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REAL ESTATE SERVICES
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Hinds Howard

Principal, Associate Portfolio Manager, Infrastructure

Week Thoughts: Stocks Get Mandate, Midstream Flips Red

The market (and midstream for most of the week) seemed to shrug off the ongoing presidential election malaise this week.  The focus seemed to be on the known outcome: no “Blue Wave”, a limited legislative mandate, limited ability to execute on promises from either winning candidate, and further Fed support for interest rates and asset values.  In this risk-on week, midstream was left out of the massive rally in the S&P 500, infrastructure and utilities, even with a rally in oil prices.

Self-Help Continues

While the hang wringing and vote counting slog continues as of this writing, midstream companies and MLPs reported progress on their efforts to reduce costs and position for free cash flow and stock buy backs.  At this point, most major midstream companies have announced buyback authorizations, even if some remain aspirational for now.

Early in the week, MPLX and PAA continued the strong 3Q earnings trend, and both announced buy back plans.  There was another small asset sale from NS, and PAA announced plans for further asset sales in 2021.  Other large midstream players ET, DCP and TRGP continued the cost cutting trend.  Larger midstream corporations like WMB, ENB posted solid results as well.  Earnings results overall beat low expectations handily, as midstream companies are showing they can run more efficiently by lowering costs and capex.

What Happened to Midstream Friday?

The market, midstream and oil prices powered through the first, second and third election nights.  Then Friday, oil prices and midstream took a sharp turn down while stocks finished basically flat.  Questions that came in to MLPguy as to why midstream was getting sold hard on Friday.  My best guess is a combination of the following:

  • Ex-dates for midstream and MLP 3Q distributions finished up late this week, so the final large dividends and distributions have been captured.
  • Tax loss selling tends to follow that final distribution.
  • Lower oil prices, demand concerns with another high COVID-19 positive test count.
  • The Presidential election result seemed clearer by Friday, and a Joe Biden victory even with a potentially gridlocked congress is not a positive for energy stocks due to likely increased regulatory challenges.

One very bad day may not portend further big bad days.  In fact, the last time MLPs sold off this much was back in late September.  Returns since then have been 7.1% through today.  The frustrating part about these swings is that since that same date, utilities are up 12.9% and the S&P 500 is up 8.4%.  MLPs and midstream continue to lag.  It feels like that will continue now that earnings season and distributions are behind us, unless oil prices rebound or there is some other major catalyst like M&A. 

Midstream Consolidation Sentiment Update

Speaking of M&A, conference call Q&A for every midstream company this earnings season included the obligatory two-part question:

  1. How does the spate of upstream M&A affect midstream?
  2. When is a similar wave of M&A coming to midstream?

The response from management teams was almost universally the same: upstream consolidation means stronger customers, better counterparties, more disciplined approach to development.  Midstream consolidation is necessary, but there are major challenges:

  • We don’t want to import leverage issues from another company.
  • We don’t want to buy someone when we can slowly take their business from our superior footprint.
  • We would prefer other companies consolidate the sector for us.
  • We haven’t found willing sellers or assets that fit with our assets.

These reasons seem valid when considering the micro challenges of corporate M&A.  But at a high level, the sector as a whole would be better positioned to rationalize excess capacity and bargain with ever larger customers if there were fewer midstream companies.

So, don’t expect M&A to be a near-term catalyst, but over time as growth capital opportunities dissipate, M&A will return to midstream in a big way as a means to backfill growth and continue to find costs to remove from the sector.  The rationalization and consolidation process is well underway (we’ve discussed how many tickers have been removed, the number is like 85 since 2014), but it remains a slower process than the market (and bankers) would like it to be.

Corporate Conversion Has Left the Chat?

In reviewing earnings call for the big remaining MLPs, one common question from prior quarters was noticeably absent this quarter: would you consider converting to a corporation?  One of the reasons cited in previous quarters for not considering a corporate conversion has been the potential for corporate tax rates to revert to previous (higher) levels with a new party in control of congress and the White House, making corporation incrementally less tax efficient than MLPs vs. today. 

Tax reform doesn’t feel very imminent after this week’s election results, so maybe the corporate conversion conversation will return in coming quarters.

Side note, one of the reactions to this line of discussion is usually a question: why would an MLP ever want to convert to a corporation?  The answer is to reach a broader group of investors and to avoid the negative fund flow pressure MLPs continue to face.  The broader group of investors primarily includes foreign investors, passive index funds for major indexes, and global infrastructure investors.  Some of the larger MLPs would be eligible for many indexes and passive funds that follow those indexes. 

Midstream Mandalorians

The second season of “The Mandalorian” started last week.  After years of incessant new blockbuster superhero and Star Wars films, 2020 has been slow going for new broad pop culture content.  This void is clearly helping the Mandalorian.  After binge watching through many old sitcoms this year, my kids and I are enjoying the Mandalorian as a change of pace.

The show is a throwback to shows like the Incredible Hulk or Kung Fu.  The episodes have a rhythm to them and variety of intra-episode plots, but the overarching plot doesn’t advance much in each episode.

The Mandalorian is basically a space gunslinger travelling from planet to planet collecting bounties and helping solve problems for small communities along the way.  The big plot issues (the origin and purpose of Baby Yoda, how the bad guy from last season figures into the mix this season, etc.) haven’t been addressed two episodes into the season, but the individual plots of the first two episodes were compelling.

The midstream sector is a bit like the Mandalorian and his people.  MLPs, like Manadalorians, have their own customs and language that seems out of place to others.  This 3Q earnings season for midstream felt like an individual Mandalorian episode.  The overarching plot remains in question (will fund outflows eventually give way to a sustained rally? Will consolidation or oil macro save the day?), but there at least seems to be some personal growth among our characters (MLPs and midstream companies). 

Will it be enough to overcome the challenges that remain in the way of our heroes? Find out next week…

Winners & Losers

MLPs

This week’s list of winners features a mix of small cap names with positive earnings announcements (OMP, GLP, BSM) and one of the largest names that announced strong results and a buyback programs (MPLX), and NGL on a small rebound from last week.  ET and PAA did not crack the top 5, despite strong earnings and bad YTD performance.  CEQP and HEP were notable losers this week.  HEP announced a new deal to adjust its economics due to a refinery conversion by its sponsor, which was not viewed as favorable to the MLP.

Week over week, GLP repeated in the top 5, no other repeats on either side.  YTD, DKL dropped out of the top 5, replaced by CAPL.  Non-traditional MLPs dominate the YTD winners list, helped by their differentiated businesses, but also by virtue of not being heavily owned by ETFs and MLP-focused funds that have seen outflows.

Midstream Corporations

Midstream corporations had a wide range of performance outcomes this week.  RTLR’s capital allocation decision and earnings were seen as positive.  Strong results and buyback announcements from TRGP, ENLC and PAGP helped them outperform.  Cheniere’s positive outlook drove large outperformance Friday and landed it a spot in the top 5 for the week.  On the downside, OKE was the worst performer after strong performance in recent weeks.

ALTM (not pictured due to small market cap) finished the week up around 200% after announcing plans for a dividend in 1Q 2021.

YTD, Cheniere reclaimed 3rd place overall this week, down less than 20% along with WMB and AM.  On the downside, RTLR jumped a few spots and OKE dropped a few spots, back in the -60% club with PAGP.

Canadian Midstream

Gibson’s earnings were not well-received, driving serious dispersion from its peers this week.  Outside of GEI, returns in Canada were tightly bunched with ENB leading the way.  Pembina traded poorly Friday, giving back gains built up to that point, but still finished ahead of Keyera.

Gibson repeated at the bottom of the group week over week.  On the YTD leaderboard, Gibson has now dropped into 3rd place overall, after leading the group for a few months.  TRP and ENB, with their stable outlooks and solid results, now lead the group, which is not surprising given their scale and financial strength in this volatile year for energy stocks.

News of the (Midstream) World

With earnings, there were a flurry of share buyback program announcements.  Some of them remain aspirational after debt reduction, but some are already being put to work (like TRGP and PAA).  We also got a few other examples of capital efficiency from TRGP moving a plant rather than building one and from NS selling another asset.  The sector’s self-help continues, which is good to see.

Capital Markets

  • MPLX announced authorization to repurchase up to $1bn worth of common units (press release)
  • PAA announced authorization to repurchase up to $500mm worth of common units (press release)
  • With earnings, EnLink Midstream (ENLC) announced $100mm unit repurchase program (press release)
  • In conjunction with a 30% distribution cut, Rattler Midstream (RTLR) announced $100mm unit repurchase program (press release)

M&A / Growth Projects

  • NuStar Energy (NS) announced sale of its Texas City Terminals to BWC Terminals for $106mm (press release)
  • With earnings, Targa Resources (TRGP) announced plan to relocate its existing 200 MMcf/d Longhorn cryogenic processing plant from North Texas to Permian Midland, where it will be renamed the Heim Plant (press release)
    • Will cost $90mm and be in-service in 4Q 2021
  • With earnings, Holly Energy Partners (HEP) and sponsor HollyFrontier (HFC) reached an agreement to terminate existing MVCs for HEP’s assets servicing the Cheyenne Refinery (press release)
    • HFC previously announced conversion of its Cheyenne Refinery to renewable diesel production
    • In exchange for MVC termination, HEP/HFC entered a new agreement starting 1/1/2021
    • New arrangement includes new 10-year lease with $5mm/yr lease payment and renewal options, a 5-yearcontango service fee arrangement whereby HFC pays base tariff to HEP for crude oil storage, and a $10mm one-time cash payment from HFC to HEP

Other

  • NGL Energy (NGL) provides update on bankruptcy proceedings related to a customer of the Grand Mesa Pipeline (press release)

Distributions

  • RTLR announced a 30% distribution cut, choosing to divert the cash towards buybacks
  • ALTM announced plans for a dividend and the stock ripped