Raymond James Analyst on MLPs and the Outlook for Natural Gas

VettaFi recently sat down with Raymond James analyst J.R. Weston to discuss the outlook for the midstream space, consolidation in the industry, and investment opportunities in MLPs and C-corps.

Despite volatility in energy prices, midstream companies largely performed well during the first quarter. Natural gas prices were down $3 or $4 from the same quarter last year. However, that did not seem to have a material impact on earnings or performance, Weston said. Marketing and optimization services seemed to drive much of first-quarter performance, he added.

However, while many midstream companies reported earnings that beat Raymond James’ expectations, not many companies were willing to take the next step and raise guidance.

“I think the overall resiliency of the business models was nice to see, but I’m still kind of looking for the next step of actually raising guidance for the year,” Weston said. “I think it’s something that a lot of people have in mind for a catalyst for maybe the second quarter.”

Weston said that first-quarter reports showed examples of early capex creep. This isn’t necessarily a bad thing, however.

“The added capex has been something that is perceived to be holding back a few of the companies now, even if it’s the right capex,” Weston said. The capex creep observed in the first quarter should be perceived as beneficial to the businesses, he said.

There are types of capex that are favorable for the midstream space. The good kind must fill a strategic need in some regard. An example is improving asset integration.

“I think the easy example would be somebody like Targa continuing to fill out the natural gas and natural gas liquids value chain,” Weston said. “Multiple processing plants in flight, an NGL pipeline expansion underway, two fractionators being built right now, an expansion of their LPG export facility being completed. Things that fit the… core competency of the businesses.”

Another type of good capex pertains to things that have a solid line of sight into the return profile. “Whether it’s how the projects are contracted, or just the market’s overall perception of the sustainability of the volumes that might be serviced by the new assets,” Weston added.

Institutional investors are clamoring for buybacks right now, even at the expense of dividends or distribution growth.

“We had gotten to a point earlier this year where I think the overall conversation had matured a little bit there,” Weston said. “We were talking more about total shareholder returns, rewarding companies with large yields that were maybe able to provide a little bit of dividend or distribution growth and not stressing buybacks so much.”

However, in the last month, the trend has pivoted back to buybacks. Weston said that part of this shift is likely a response to stocks being weaker as of late. Therefore, the perceived returns on buybacks are even stronger.

In the weeks following first-quarter earnings, Weston said that conversations in the midstream space have largely focused on natural gas. The big selloff and improving fundamentals are in particular focus.

“You’re seeing supply starting to tighten up a little bit. So, there are some trends that are positive within the gas market itself,” Weston said.

Weston noted that those trends are improving the risk/reward picture for natural gas. Accordingly, investors are starting to position for a recovery in natural gas prices.

The other offshoot of the natural gas conversation is on the logistic side, Weston said. With high LNG demand along the Louisiana Gulf Coast as well as in Texas, coupled with lower natural gas prices and more of a supply push headwind in the Haynesville, a question arises: Where do you source the gas?

“The question is kind of how do we get gas from, let’s say, the Houston area very broadly into Louisiana, then ultimately to the LNG facilities?” Weston said. “So I think there are some interesting logistics opportunities there that are getting a little bit more attention.”

Since late April, Weston said that demand from power generation has been higher, which has been a surprise. Additionally, prices coming down in Europe and maintenance of facilities in the U.S., including the Freeport facility, led to uncertainty in LNG exports. That has also surprised to the upside.

“U.S. natural gas prices should have come up a little bit, and I’m not sure we’ve totally seen that across the strip,” Weston said. “I think maybe ‘24 has looked a little bit different, but kind of front month here, still awfully weak and a little bit frustrating. I think some upside to the strip is pretty reasonable to assume right now.”

Raymond James is pricing natural gas under $3 for the full year 2023. For the second half, Raymond James is pricing $2.85 for the third quarter and $3.30 for the fourth quarter.

“That would suggest a little bit of upside to the current strip as it stands at this moment, and you could argue that supply and demand fundamentals have gotten even better over that month,” Weston added. “As ‘23 gets tighter, the gas market is cumulative, and that’ll impact ‘24 expectations as well. Maybe a little bit more upside to the strip would be how I would think about things there as well.”

Midstream corporation ONEOK (OKE) surprised the industry last month when the firm announced that it will acquire MLP Magellan Midstream Partners (MMP) in a cash-and-stock deal valued at $18.8 billion.

“ONEOK had been trading at a premium for a while. Magellan was as well, but I think ONEOK was the one that investors had perceived to be needing to do some sort of a deal,” Weston said. “Whether or not that was actually true, I don’t think management necessarily looked at it the same way.”

Weston said that management likely saw this Magellan deal as a bit more of a strategic long-term play, rather than the investor concern that the firm needed to go out and do something to take advantage of their premium valuation.

“It is probably underappreciated how much Magellan did in terms of batching and blending. That does overlap with ONEOK a fair bit better than what people expect,” Weston said. “Access to the water is obviously quite valuable… I think that there is a fair bit of synergy potential.”

The tax items are probably being overplayed by investors, Weston said. He thinks the narrative that ONEOK’s cash tax situation forced their hand — and is perhaps the only real driver for the deal — is definitely incorrect.

“Consolidation in general I think is an important theme,” Weston said “We’d love to see more of it. As long as it makes sense and valuations are reasonable for both parties, asset level M&A still seems like it should be something that is a big focus.”

There are network effects in the midstream space where bigger can be better; however, the M&A market is poised to be slower, so investors shouldn’t expect to see a ton of deals in the near future.

Raymond James currently has six strong buy-rated names, including Cheniere Energy (LNG), Targa Resources (TRGP), Enterprise Products Partners, LP (EPD), Energy Transfer, LP (ET), Plains All American (PAA), and Plains All American (PAGP).

Weston said that MLPs versus C-corps is an interesting conversation right now. All else being equal, he said that Raymond James likes the kind of added exposure that C-corps offer compared to MLPs.

“Targa, in particular, being an S&P 500 constituent — I think that does ultimately matter and [is] making them a bit more accessible to generalists,” Weston said. “Cheniere is still trying to get there. But Williams, DT Midstream, Kinder, ONEOK, all some sort of S&P constituents. So I think that does ultimately help those names.”

Conversely, Weston said that looking at current valuations, investors should not write off MLPs. From a tactical perspective, there’s a wider valuation spread between the two at this point.

“Tactically, it could make sense to like MLPs a bit more,” Weston added.

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