COVID-19, OPEC, Midstream, and Comparisons to 2008
Total Page：16
File Type：pdf, Size：1020Kb
..................................................................................................... COVID-19, OPEC, Midstream, and Comparisons to 2008 ............................................................. MARCH 9, 2020 .......................................................... All of us at Chickasaw Capital Management LLC fully INVESTMENT TEAM respect and are engaged in the assessment of the novel Geoffrey P. Mavar – Principal coronavirus, COVID-19, as it relates to our employees, Matthew G. Mead – Principal clients, partners and friends. We share our sympathies Robert M.T. Walker – Principal Bryan F. Bulawa – Principal with the victims and their families. Paul R. Jacob – Vice President Below we offer our perspective for Energy and Midstream Scott B. Warren, CFA – Senior Analyst markets to give investors insights into our thinking. Luke B. Davis – Senior Analyst Much has been said about the coronavirus and the potential impacts and outcomes to the economy. At this point we cannot claim to know fully how events will unfold since the new paradigm created by how this disease is manifesting itself and what is still not known may categorize this as a “black swan event”. What can be said is that over the past few weeks we have witnessed increased volatility in the market that has led to historic events. The Dow Jones Industrial Average closed at a high of 29,551.4 on February 12th and has declined to 25,864.8 through March 6th, representing a (12.48%) pullback, which has been one of only 15 such pullbacks outside of the Great Depression over the past century. The Fed’s inter-meeting 50 basis point cut on March 3rd was one of only a handful of inter-meeting cuts over the past two decades. The 10-year Treasury rates are at record lows closing March 6th at 0.77%. Energy has been hit harder in this pullback than other sectors. Even though Midstream has held up better than other parts of the energy sector with the Alerian MLP Total Return Index (AMZX) down (26.9%) quarter-to-date vs. the Energy Select Sector SPDR Fund (XLE) down (29.2%), the decline is still the most rapid pullback for our universe since the Great Financial Crisis in 2008. But is it as bad as the financial crisis? We don’t believe it is. Last week at its most recent extraordinary meeting in Vienna, the Organization of the Petroleum Exporting Countries (OPEC) was discussing an additional 1.5 million barrels per day (MMbpd) cut in crude oil production on top of the 2.1 MMbpd quota currently in place. However, Russia, which has previously been act- ing in concert with OPEC but is not a member, chose not support the proposed cut. Reports as of this weekend indicate “...the decline is still the that Russia and Saudi Arabia will most rapid pullback for our both be increasing production to universe since the Great retain market share thus leaving crude oil to find lower price levels, Financial Crisis in 2008. But and shaking out more vulnerable is it as bad as the financial producers. crisis? We don’t believe it is.” ....................................................................................................... ................................................. ........................................................................................................ The Energy complex has already dealt with a recent Similarly, our research shows Midstream is much better commodity price correction from 2014 to 2016, where the positioned today than it was before the financial crisis, and this generic front month contract for WTI declined by over 75% improvement has been accelerated by the move to Midstream as it fell from $107.26/bbl in June 2014 to $26.21/bbl in 2.0. As a reminder the hallmarks of this shift include elimination February 2016. The ultimate impact to U.S. production from of incentive distribution rights (IDRs), increased distribution this price decline was a 1 million barrel per day (MMBpd) coverage, improved balance sheet leverage (measured as debt reduction year over year to 8.5 MMBpd. During that time to earnings before interest taxes depreciation and amortization period and since then domestic producers dramatically (D/EBITDA)), and increased cash retention for greater flexibil- improved efficiency, which helped to lower costs and has ity for corporate capital allocation. If we look back historically, allowed the United States to become one of the lowest cost coverage ratios in 2008 were closer to 1.1x versus nearly 1.5x producers of hydrocarbons globally. As of the end of 2019, now; access to equity capital markets is not needed today; and the U.S. was producing greater than 12.5 MMBpd. We believe we estimate D/EBITDA for the AMZX is currently 3.7x versus the vast majority of domestic producers should be able to our estimate of 3.6x in 2008. Ironically, with all these improve- withstand the front month WTI contract price decline, but ments the equity prices are currently indicating the future it’s logical to assume that there will at least be a flattening outlook for these companies is as bad as it was in 2008 when of growth or even a near term pullback. It’s important to measured by the Price to Distributable Cash Flow (P/DCF) met- emphasize that typically when these events have happened ric, which is registering a lower valuation than in 2008. We it is initially painful, but the effects are not long lasting. We strongly believe we have a severe, momentum-driven, discon- will obviously continue to be monitoring this fluid situation. nect between fundamentals and valuation. Alerian Weighted P/DCF Alerian Weighted Price to Distributable Cash Flow (P/DCF) The current Weighted Average Average P/DCF ratio is the 16x minimum for historic periods. 14x 12x 10x 8x 6x 4x Source: Bloomberg, Chickasaw Average = 10.3x | Current = 4.7x | Minimum = 4.7x Bloomberg, Chickasaw, 3/6/20 chickasawcap.com | 800.743.5410 See “Additional Information” at the end of the presentation. Midstream Valuation | 2 ................................................. OBSERVATIONS & OUTLOOK . MARCH 9, 2020 ................................................. ........................................................................................................ Let’s return to the fundamentals. Take or pay contracts in periods of dislocation to generate additional cash flow on long haul pipelines within our portfolio are largely beyond the requirements of their underlying contracts. covered by minimum volume commitments (MVCs). Put If we were to contrast the industry’s contract profile another way, the counterparty has to pay whether vol- to 2008, some important and crucial differences are umes flow on the pipeline or not. We recently examined apparent. In terms of similarities between 2008 and now, pipelines owned by our portfolio companies tied to two the security of the contracts on long haul pipelines and of the most important onshore basins — the Permian and other demand facing assets have remained alike. the Marcellus/Northeast. On a combined basis, we found Gathering and processing and certain other Midstream that even if volume growth slows materially, the maxi- activities, though, had much more variability as both cash mum impact to our portfolio EBITDA is less than 3% due flow and volumes were more equity-incentivized to align to the presence of MVCs. with producer activities, which created greater sensitivity There could be some variability around certain assets to swings in production and commodity prices. that are closer to production activities, which represents We believe the most significant improvement over ~20% of the portfolio’s cash flows, but a few things need the past 12 years is in company balance sheets, which to be considered. First, Midstream companies with gath- helps companies weather the global business cycle better ering and processing assets are by and large diversified when changes occur, such as now. Revolver balances, as a across basins. Second, the majority of these assets are percentage of total debt, are the lowest since we started integrated into large value chains truly connecting supply measuring in 2008 at 8.9% across the industry, and we to demand, and are not tied to single producers. Third, estimate there is $75 billion of available liquidity across the majority of these contracts have similar protection the sector (if needed). Today we face near term uncer- mechanisms as would large diameter takeaway pipelines. tainty around business conditions, which we believe will This is exemplified by our estimation that over 90% of the be resolved in time. However, in 2008, Midstream faced cash flow of our total portfolio is fee-based. Lastly, com- a greater uncertainty around their near-term business panies with large integrated systems will find opportunity fundamentals, which was coupled with a liquidity crisis. Revolver / Total Debt Revolver / Total Debt 35% 30.9% 30% 25% 20% 14.2% 12.6% 10.7% 15% 18.3% 10.7% 9.4% 10% 12.8% 14.2% 9.8% 9.2% 5% 8.9% 0% 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Bloomberg, Chickasaw, 2/29/20 Source: Bloomberg, Chickasaw .................................................chickasawcap.com | 800.743.5410 OBSERVATIONSSee “Additional Information” at the& endOUTLOOK of the presentation. MARCH 9, 2020 .................................................Midstream Valuation | 1 ........................................................................................................ As a result of Midstream 2.0 and well-managed balance are non-investment grade companies, but the majority sheets, we don’t expect