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July 20, 2014

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MLP Week Thoughts: High Grade for Kinder

MLPs drifted higher this week, with a slight pause on Thursday when the broad market sold off, sending the volatility index (VIX) up 32% from Wednesday to Thursday.  For the week, the MLP Index finished up 0.9%, slightly ahead of the market (S&P 500 +0.5%), and well ahead of utilities, which were down slightly. Natural gas prices have declined substantially of late (hitting a seven month low this week) as the coolness of the summer is making natural gas storage levels refill faster than the market was expecting entering injection season.  Balancing the decline in natural gas was a 2.2% increase in WTI crude oil futures price, probably the result of escalating tension between Russia and the rest of the world. Weekly MLP Review_7-18-14The Hope of Lower Slope
Kinder Morgan announced second quarter results this week that failed to meet market expectations. On the conference call that followed the release, KMP announced new projects to be added to the ever-growing backlog of projects that stands at around $17bn.  But KMP’s high cost of capital will consume large portions of the returns from those projects, unless KMP can do figure a way to reduce its cost of capital. I spent a lot of time in airports this week.  So it’s no surprise that this KMP conundrum brings to mind a vivid and all too familiar airport image: the moving walkway. Moving Walkway
Because MLPs pay out most (and sometimes more than all) of their cash flow, they must constantly replenish capital in order to move distribution growth forward.  It’s like walking against the flow on one of those gigantic airport treadmills.  For KMP and other mature MLPs with high IDR payments, the cost of capital burden is like adding an incline or upward grade to the walkway.  Absent the incline, the same effort (high return projects) would result in a faster trip down the growth walkway. KMP would love to find some magical switch on the endless treadmill to reduce its incline.  But KMI is standing in the adjacent lane being moved along with the belt’s flow.  A reduction in the incline of KMP’s track will probably necessitate a decline in KMI’s growth rate, and that’s the rub. The great thing about the stock market is you can place a bet on whether or not KMP can find such a cost of capital reduction transaction.  The alternative is for Kinder to accept its station as a mega-cap MLP, and keep plodding along at the high incline, executing mid-teens IRR projects that result in maybe 4-5% annual distribution growth with tight coverage and elevated leverage.  There is no simple solution that immediately benefits all parties involved, otherwise we’d have seen it already.
Winners & Losers
Refined products logistics drop down MLPs dominated the bottom 5 this week, continuing weakness from last week (VLP and WNRL made the bottom 5 for the second straight week).  The price action of the losers this week seems to have been driven by profit taking and valuation concerns, while the top 5 seem to have been driven by news.  SDLP announced a drop down acquisition, HCLP announced a distribution, EXLP announced an acquisition, and BWP caught some favorable PR via Jim Cramer’s Mad Money.
Top5Bottom5_7-18-14 Top5Bottom5_7-18-14_chart
There were no changes among the top 5 constituents this week, although HCLP reclaimed the number 2 spot,a nd the gap between number 1 (PSXP) and number 2 has narrowed considerably.  The real action was among the bottom 5, which saw: (1) BWP edge closer to escaping the cellar, (2) EROC and CMLP move up a spot each, and (3) EXLP climb out of the bottom 5 entirely.
Top5Bottom5_7-18-14_YTD Top5Bottom5_7-18-14_YTD_chart
News of the (MLP) World
This week the market chatter was all about Kinder Morgan’s earnings release, which tends to happen each quarter because KMP is such a bellweather MLP and because it reports first.  However, there were several interesting equity and M&A transactions announced by other MLPs as well.  Institutional investors stepped up for a big private placement into AMID tied to an acquisition, akin to those 2006-2007 PIPE deals we used to see, but with a larger number of participants.  There was also a big block trade from an institutional seller of NGL (not listed below) that moved NGL’s stock price on Thursday.  Institutional capital will continue to drive growth in block trades, PIPEs and ATM transactions. News-of-the-World Equity

  • Teekay LNG (TGP) prices public offering of 2.8mm units at $45.05/unit, raising $126.1mm in gross proceeds (press release)
    • Overnight offering, priced at 4.1% discount to prior close
  • American Midstream (AMID) announces private placement of 7.6mm common units at $26.27/unit, raising $200mm in gross proceeds from institutional investors (press release, unit purchase agreement)


  • Memorial Production (MEMP) prices $500mm of 6.875% senior notes due 2022 at 98.485%, to yield 7.0% to maturity (press release)

M&A / Growth Projects

  • American Midstream (AMID) announces $115mm acquisition and distribution increase (press release)
    • Onshore natural gas processing, offshore natural gas processing and transportation, and oil gathering assets acquired from DCP Midstream, LLC
    • Assets complement AMID’s High Point system in Southeast Louisiana
    • Price represents 8.5x next 12 months EBITDA, 6.5x 2015 EBITDA, according to management
    • AMID plans to recommend 3-5% distribution increase in 4Q 2014 as a result of the acquisition
  • Seadrill Partners (SDLP) announces acquisition of additional 28% interest in Seadrill Operating LP for $373mm (press release)
    • SDLP will own 58% following this transaction
  • Exterran Partners (EXLP) announces acquisition from MidCon Compression for $135mm (press release)
    • Adds 110,000 horsepower, the majority of which is operating under 5-year contracts
    • Transaction immediately accretive, and EXLP expects to increase distribution by $0.005/unit next quarter ($0.02 annualized)
    • Acquisition expected to close in 3Q 2014
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