In a world of wildcatting oil men, MLP management teams run unsexy, predictable business models. Assets aren’t built until long term and fee-based contracts securing the needed IRR are signed. Still, over the past two years, MLPs have progressed through the stages of an industry cycle in textbook form: shock, denial, panic, capitulation, and now—consolidation. July has shown that MLPs are taking their boring, conservative nature to an even higher level: flat distributions, asset sales to raise cash, and avoiding even slightly risky geographic areas.
Slashed Distributions Are (Sometimes) Praised
Third quarter MLP distribution announcements (reflecting second quarter results) are nearly all released. Of the 44 companies in the AMZ, 18 have increased distributions, 24 have held them flat, one has (technically) cut, and one is still unannounced. Many MLPs are choosing the conservative route of maintaining their distributions.
Investor response to distribution cuts has been counterintuitive. One would imagine that investors would punish companies cutting distributions, and yet, recent examples prove otherwise. Sometimes investors even reward a complete distribution elimination:
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CNX Coal Resources (CNXC), a $330 million MLP, elected not to pay distributions to subordinated unitholders, while also announcing coverage of 0.4x for the distributions to common unitholders. The units rose over 20% on the news.
Plains All American Pipeline (PAA) and Plains GP Holdings (PAGP) distribution cuts were announced amid a simplification transaction, but still, both stocks rose over ten percent.- On August 1st, the Williams Companies (WMB) announced that it would be cutting its dividend to send the extra cash to its MLP, Williams Partners (WPZ). WMB stock promptly rose about 6% on the news of the cut. WPZ rose about 9% that day, presumably because investors believed it would not need to cut its distribution.
Investors are not rewarding all distribution cuts, though. Seadrill Partners (SDLP), an Upstream Services MLP with a market cap of around $350 million, cut its distribution by 60% in July. This was the second cut within a calendar year and both cuts reflected negative changes in the underlying business. In response, the stock fell 30% amid questions of why it had not just ripped off the bandaid and dropped the distribution to zero.
Geese Laying Cash Eggs for Sale!
Kinder Morgan (KMI), while no longer an MLP, still acts as a bellwether for the space. Under the leadership of industry founder Rich Kinder, KMI has always been acquisitive. From one of the first in $5+ billion Teresen acquisition in 2005 to one of the largest in the $38 billion El Paso acquisition in 2012, this is primarily how Kinder has become one of the largest energy infrastructure companies. However, now the company is showing signs of a different approach.
All throughout 2016, management has focused on decreasing leverage by reducing debt. It started with the dividend cut in late 2015, but has accelerated to Kinder selling interests in assets it already owns, presumably to raise cash. In late June, it sold a 50% interest in its Utopia Pipeline to Riverstone Investment Group, and more than the purchase price alone, Riverstone will also reimburse Kinder (in cash) for 50% of prior capital expenditures. Valero (VLO) also announced that it had purchased the remaining 50% interest in the Parkway Pipeline from Kinder. VLO paid cash. And the largest: a sale of 50% interest in Southern Natural Gas to Southern Company (SO), for $1.5 billion. At a 10.4x EBITDA multiple, the price seems a bit low, although it was again paid in cash.
Kinder has repeatedly said that cash proceeds will be used to pay down debt, a step the credit rating agencies view positively. KMI will have further solidified its investment grade rating, but what is best for debt holders is not always what is best for the equity holders. (A very strong argument can be made for these steps establishing a solid base on which KMI can grow. The counter argument to that is that KMI has also reduced its need for expansion capex, meaning that it has canceled future projects. The rebuttal to that is that KMI can also grow value through financial means like share buybacks.)
Oh (No) Canada!
There are more ways to be conservative than just with cash. There are two recent examples of MLPs avoiding energy infrastructure in Canada. First, Devon Energy (DVN) sold Access Pipeline in Alberta not to its partner MLP, EnLink Midstream Partners (ENLK), but to Wolf Midstream. Presumably, ENLK did not want to expand into Canada? The Williams Companies (WMB) and Williams Partners (WPZ), mentioned above, are also selling their Canadian business, for expected proceeds of $1 billion, despite a recent press release touting the business’ merits. Williams may be making difficult choices like Kinder in selling assets, or perhaps it is deciding to avoid the region as ENLK is doing. Maybe both.
A Potential New Partner
As MLPs (and the broader energy industry) continue the consolidation phase of the cycle, it’s time to pay attention not only to what assets are for sale, but who’s buying them. Private equity traditionally buys quality assets at bargain prices, very rarely expecting only a modest return, although they are content with a long time horizon. MLPs themselves will often come to the bargaining table, of course. Now there is another potential and very competitive buyer: Utilities.
It’s not just Kinder working with SO. Earlier this year, Crestwood Equity Partners (CEQP) partnered with Consolidated Edison (ED). ConEd bought a 50% interest in four natural gas storage facilities and three natural gas pipelines. MLPs cannot own traditional Utility assets as they deliver energy to the end consumer, but Utilities have no such restriction on owning assets traditionally owned by MLPs. In fact, Utilities have performed very well this year, making their equity an attractive source of acquisition capital. For MLPs, the stability of locked-in long-term utility customers could be even more beneficial than the cold hard cash.
