Priced at $6.57/share, 3.7% discount to prior day close
    • Warburg Pincus has no more AM shares to sell after a series of secondary offerings over the last 5 years
    • The sellers picked a bad week to blow out of these shares at 52-week low prices, but price didn’t seem to be a factor after this quarter’s distributions were paid

Growth Projects / M&A

  • DCP Midstream (DCP) and its general partner, Enbridge (ENB-CA) and Phillips 66 (PSX), closed a transaction to eliminate all GP economic interests in DCP and IDRs in exchange for 65mm newly issued DCP common units (press release)
    • New units have a total equity value of $1.53bn based on a 20-day VWAP of $23.62
    • The GP now holds 57% of DCP’s outstanding common units
    • Purchase price was 9.0x cash flow, according to DCP management, but represented a premium to cash received by the general partner and is dilutive to distribution coverage and cash flow of DCP
  • Kinder Morgan (KMI) closed acquisition of $76mm worth of assets from Southcross Energy, which was seeking approval for the sale from its bankruptcy court for the sale (press release)
    • Assets described as nice complement to KMI’s existing Texas portfolio and allow for further connectivity on KMI’s Texas Intrastate system
  • Whitewater Midstream, a joint venture partially owned by MPLX, announced major expansion of the Agua Blanca system (press release)
    • The expansion will more than double the natural gas capacity of the system capacity due to the addition of a new 42” trunkline
    • Expansion backed by 10-year take-or-pay transportation agreements
  • Targa Resources (TRGP), on its earnings call, announced sale of crude gathering assets in Permian Delaware Basin to Oryx Midstream for $135mm (press release)
    • TRGP also announced that Jefferies has been retained to market additional crude related assets in the Delaware Basin
  • Starwood Energy Group announced acquisition of gas gathering infrastructure located in Lavaca County, TX from Third Coast Midstream (press release)
    • Third Coast Midstream is the new name of American Midstream, which was taken private earlier this year
    • Assets include 260 miles of pipeline and associated infrastructure that serves local upstream clients focused on oil and gas development