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Hinds Howard

Principal, Associate Portfolio Manager, Infrastructure

Week Thoughts: Midstream Checked, Market Unbalanced

Midstream stocks declined for a 6th straight week, this time joined by a pretty scary broad stock market decline on Friday.  Broad market fear appears to be joining the energy sector antipathy and midstream apathy we’ve seen all summer. Only utilities escaped the week unscathed, in the ongoing flight to safety that has driven outperformance for treasuries and utilities all year. 

The MLP Index has fallen 12.8% since peaking 6 weeks ago and is just 1% away from being flat on a price basis for the year.  The AMZ at -8.1% return so far in August is on pace for its worst month since February 2018. Ethane and propane were higher this week, diverging from oil and natural gas, indicating some improvement in the oversupply situation on the U.S. Gulf Coast. 

Before I get into other topics, if you were one of those concerned about a comment I made about certain MLPs and corporate conversion last week, scroll down to the bottom for my general response to all the inquiries.

Right Sizing the Universe: 5 Years In

The 5 year anniversary of the peak of the MLP Index is coming up at the end of August.  I’ve collected thoughts on what’s happened since and some key takeaways from the changes the sector has undergone since that date, and because those thoughts ran long, I made them into a separate post, which you can read here.

There are several fun charts and lots of other details, so I hope you go read and enjoy.  But, to summarize:

  • No surprise: Performance of midstream has been bad, MLP performance has been worse
  • 80+ tickers have been removed from the sector, “right-sizing” process has come a long way in 5 years
  • Financial health of remaining stocks much improved
  • Midstream stocks should prove more durable going forward, especially considering more reasonable starting valuations today
  • Stand-alone MLP/Midstream allocations should be giving way to broader global infrastructure, where the Midstream sector can be part of a diversified infrastructure exposure and dampen an investor’s exposure to Midstream’s volatility and oil correlation

Winners & Losers

CEQP was notable as the best performing midstream MLP this week after reiterating positive commentary at the conference last week and receiving some sell-side support this week.  Two shipping MLPs and one coal MLP were in the top 5 this week, all probably helped by not being in the major MLP Indexes.

SHLX went from first last week to near the bottom this week on no news.  SMLP repeated in the bottom 5, and on the YTD leaderboard SMLP crossed over the -50% threshold.  EQM is now the third worst performer at -25%.  On the positive side of the ledger, USAC and TGP rejoined the top 5, replacing SHLX and APU. 

Midstream Corporations

The median U.S. midstream corporation return of -3.4% was much worse than the MLP or midstream index returns, likely due to smaller names in the group performing worse.  Not a single one in the group traded up this week, but some did much better than others.  RTLR led the group, and the remainder of the top 5 skewed towards contracted natural gas infrastructure companies like WMB, LNG and KMI.

ALTM dropped 8% Friday to close the week down 16% for the week. SEMG was positive for the week before Friday’s 9.5% decline.  The three simplified former GP holding companies that the market has turned its back on (TGE, ENLC, AM) round out the bottom 5.

OKE repeated in the top 5 this week.  TGE repeated in the bottom 5.  On the YTD leaderboard, KMI maintained its slim lead over OKE, while Cheniere (LNG) turned negative YTD.  ALTM broke through -70%, more than twice as bad as the next worst performing stock.  Others in the bottom 5 are tightly bunched around -30%.

Although not pictured in the charts above, early-stage LNG development company Tellurian (TELL) had a wild week and a half.  After bottoming at $5.54/share on 8/14, it appears there was an epic short squeeze sparked by positive commentary at the conference that sent the share price up 66% to $9.19/share over 6 trading days, before dropping 18% Friday.

Canadian Midstream

The big M&A announcement of the week certainly skews the Canadian midstream chart.  KML obviously led the way, TRP was the only other name to be positive in this group.  But all of the Canadian midstream stocks outperformed the median U.S. midstream corporation return, which is what we’ve come to expect from Canadian midstream, which tends to be more defensive than U.S. midstream.

ENB went from first last week to worst this week.  KML’s huge week moved its YTD return into positive territory, but it is still the worst performer in the group for the year.

News of the (Midstream) World

It seems like it was all Canada news this week.  The KML experiment announced its conclusion by selling out to Pembina, which continues to grow and absorb smaller players.  Also, Canada related, Keystone XL received affirmation of its planned route in Nebraska.  Finally, the Canadian province of Alberta extended its production curtailment for another year.

Capital Markets

  • Sunoco LP (SUN) filed shelf registration form S-3 to register up to $300mm worth of equity securities for sale (filing)

Growth Projects / M&A

  • Pembina (PPL-CA) announced acquisition of all of the outstanding common equity of Kinder Morgan Canada (KML-CA), including the 70% majority voting interest held by Kinder Morgan (KMI) (press release)
    • KML shareholders, including KMI, will receive .3068 shares of PPL for each KML share implying a C$15.12 takeout price, or a 38% premium based on prior day closing
    • KMI will receive 25mm PPL shares, slightly less than 5% of PPL common equity, which it plans to sell
    • In addition to the KML sale, PPL will purchase the US portion of the Cochin Pipeline from KMI for $1.546bn, approximately 13x 2019 EBITDA
    • Cochin has capacity of 110,000 bpd and spans from Chicago, IL to Fort Saskatchewan, Alberta
    • KMI will use proceeds to reduce debt and to invest in projects and/or buyback shares
    • The closing of both transactions cross-conditioned upon each other and are expected to close in late 2019 or in Q1 2020
  • The Nebraska Supreme Court affirmed the November 2017 decision by the Nebraska PUC that approved the Keystone XL Pipeline route through the state (press release)
    • TC Energy (TRP) has been developing the project for more than a decade
    • The ruling removes one challenge to the project, but Keystone continues to be challenged in Montana, and TRP missed its chance to start any major construction this year and would be a hot-button issue if a new administration took over the executive branch of the U.S. government in the next election
    • TRP has yet to make a final investment decision (FID) on the pipeline

Other

  • In Alberta, the provincial government announced extension of the mandatory oil production curtailments through year end 2020, due to ongoing delays in pipeline development (Reuters)
    • Some had hoped for a carve-out of the concession for more rail volumes, but such a deal was not struck
  • No CEO changes across midstream this week, after several in the last few weeks

Visceral Reaction to Conversion Comment

There was a single sentence in last week’s post that you guys seemed to focus on: “ET and PAA management teams appeared more open to full corporate conversion.” Since so many of you asked, let me explain myself.

I was not impying that either of those MLPs was imminently likely to convert to a full corporation, but it was clear in my group meetings that management of both entities wanted to give the impression that they are not 100% against changes that might improve share price performance. 

If the market is changing and if there is a case to be made for converting to corporations, they appeared to be marginally more open to the idea.  Whatever % chance I put on ET’s likelihood of conversion, this latest meeting would have upped those chances on the margin. 

I still think the chances are low overall (certainly less than 25% over the next 18 months), but management wanted to give the impression that they wouldn’t rule it out as a lever to pull at some point.  Do you own homework, draw your own conclusions, but I apologize if last week’s comments made it sound as if conversion were imminent and apologies if that scared you.