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November 5, 2017

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Week Thoughts: SelfFundMe Campaign

MLP prices were down for a 4th straight week, but counting distributions (and they do still count!) MLPs produced a slightly positive return overall, despite Thursday’s 2% decline.  Strong oil and natural gas prices, solid earnings overall were balanced against tax reform uncertainty and distribution ex-dates, both of which held MLPs back from a more robust rebound.

Fundamentals of the sector (i.e. operating results of midstream companies, supply and demand backdrop, commodity price backdrop) are improving, which raises questions from midstream/MLP fans as to why the stocks aren’t working.  For enough of the sector, financials (leverage, coverage, unit count, etc.) remain a headwind to broad interest in the sector.  Beyond financials, midstream seasonality (tax loss selling, distribution payments) and uncertainty on impact of tax reform are also weights that will be shrugged off with time.
Tax Reform
On tax reform, I don’t believe it’s a massive driver for the midstream sector overall.  Many companies have already switched from MLP structure to corporate structure, and many retail investors have already eschewed MLP exposure or own the sector through open-end mutual funds.
So, tax reform that makes MLP tax benefit marginally less attractive doesn’t feel like it will be some huge catalyst in either direction, outside of some short-term volatility like we got this week as traders look for winners and losers.
The buzzwords of this earnings season are “self-funding”, which essentially means funding growth capital plans in a way that maintains your share count through a combination of retained cash flow and debt.
I have a long-term goal for my children to be self-funding.  Right now, that seems like a fairy tale, but it is in the realm of possibility some day in the distant future.
According to statistics released last year, more young adults (18-34 year-olds) live with their parents (32.1%) than live with a spouse or partner (31.6%), the first time in 140 years since that has been the case.  So, because I have 3 kids, chances are one of them will linger on like the main characters of Step-Brothers.

My dog, on the other hand, is a straight up dependent, and won’t be self-funding unless it becomes the star of a national ad campaign like Spuds Mackenzie, aka the Original Party Animal.

Self-funding as a goal puts the cart before the horse for a number of midstream companies.  Before self-funding comes earning enough cash flow to cover your distribution.  As we’ve seen in recent months, the easiest way to meet that pre-requisite is to pay a lower distribution, so be careful what you wish for…
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Status Update
Tuesday marked the end of another month.  While month-end coincided with Halloween, October didn’t finish quite as scary as it could have after a 4-day, 3.3% rally off 52-week lows to close the month.  The MLP Index has declined in 6 of the last 8 months and 3 of those months have seen 4%+ declines.
October has recently become one of the weaker months for MLPs, when before 2014 it was a consistently strong month in the lead up to distribution payments in November.  This year was the 2nd straight 4%+ declining October, and 3rd in the last 4 years.

Looking ahead, November has historically been neck and neck with May for the worst performing month, which makes sense because quarterly distribution payments happen in both May and November.
Winners & Losers
Earnings and commentary on earnings calls drove of performance in both directions this week.  CNNX led all MLPs with a 5.8% return on the back of solid results.  CEQP hit all the right notes on its conference call after besting analyst expectations for the quarter.  BKEP also reported results.  AM was the first MLP of the quarter to really whiff relative to market expectations, and the stock sold off as a result.  NS’s weak distribution coverage and high leverage continues to plague its stock price.

A tale of two nearly irrelevant MLPs: two straight weeks in the top 5 for CNNX, and two straight weeks in the bottom 5 for CCLP.  On a year to date basis, not many changes.  There are still just 5 MLPs with 20%+ returns YTD (excluding those acquired).  PAA’s strong week wasn’t enough to pull it out of the bottom 5.

General Partners and Midstream Corporations
LNG and TRGP were standout winners among general partners and midstream corporations, even as the group overall underperformed the MLP Index this week.  LNG’s rally likely on the back of global oil price strength, while TRGP’s was more of a relief rally on strong 3Q results, especially in terms of G&P results.  TEGP bounced back but fell short of reclaiming all of last week’s losses, despite ongoing execution from TEP, as evidenced by another strong quarter. On the downside, AROC and subsidiary APLP had weak results that hurt stock price performance.

Some movement in YTD leaderboard among the group to note:  OKE has rolled over and fell out of the top 5, leap-frogged by TEGP and ETE.  LNG took over the top spot from EQGP, and NSH took over the bottom spot from PAGP.

Canadian Midstream
Wider than usual disparity of price performance this week in Canada.  Two of the three largest players in Canada, Pembina and Enbridge, reported 3Q results this week.  ENB left some lingering uncertainty as to the pace of future dividend increases with the cliffhanger unlikely to be resolved until analyst day in December.  Pembina reported the day after ENB, and had solid 3Q results, but the strength of its balance sheet and ongoing execution stood in stark contrast to ENB.

Just a few weeks ago, all Canadian Midstream corporations had positive YTD returns in USD terms. Not so anymore…

News of the (MLP) World
Little news outside of earnings.  It is refreshing to see AMID continue to roll up small-cap, zombie MLPs to the benefit of the sector.  ANDX and HEP separately closed their IDR simplifications this week, another positive trend for the midstream sector.  The news we didn’t get was closure on Enable Midstream’s general partner situation, as Centerpoint’s earnings Friday offered no new update.

Capital Markets

  • Noble Midstream (NBLX) filed S-3 to register up to $125mm common units for sale (filing)

Growth Projects / M&A

  • CVR Refining (CVRR) announced acquisition of certain PAA assets and the joint venture of Midway Pipeline, LLC (press release)
    • The 50/50 JV of the 100-mile Cushing to Broome pipeline system will continue to be operated by PAA
    • PAA also agreed to sell a 100-mile crude oil pipeline from Cushing to Ellis to CVRR
  • Crestwood (CEQP) announced sale of US Salt, LLC to Kissner Group Holdings for $225mm (press release)
    • CEQP believes the proceeds will eliminate the need to access the equity capital markets through 2018
    • The divestiture and subsequent return on re-deployed capital is expected to be 3-5% accretive to DCF/unit by 2019
  • American Midstream (AMID) announced acquisition of Southcross Energy Partners (SXE), including its general partner and common units in two transactions valued at $815mm all-in (press release)
    • AMID will acquire 100% of the limited liability company interests of the GP of SXE and 55% of the SXE common units from Southcross Holdings by issuing 3.4mm AMID units, 4.5mm new Series E convertible preferred units, options to acquire 4.5mm AMID units, and the repayment of $139mm of estimated new debt
    • SXE unit holders will receive 0.160 AMID units for each SXE unit
    • ArcLight Capital, AMID’s sponsor, agreed to transfer 15% of AMID’s IDRs to Southcross Holdings as part of the transaction
    • The transaction is expected to be single-digit accretive to DCF/unit in 2018 and 2019, approaching double digit accretion in 2020 while maintaining coverage of 1.1-1.3x
  • American Midstream (AMID) announced dropdown of an additional 17% interest in the Destin Pipeline from ArcLight Capital Partners for $30mm (press release)
    • AMID will own 66.67% interest in Destin following the transaction
  • Blueknight Energy (BKEP) announced acquisition of two asphalt terminalling facilities for $32.5mm to be financed with $10.5mm equity and $22mm cash (press release)
  • EnLink Midstream (ENLK) announced two new 200 mmcf/d natural gas processing plants in Central Oklahoma (Thunderbird) and in the Delaware Basin (called Lobo III) (press release)
    • Thunderbird expected to be in-service by 1Q 2019
    • Lobo III expected to be in-service in 2H 2018
  • Summit Midstream (SMLP) announced expansion of its Weld County, CO gathering & processing complex with a new 60 mmcf/d processing plant (press release)
    • Plant expected to cost $60mm and to be in-service by the end of 2018

Distribution Announcements
A few (7 by my count) midstream distribution announcements still dribbling in this week.  We should be almost entirely done at this point, with only a few smaller names left to announce.

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