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November 8, 2015

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MLP Week Thoughts: Mixed Results, Mixed Performance

MLPs finished the first week of November with a total return of -1.1%. And with just 8 more weeks and 37 trading days remaining in 2015, the MLP Total Return Index has declined 24.8%. Generally solid MLP earnings helped MLPs follow-through on last week’s rally early in the week, until Wednesday when MLP prices gave way to lower oil prices and more uneven earnings announcements the rest of the week. Distribution ex-dates seemed to play some role in MLP weakness this week, as investors hung on for one final juicy distribution before selling. MLPs underperformed the broader stock market (S&P 500 +1.0%), but outperformed utilities (-3.9%), which were crushed by higher interest rates following the blowout jobs report.
Weekly Review_11-6-15
On the bright side, PAA’s negative tone and lower guidance had much less impact on the sector than it did last quarter. MLP expectations and prices appear to have priced in a lower 2016 outlook, and a lower for longer commodity price environment. Earnings season was mixed, and stock price reactions seemed to reflect relief over the last two weeks.
The market is beginning to price in more optimism, or at least a willingness to get paid a high yield to wait. Distribution growth in 2016 will be down from the last 5 years, but that doesn’t spell doom for MLP prices. Let’s not forget that 2009 was the lowest distribution growth year of the 21st century for MLPs, but it was also the best year for MLP prices. The combination of high yield and price appreciation produced 77% total return in 2009.
At this point, there are still plenty of MLP skeptics out there. The MLP bear case bullet points have become so ingrained over the last year and a half that investors seem to ignore any upside risk to MLPs at this point, which is generally a bullish sign. It’s like in the movie Major League, when the Cleveland Indians go on a winning streak and the grounds crew still doesn’t buy in, saying essentially, “they still suck”.
Major League
MLPs have reached a “show-me” stage, where investors are unwilling to give much benefit of the doubt on the future. To make another Ohio sports reference, not many sports fans are willing to bet that the Bengals undefeated record so far portends any positive outcome in the NFL playoffs given how badly the fan base has been burned after past regular season success.
This week’s non-earnings news saw a continuation of two trends in particular that seem to be gaining traction. One is private placements of equity, like RMP’s $175mm deal announced this week. While the capital markets are closed for public equity offerings to retail investors (last deal was early September), institutional investors seem willing to step in (at a discount) to support accretive acquisitions for early stage MLPs like AM and RMP, and occasionally for mature, low coverage MLPs that are financing regular growth capex (like OKS).
As highlighted here in recent weeks, MLPs have alternatives to the public markets, and it may not be a terrible thing if the bar is raised for which MLPs have access to equity capital. Some financing discretion in the market can help avoid marginal MLPs financing marginal infrastructure.
The other trend, MLP buy-ins, are as unpopular as ever with retail owners of MLPs. TRGP announced an agreement to “pull a Kinder” and buy in its MLP. Owners of NGLS will get a reduction in income (like we saw with ACMP/WPZ and MPLX/MWE) and a big tax bill (like we saw with KMI/KMP/EPB). The math and governance works, so expect that trend to continue under the right circumstances. But the market has certainly not rewarded such transactions.
The TRGP buy-in also re-raises existential questions about the traditional MLP structure with IDRs that are probably worth exploring further in a week that wasn’t saturated with 50 MLP earnings releases. The MLP structure’s flow-through tax status should afford it a higher multiple than a corporation, all else being equal. But the sector may need to re-think the IDR construct in order to attract more institutional investment going forward, especially as the life cycle for an MLP grows shorter and IDR thresholds get surpassed more quickly.

Winners & Losers
Blowout 3Q results and increased 2015 guidance reminded the market that CNNX exists, driving a 30.7% re-rating this week. RMP’s 3Q results and the low multiple drop down (see below) helped it gain nearly 10% on the week. SXE made it two weeks in a row in the top 5 on what appears to be a stable outlook.
Weak results and lower outlooks sent PAA and RRMS lower this week. NGL reports next week, but seemed to be dragged down by results from TEP, PAA and RRMS that highlighted increased competition and challenged pipeline utilization for oil pipelines out of the DJ Basin. NMM was the worst performing MLP after announcing a distribution cut.
Year to date winners and losers are listed below. Not many changes, although SRLP popped into the top 5, displacing MMLP.
News of the (MLP) World
Capital Markets

  • Rice Midstream (RMP) announced private placement of 13.4mm common units with institutional investors, raising $175mm in gross proceeds (press release)
    • Proceeds will be used to partially fund the $200mm drop down acquisition announced this week

M&A / Growth Projects

  • Targa Resources Corp (TRGP) announced agreement to acquire all outstanding units of Targa Resources Partners (NGLS) in an all equity $6.7bn buy-in (press release)
    • NGLS unitholders to receive 0.62 TRGP shares per NGLS unit, a ratio that implied an 18% premium to pre-announcement price, but linkage to TRGP and TRGP’s price decline eliminated most of that premium
    • Coverage erosion was key driver of the transaction: Management cited 0.9x coverage for NGLS through 2018 in a rising commodity price environment case and sub 0.8x distribution coverage in a lower for longer case
    • No taxes for TRGP for an extended period of time, which is where the extra coverage comes from, along with the reduced payout to NGLS and elimination of IDRs
    • Transaction would result in a stealth distribution cut and tax hit for acquired MLP owners, similar to other recent MLP mergers
    • Breakup fee is less than $100mm, unitholder approval votes to occur in 1Q2016
    • Another 2.7% weight in the Alerian Index going away
  • Western Refining Logistics (WNRL) announced $180mm acquisition of TexNewMex pipeline from sponsor Western Refining, Inc. (WNR) (press release)
    • Pipeline is supported by a 10-year contract with WNR that includes minimum volume commitments
    • The acquired assets are expected to generate $18.75mm in EBITDA (9.7x multiple)
    • The acquisition was financed with a combination of cash and equity issued to WNR
  • Rice Midstream (RMP) announced acquisition of water services business from Rice Energy, Inc. (press release)
    • Purchase price of $200mm represents 5.0-5.7x 2016 EBITDA
    • RMP also agreed to a $25mm payment to Rice if Rice obtains an additional 5 mm gallons/d of connected water sources by December 2017
    • The acquired assets include Rice’s Pennsylvania and Ohio fresh water distribution systems, supported by a 15-year water services agreement with Rice
  • Genesis Energy (GEL) announced $350mm of new growth projects to support ExxonMobil’s Baytown, TX refinery and producers in Wyoming (press release)
  • TransCanada (TRP) announced sale of 49.9% interest in PNGTS to subsidiary MLP TC Pipelines (TCP) for $223mm (press release)
    • Asset is expected to generate $23mm EBITDA in 2016 (9.7x multiple)
    • Acquisition to be funded with cash on hand and borrowings on credit facility
    • The Portland Natural Gas pipeline that runs from the Quebec border and extends 295 miles into the U.S. northeast

Distributions / Other

  • Distribution announcements
    • SUN +7.5%
    • SEMG +7.0%
    • CPPL +3.0%
    • Flat: EEP
    • Reduced distributions: NMM
  • White House formally rejects proposed Keystone XL pipeline
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