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January 29, 2012

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MLP Week Thoughts: More ProPAIN for NRGY Investors

MLPs had a flat week, despite a sharp rebound in natural gas prices, and despite the Alerian MLP price index breaking through 400 for the first time ever.   The Fed’s mid-week announcement that it would keep interest rates extra low through 2014, helped push MLPs and other assets higher through Thursday.
A sharp sell off Friday of 1.5% erased all gains for MLPs on the week.  Friday’s drop was somewhat a result of broader market weakness, but also a result of 10 MLPs going ex-dividend Friday, including bell-weathers Enterprise Products (EPD) and Kinder Morgan Energy (KMP).

That broader stock market weakness Friday resulted from news of weaker economic growth than expected, with only 3.2% nominal growth, the slowest such rate since Q32009.  FOMC action this week pushed treasury rates lower (10-year back below 2%), and gold higher.

The MLP equity offering pace slowed this week, with just 2 equity deals for under $500 million in gross proceeds.  Also, of note, there have been no filings for MLP IPOs in January and no updates of previously filed S-1’s, so looks like the MLP IPO market is not going to be as hot as it was last year.
Natural gas’ 14.5% bounce may have legs given the announcement by Chesapeake ($CHK) on Monday.  CHK announced that as a result of the lowest natural gas prices in a decade, it plans to curtail gas production by as much as 1.0 bcf per day in 2012 and reduce its operated dry gas rig count by more than 50% from 50 rigs to 24 rigs.  Chesapeake plans to reallocate capital investment into liquids-rich plays (press release).
Dry gas shale plays like the Barnett Shale and Hayneville shale will be affected most by the strategic shift.  CHK’s midstream subsidiary MLP, Chesapeake Midstream ($CHKM), has a contract mix with CHK that includes minimum volume commitments and fee-based payment structures.  CHKM was nonetheless down 5.9% on the week, even with a 4.0% quarter over quarter distribution increase announcement on Thursday.
Other gathering and processing MLPs might be affected by future production curtailments from other producers in the Barnett and Haynesville shales.  Since 2008, G&P MLPs have mostly shifted towards a fee-based contract mix, to avoid the double whammy of declining volumes and declining margins that they experienced in 2008.
Even with contract mixes that make all cash flow fee-based, G&P MLPs are exposed to volume risk.  Contracts can mitigate that risk as well, with minimum volume commitments, but usually the minimum volume commitments are well below the volume management is expecting when the contracts are signed.
Other G&P MLPs that might see production curtailments akin to CHK’s around their assets include:

  • CMLP
    • Assets in the Barnett and Fayetteville shale areas
    • 85% of CMLP’s volumes still come from Quicksilver Resources
    • 95% of cash flow from fixed fee contracts
  • XTEX
    • Slightly less than 50% of cash flow from Barnett Shale
  • EXLP has significant operations in dry gas areas, and depends on dry gas production to drive its business, so if more production cuts are coming, that should be a short term negative for EXLP.

Midstream MLPs with operations focused on liquids-rich areas where drilling is expected to continue to grow should be fine.  The current environment is set to produce larger disparities than ever before between the winners and losers in the MLP space. The haves (crude and NGL-focused midstream players in areas of growing production) and the have nots (propane, natural gas storage MLPs, natural gas pipelines) are not usually this far apart.

(Clubber Lang’s prediction for fight against Rocky: Pain)

NRGY: My Prediction? Pain, Pro-PAIN
NRGY’s slow motion train wreck finally hit its climax Friday.  Hopefully most of you got off the train a while back and were just rubberneckers as it unfolded.  Propane distribution continues to be a challenging business, which is not new news.  However, it seemed as though the propane MLPs were going to be able to maintain cash distributions and muddle through the challenging environment.  That sentiment seems to have changed for the worse on Friday for NRGY, when the company added some comments to its announcement of a flat distribution for the quarter (my emphasis added):

“For the twelve months ended December 31, 2011, Inergy generated distributable cash flow of approximately 68% of the total cash distributions paid for the period. Market conditions, primarily in its propane operations and to a lesser extent in the Texas gas storage market, remain challenging. Although there are a number of factors that may impact its operations through the remainder of this fiscal year, a material improvement in distribution coverage is not expected. In light of these factors, management is conducting an evaluation of the operating businesses at Inergy, and is in the process of a major cost reduction initiative in its propane operations. In addition, management and the board of directors of Inergy are evaluating a reset of the quarterly distribution to a level that is supportable by the cash flow expected to be generated from Inergy’s businesses in the near term.”

So, in summary, cash flow last year was only 68% of distributions, things are not improving fast enough, the Inergy Midstream transaction was a marginal positive, but conditions didn’t improve fast enough in order to maintain its distribution.  It seems like NRGY management is still holding out hope that some miracle will occur that will enable them to not reset their distribution, but the market is not so hopeful, as evidenced by the 23.6% drop in NRGY’s price Friday.
We’ve been watching this play out for a while.  I started writing about it in middle of last year (see below), but the decline really started in Early May.

On May 3, 2011, NRGY closed above $40 for the last time.  The next day was the ex-date for its quarterly distribution, and May 10th NRGY announced earnings that disappointed.   At the NAPTP conference in May, I remember how disappointed a few long term holders were in that earnings report, and the savvy ones got out soon after that earnings report, into June and July.

NRGY issued $324mm of equity at $36 in late May, and NRGY held flat for a month or so, until Citi’s downgrade and $31.50 price target report in mid-July.   Weak earnings announcements in August and November, coupled with warm weather, helped assure that NRGY would not recover.  NRGY has its earnings call Tuesday morning, so we’ll all get more color, and expected to hear some unhappy Q&A at the end of it.
Other propane MLPs aren’t doing well either.  $APU announced earnings this week, and the results were ugly (press release).  APU saw a 14% year over year drop in volumes, resulting from warmer weather (16% warmer than last year) and customer conservation resulting from high commodity prices (14% higher year over year increase in propane prices).  The main difference is that even in the face of terrible operating conditions, APU has a 1.2x distribution coverage ratio, almost twice as much as NRGY.  APU faces plenty of headwinds, but isn’t in distressed territory like NRGY at this point.
More earnings to come this week, buckle up…
Distribution Announcements
26 MLPs announced distributions this week (16 increases, 10 flat).  So far this quarter, 57 MLPs have announced distributions, 35 (61%) raised distributions.  Average distribution growth has been 1.5% quarter over quarter.  This week:

  • CPLP, ETP, LINE, NMM, NRGY, NS, OXF, PSE, RNO, STON held distribution flat
  • CLMT increased 6.0%
  • EROC increased 5.0%
  • MWE increased 4.1%
  • ARLP increased 3.7%
  • BBEP increased 3.4%
  • PVR increased 2.0%
  • WPZ increased 2.0%
  • MMP increased 1.9%
  • APL increased 1.9%
  • SXL increased 1.6%
  • DPM increased 1.6%
  • RGP increased 1.1%
  • HEP increased 1.1%
  • SEP increased 1.1%
  • EXLP increased 1.0%
  • OILT increased 0.7%
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