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Hinds Howard

Principal, Associate Portfolio Manager, Infrastructure

Week Thoughts: Midstream Floats Higher in Light Action

On the week of America’s birthday, U.S. midstream (MLPs and corporations) outperformed Canadian ones, and the overall sector kept pace with a positive week for the S&P 500 and utilities.  The AMNA crested 25% total return for 2019 so far and is off to a good start for the back half of the year.

Natural gas prices rallied late in the week to finish up 5%, showing signs of life after plunging to fresh depths the last few months.  Things were quiet in midstream this week, but in less than 2 weeks we get another round of earnings, and we’ll have a clearer picture as to producer activity and volume trends from here.

MLPs Camped Out

I’m in the rural Texas Hill Country this weekend dropping my kids off to summer camp for a month.  I went to camp for 8 years in this same town.  My mom went to camp here starting in the 1960s.  My sister lives year-round at that same summer camp which she helps manage after attending herself for more than a decade.  We are a camp family, and the tiny town with all these camps is a very comfortable place for me.  Each year I return, so does the strong nostalgia vibe.

MLP investors can be quite nostalgic, too.  There was a time, right about when I stopped going to summer camp in the mid-1990s, when MLPs were exclusively yield vehicles.  MLPs gained a strong following because they offered dependable, and later growing sources of income.  Their yields were reliable enough to be compared with other interest-bearing securities, including the rate on 10-year U.S. treasuries.

Yields haven’t been a good valuation tool for midstream stocks for a while now, and we’ve said as much on this blog.  We’ve even gone so far as to call the yield on the AMZ fake yield, and at times it has been for months after a backdoor distribution cut was announced, but before the deal closed.  For reference, the AMZ current yield is 7.88% and for the AMNA its 6.16%.

But let’s just pretend yields were still of paramount importance to midstream stocks…If that were the case, the current yield spreads would be eye popping.  Maybe you haven’t noticed, but yields across the sector are stubbornly high, even as the risk-free rate in this country has been dropping like a lead balloon.  This has created an unusually wide yield spread. 

As shown above, the spread hasn’t been this high in the normal course of Midstream trading, outside of events like the global financial crisis in 2008 or the oil collapse of 2014.  Distributions have stabilized, but MLP yields haven’t adjusted down with the rest of the market.  As such, MLPs stock prices continue to camp out around the 250 area.  The chart below zooms in on the last 5 years.

In July 2007, the yield spread for MLPs relative to US 10 year got to their lowest point at 26 bps.  The chart below offers more detailed stats on yield spreads. 

High yield spreads have become more glaring as dividends have stabilized.  But does that really make much difference if yield doesn’t work as a valuation tool?

Winners & Losers

No news among the winners and losers in the MLP space this week.  EQM traded off and saw no positive readthrough from the healthy multiple paid by UGI to acquire Northeast gathering & processing assets from TRP this week.

TOO repeated in the top 5 on no news.  CINR went from first last week to worst this week.  On the YTD leaderboard, each of the top 5 best performing MLPs has produced 45%+ so far this year.  CINR dropped into the bottom 5 this week.

Midstream Corporations

ENLC repeated at the top of the group for a second straight week, while ALTM and ETRN repeated at the bottom of the group.  KMI underperformed for a second straight week.  On the YTD leaderboard, the top 5 remained intact, and PAGP joined the 30% return club at the top. 

Canadian Midstream

Inter Pipeline was far and away the best performer in Canada this week on no news.  IPL has exposure to NGL prices in Mt Belvieu that were positive this week.  TRP’s large asset sale Monday didn’t end up having much impact on TRP after a sell-off Friday negated the week’s gains.

In small cap Canadian midstream stocks that aren’t well-followed, IPL repeated near the top of the group while GEI underperformed for a second week.  IPL’s big week puts its YTD returns at 20%+, making every name in the group 20%+ in USD terms for the year.

News of the (Midstream) World

TRP had the biggest announcement this week, as it appears they were hard at work through Canada Day (Monday) on a major asset sale at an attractive multiple.  NGL Energy finalized the complicated financing of their latest water acquisition.  But other than that, it was a quiet week across the midstream world.

Capital Markets

  • NGL Energy (NGL) announced $400mm private placement of equity securities and warrants sold to institutional investors EIG Global Energy Partners and FS Energy and Power Fund (press release)
    • Press release did not indicate pricing or warrant information associated with these securities, but a subsequent 8-k filing was filed (read here)
    • The $400mm equity securities are Class D Preferred Units plus warrants to purchase common units
    • The Class D Preferred Units bear an initial distribution rate of 9.00%
    • The warrants are exercisable at any point after 1 year and have a 10-year expiration date
    • The warrants: right to buy 7.0mm units at $14.54 and 10.0mm units at $17.45
    • NGL issued these units to help fund the $892mm purchase of Mesquite Disposals Unlimited announced in May
  • NGL also issued $100mm of additional units out of its existing preferred equity series Class B Fixed-to-Floating Rate Cumulative Redeemable Perpetual Preferred Units

Growth Projects / M&A

  • TC Energy (TRP) announced sale of Columbia Midstream assets for $1.275bn to UGI Corporation (press release)
    • Assets include 5 natural gas gathering systems and one gas processing plant
    • UGI hosted a conference call where management referenced $100mm incremental EBITDA from the acquired assets, implying a 12.8x EBITDA multiple for the sale
    • Sale expected to close in 4Q
    • UGI indicated an opportunity to invest $300-500mm into the assets over the next 5 years at 5-7x multiples to grow EBITDA
  • Enbridge (ENB) announced open season on the Express Pipeline in Canada, for existing and expanded capacities, for service originating in Alberta with delivery points on Express Pipeline in the U.S. (press release)
    • ENB had previously discussed potential to add 50k bbls/d of capacity to the 280k bbls/d pipeline with pumps and drag reducing agents
    • Expansion would deliver into Platte Pipeline interconnect in Guernsey, Wyoming
    • Small, but positive move by ENB to squeeze additional capacity out of its system for oil egress

Other

  • Noble Midstream (NBLX) CFO John Bookout IV resigned, effective June 28th, to support another business opportunity, according to the letter in the filing (filing)