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February 18, 2018

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Week Thoughts: Roses are Red, Midstream is Green

MLPs finished positive for the week, but underperformed the rest of Midstream, the S&P 500, utilities, and oil prices.   The broader energy infrastructure index (AMEI) traded better on the back of a strong week in Canadian Midstream and some of the larger U.S. Midstream Corporations.

Midstream earnings released this week were better than last week, with 4Q results and 2018 guidance releases generally meeting the street’s expectations.  That wasn’t good enough to attract interest from the market distracted by the best weekly gain for the S&P 500 in more than a year.
MLPs still have a strong following among their base, but its clear that base is shrinking after a painful few years when MLP income has become more variable than in the decades prior.  A positive fundamental backdrop and continued execution should eventually bring the crowds back, but the penalty box is hard to escape when (1) leverage is stubbornly high, (2) coverage was fixed with distribution cuts and (3) IDR simplifications are still pending.
Poll Question: MLP Relevance
MLPs at one time seemed to offer it all, aligning a broad spectrum of investors.  High current income that is largely tax deferred.  Exposure to secular growth in building assets to support new regions of supply and demand in the U.S.  They also offered that exposure in the form of defensive assets that didn’t carry as much commodity price risk, akin to betting on the gold rush through selling pickaxes or dungarees rather than trying to bet on gold itself.
There was a lot to like, and it got boiled down into a strong sales pitch: income that doesn’t go down, but reliably grows and creates a large total return of yield plus growth.
All of that is history, but what I find interesting from my perspective as an institutional money manager is how married to the structure some investors still are.
I invest in MLPs to gain exposure to the theme of energy infrastructure and the defensive nature of certain assets owned by some MLPs that produce infrastructure-like returns.  But MLPs began as income vehicles with attractive tax characteristics.  A substantial portion of the MLP investor base remains interested in MLPs for those specific features and wouldn’t care much about Kinder Morgan or ONEOK, Inc. if they didn’t have shares leftover from their legacy MLPs.
So, this week’s poll question is a chance to share why you still care about MLPs, without the option of “all of the above”.
Sorry, there are no polls available at the moment.
Re-Booting a Universe
Marvel’s Black Panther was released in Theaters this week.  It was the 18th Marvel super hero movie released since the franchise launched in 2008 with Iron Man.  The films have combined to gross more than $14bn at the box office, making it the highest grossing film franchise of all time.  More than Harry Potter, Star Wars and James Bond.  Another 5 Marvel movies will come out in the next 18 months.
A few weeks ago, my two boys saw a trailer for Avengers: Infinity War.  It’s a crazy trailer, with like 25 different super heroes scattered throughout, including the gang from Guardians of the Galaxy.

My boys really want to see it (like they do after watching almost any movie trailer).  They hadn’t seen any of the prior movies, so my message back to them about Infinity War was: sure, we can see the movie when it comes out, but first you have to see these other 18 movies, so you at least know who everyone is.
So that’s what we’ve been doing, plowing through 3 Thor films, 3 Captain America films, and even Ant-Man.  As you know, Midstream and MLPs are never far from my thoughts.  So, I couldn’t help but draw a few parallels between the Marvel and Midstream universes.
First, Marvel’s success was sparked by the success of its first film: Iron Man.  MLPs are Iron Man in this analogy.   Without the huge success of Iron Man, the rest of the universe wouldn’t exist.  But Iron Man had his trilogy and is likely done being featured in standalone films (until the inevitable reboot).  Iron Man is part of the larger team and universe now, no longer THE guy.
Another parallel: just like with the Marvel universe, it’s hard to jump in to the Midstream sector today without knowing how we got here.  The history of pipelines migrating to MLPs then back into standalone corporations, their successes and struggles with IDRs, are critical to understanding why things are happening across the Midstream universe today.
This blog hopefully is a good place for investors to go for context and historical perspective on all things Midstream.  Thanks for reading as always, Happy President’s Day.
Winners & Losers
TEP went from second worst to first this week after reporting results and offering more commentary on the change in drop-down plan and expectations around the goals of the simplification (including not cutting TEP distribution, even a stealth cut).
CEQP continues to trade well.  DCP and BWP underperformed the group after reporting results.  A large holder of DM units sold out overnight Thursday, pushing DM down.

Three of the bottom five on the YTD leaderboard are sponsor-supported drop-down stories (DM, VLP, SHLX).  SHLX and DM both have had some pressure due to equity offerings or sales, while VLP hasn’t issued equity in more than a year and doesn’t need to this year.

General Partners & Midstream Corporations
Midstream corporations and general partners outperformed the MLP Index this week, on average.   SEMG bounced back to lead the way.  AMGP, TRGP and WGP reported results and traded well ahead of (WGP) or after (AMGP and TRGP) those results.   TEGP was the worst performer on what appears to be the beginning of a pair trade out there: long TEP, short TEGP on the eventual simplification transaction.  The bet seems to be TEGP will buy out TEP, but if the trade persists for too long, the reverse may start to make sense.

The top of the leaderboard year-to-date for this group didn’t change much week to week, AMGP joined the top 5 and each of the top 5 are positive.

Canadian Midstream Corporations
Canada was the best performing group in midstream this week.  Each one of the group was positive this week, although KML (again) and TRP standout at the top.  KML traded up all week, I guess on positive political momentum for Trans Mountain at the Federal level in Canada.  TRP rallied late in the week on earnings.

KML led the group for a second straight week, ENB lagged this week after outperforming last week.

News of the (Midstream) World

Capital Markets

  • Navios Maritime Partners (NMM) priced public offering of 18.4mm units at $1.90/unit, raising $35mm (press release)
    • Overnight offering, priced at 11% discount, and traded up 4.2% from pricing in the following session
  • U.K. utility National Grid sold 6.8mm units held Dominion Energy Midstream (DM) in a block trade Thursday night
    • National Grid received the units in August 2015 when the company sold the Iroquois Gas Transmission System
    • National Grid was the 2nd largest holder of DM units, and this trade represents all of their units

Growth Projects / M&A

  • TransCanada (TRP-CA) announced a $2.4bn expansion of its NGTL System to connect incremental supply and export capacity by 1 Bcf/d of natural gas at the interconnection with its Canadian Mainline (press release)
    • This follows NGTL’s recently completed open season for existing and export capacity at the Empress/McNeill Export Delivery Point that was oversubscribed
    • Service is expected to begin in November 2020 and the average contract length awarded to the expansion is 28.6 years
  • Andeavor Logistics (ANDX) announced one acquisition and two growth projects:
    • Acquisition of Wamsutter Pipeline System, a 575-mile crude oil pipeline, from Plains All American (PAA) for $180mm (press release)
      • ANDX expects the assets to provide EBITDA of $20-24mm, implying a 8-9x multiple, and expects the acquisition to be immediately accretive to unitholders
    • Development of North Dakota Logistics Hub, which will convert a segment of the Bakkenlink crude oil pipeline into NGL service to enable the transportation of mixed NGLs to a newly expanded fractionation complex at the ANDX Belfield procession facility
      • Project is expected to cost $140-150mm and deliver $22-26mm EBITDA, representing a 6-7x multiple
    • Two new crude oil gathering projects in the Delaware Basin for capex of $25-30mm with project completions in late 2018 and early 2019

Other

  • Canadian Natural Resources Minister Jim Carr told the House of Commons that the federal government would not let British Columbia “stall or stop” Kinder’s (KML-CA) Trans Mountain and would take necessary action to ensure the project proceeds (Global Mail)
  • Large MLP manager Kayne Anderson announced merger of two closed end funds (KYN and KED) and announced name change to reflect increased opportunities to invest in midstream energy corporations (press release)
    • The standalone MLP group does not support large AUM
    • The future is midstream, as we have written here lately, specifically in this post where the Elephants in the Room were discussed