The MLP index pushed higher Monday and Tuesday to reach its highest point since 5/2, before falling back again the last 3 days of the week on weaker oil prices and due to challenge of funding a large equity deal on a Friday before a long weekend.
Now that OPEC is behind us, and now that we’ve had 7 straight weekly declines in U.S. oil inventory, expect sentiment for energy stocks to improve from here (can’t get much worse). Oil prices in the $50-60/bbl range seem to “work” in terms of U.S. oil production growth. U.S. production growth benefits midstream as a whole.
Growing confidence in U.S. production growth outlook makes climbing the wall of negative midstream sentiment less macro and more sector-focused. Capital discipline and rationalization of spare infrastructure capacity balanced against efforts to protect existing and future market share.
The MLP version of the “Plunge Protection Team” can only do so much without a change in sentiment that leads to a renewal of MLP interest and a ramp up of fund flows. In the absence of new flows, every MLP has to compete for limited capital and may feel the need to take drastic measures to shove their way to the forefront. Like NS did with its splashy Permian acquisition, like TRGP did with its equity deal this week, and like Trump did when he shoved a lesser NATO member out of the way before a group photo in Brussels this week.
Sentiment in midstream may hinge on a second half recovery that shows growth in cash flow per share, as opposed to the profitless recovery to date. That leaves the sector in something of a limbo period until that 2H2017 ramp. Investors are also being asked to pay to wait on that cash flow per share recovery as midstream capex ramps up again.
Drop-down MLPs struggled in the second half of the MLP downturn – the capital markets-driven portion of the downturn – because their business models depend explicity on access to capital. But it was not just their reliance on capital markets that hurt them, it was their willingness to issue equity at prices much lower than their current price. It was the reality that drop-downs would still be accretive, the math still worked even if their unit prices were 20% lower than their prior equity deals, and the market knew it.
If you are trading at 18-20x EBITDA and buying cash flowing assets for 8-10x, then you don’t really mind if you trade down to 15x and issue equity there, your cost of capital still makes the drop-down “accretive”.
This has bled over into non-drop-down MLPs now that they are ramping back up capital expenditures. If you have a 6-8x EBITDA project, issuing equity at a 10-11x multiple still works, even if you were trading at a 13-14x multiple just a few months before.
The chart below shows equity deals in the midstream sector since SXL’s offering to fund a Permian acquisition in September 2016. SXL stock purchased in that deal is down 15%+ since then, not counting the 7.4% discount if you bought just before the deal. Other MLPs have fared better, some worse, but overall MLP deals have traded better than corporate deals. The deeper pool of capital available to 1099 issuers has been tested this year with massive equity deals at tighter discounts that and have traded worse than MLP deals.
The cost of carry for high multiple M&A and low multiple (but long-dated) growth projects is born by shareholders, and eventual accretion is likely to be masked by other strategic moves in the interim. This is nothing new for MLPs (MWE at the beginning of this decade comes to mind).
The timing doesn’t help MLP sentiment, however, when investors are asked to bear the burden of additional growth projects despite not yet seeing a fulsome recovery with existing assets. Its basically the inverse of what Wimpy used to say in Popeye: Pay me today for a (probable) hamburger Tuesday.
Competitive dynamics and market share concerns make offensive/defensive growth efforts imperative, sparking a movement towards greater scale, integration and in-sourcing of volumes. With a finite amount of investor capital, these big strategic moves will eventually lead to winners, losers and sector rationalization, but the weeding out process may take much longer and prove more costly to the eventual winners than I would have guessed 2 years ago.
This environment can actually be very good for stock picking, because the stakes are so high. Even if it takes a long time, the eventual winners will be integrated operators with scale and access to capital that should put the sector on much firmer footing over the long-term.
Winners & Losers
SXCP led the sector this week as the only MLP up 5%+. SXCP’s only news was the successful tender of 2020 notes with proceeds from recently issued notes due 2025. WPT was positive on a revised offer from its sponsor. TGP and TOO bounced a bit after last week’s carnage.
On the downside, NGL dropped another 10.4% despite meeting their pre-announced quarterly EBITDA in results released this week, as leverage remains a concern for the market. CCLP made it two straight weeks near the bottom of the group.
Year to Date Leaderboard
No change to the group at the top of the sector as compared with last week. On the downside, EEP continues to climb out of the hole as other MLPs falter. This week’s NGL decline dropped them into second to last for the year so far.
General Partners & Corporations
GPs and midstream corporations were roughly in-line with MLPs this week, with the median down 1.4%. Only 3 out of the group were positive, with AMGP as the clear outlier after a rough initial few weeks after IPO. TRGP was the worst performer before their equity offering, which solidified their spot at the bottom. Other high beta names PAGP and ETE struggled with weak oil prices.
LNG and OKE made it two straight weeks in the top 5, ENLC and WGP made it two straight weeks in the bottom 5.
News of the (MLP) World
It ended up being a pretty busy week for news, after a slow start. Kinder Morgan Canada priced its IPO and announced FID on its Trans Mountain Expansion, TRGP threw down an NGL pipeline gauntlet along with a boat load of equity, and CEQP announced incremental with its Permian plans. Also, PAA updated its outlook at analyst day.
Growth Projects / M&A