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Hinds Howard

Principal, Associate Portfolio Manager, Infrastructure

Week Thoughts: Midstream Remains Resilient (Recently)

The streak is over, midstream stocks traded down for the first time in 7 weeks.  But positive sentiment for energy stocks due to higher oil prices helped MLPs (and to a lesser extent broader midstream stocks) outperform utilities and the S&P 500 slightly this week.  

The inventory report Wednesday included the first oil draw since January.  Oil prices were resilient all week as they have been all month (from a very low base).  EPD CEO Jim Teague appears to have been right when he said the world wouldn’t run out of oil storage.  Production curtailments and bottoming demand appear to have alleviated the crisis, and now the forward curve for oil prices seems to reflect that.

End of Earnings Season

Unlike major professional sports to date, we did get to finish the season…of first quarter earnings.  There were a few final releases this week (although we did have one incomplete: OMP delayed its report this week).

Energy Transfer (ET) was a laggard this week, trading down 5.8% this week after reporting results Monday night and catching a negative outlook from S&P on Tuesday.  ET is continuing to evaluate capex cuts but is moving forward with $3.6bn in spending in 2020, but is expecting free cash flow in 2021, at least that’s the current plan (and assuming no major acquisition).

While ET results were met with skepticism, earnings season overall (and the slew of negative guidance revisions) wasn’t the negative catalyst the market might have feared at the depths of the selloff in March.  Midstream powered through.  Steadily recovering oil prices seem to have placated the incremental investor seeking to get exposure to a bombed-out group of energy stocks that sport dividends that are maybe, finally now sustainable.

Where to From Here?

After the furious rally in value stocks to bring the sector back into balance, from here it feels like quality will retake the performance mantle.  Quality being defined as far from the well-head, well-contracted, limited competition assets combined with strong balance sheets and reasonable payout structures.  On the other hand, if oil prices rally another 20% next week, then lower-quality, higher-beta is likely to trade well.  Like the rest of the market in recent weeks, midstream may be rudderless for a while as the unprecedented pandemic response plays out.

One potential catalyst is M&A, which we’ve not seen much of since the pandemic lockdown began. Now that earnings season is over, it seems possible that big strategic M&A in some form could emerge.  Big strategic M&A is complicated, but so is finding attractive growth projects in a declining production environment.  Consolidation and contraction in the sector has been a steady theme in recent years, helping to rationalize the sector to a more manageable number of players.  A weaker outlook for U.S. production growth probably keeps that theme going.

Winners & Losers

MLPs

NBLX led all MLPs this week with all of its weekly gains coming on a 10%+ move on Friday.  PBFX was in the top 5 even with a 42% distribution cut.  On the downside, weakness for ARLP and others MLPs that don’t have traditional midstream assets (GLP, WLKP, BSM) underperformed.  ARLP may have been impacted by weaker front month natural gas prices impacting outlook for coal, or perhaps it was the carryover of reporting results last Friday.

SHLX and PBFX went from bottom 5 to top 5 week over week.  ARLP repeated in the bottom 5, NS repeated in the top 5.  On the YTD leaderboard, not much changed, except CEQP fell back into the bottom 5 and TCP climbed back into the top 5.  Each of the top 5 is still down less than 20%.  On the other end of the spectrum, each of the bottom 5 YTD is still down more than 60%. 

Midstream Corporations

TRGP was the big winner this week, catching a persistent bid on stronger commodity prices.  HESM and OKE were also in the top 5, perhaps feeding off of commodity price strength and its potential impact on Bakken outlook.  AM was the biggest loser in the group. 

TRGP repeated at the top of the group, RTLR and OKE were also repeats in the top 5 this week.  AM repeated at the bottom week over week.  LNG was again among the underperformers.  On a YTD basis, no change among the bottom 5, while in the top 5, HESM leapfrogged KMI into second place overall.  Note that ALTM was removed from the charts this week on sub-$250mm market cap.

Canadian Midstream

Within Canadian midstream this week, higher beta names IPL and PPL outperformed.  The largest, most stable names ENB and TRP were at the bottom.  Keyera’s beat in the quarter was offset by weaker outlook for its gathering & processing assets from here.

TRP repeated at the bottom of the group on weekly performance.  This translated into a narrowing of TRP’s lead on the rest of the group on the YTD leaderboard.  ENB is now just a few percentage points behind.

News of the (Midstream) World

Light week of news overall.  Outside of the midstream mainstream, TGP announced the most one-sided IDR eliminations I can remember seeing, which was probably the most interesting announcement for the week.

Capital Markets

  • Enterprise Products (EPD) registers 54.3mm units on behalf of holder Skyline North America (filing)
  • Williams Companies (WMB) priced $1bn worth of 3.50% senior notes due 2030 at 99.495% of par (press release)
    • WMB to use proceeds to repay its 4.125% senior notes due 2020

Growth Projects / M&A

  • Teekay LNG (TGP) announced elimination of incentive distribution rights (IDRs) in exchange for $120mm in new TGP shares (press release)
    • Teekay Corporation (TK) to receive 10.75mm common units in TGP, valued at $120mm
    • This is an egregious IDR elimination transaction, given than TGP is paying $0 annually to the IDRs owned by TK and TGP is 65% distribution growth away from paying anything on the IDRs
  • The three midstream companies reporting this week each announced reductions in 2020 planned capital expenditures, including:
    • Energy Transfer (ET) announced at least $400mm in additional capex reduction, with $300-400mm of additional potential cuts under consideration
    • EQM Midstream (EQM) reduced capex by 15% to $1.065bn
    • Keyera (KEY-CA) delayed KAPS project, reduces capex by around $250mm

Distributions

  • PBFX reduced distribution 42% back to its minimum quarterly distribution
    • In total, 25 distribution cuts in midstream and MLP space this quarter
    • 19 of those were operators of midstream assets
    • 9 of those were operators of mostly gathering & processing assets