Midstream executives pipe up as stocks go down
They say investors ignore the stability of companies’ revenues
Chief executives across the midstream industry united in a common complaint as they discussed secondquarter earnings: Their stocks are too cheap, they said, and the market is undervaluing their companies.
It’s not uncommon for executives to protest that their companies’ stock prices are too low. But some analysts say the sentiment may be justified as it applies to midstream companies, which provide oil and gas processing, transportation and storage.
Their companies’ equities have tanked by about one-third alongside oil in 2015, wiping billions of dollars from the value of a business that executives argue should linked only loosely to the price of crude.
“I’m mad as hell, and I’m not going to take it anymore,” Kinder Morgan’s co-founder and executive chairman, Richard Kinder, told investors during his company’s second-quarter earnings call, referencing Peter Finch’s crazed outburst in the 1976 movie “Network.” Share prices for the Houston-based pipeline giant have fallen by about 20 percent in 2015 — despite management’s insistence that the
overwhelming majority of revenue comes from contracts that pay the same whether the price of oil is $20 per barrel or $100.
Other executives have had the same complaint.
“Since the beginning of the year, we believe for technical reasons, the market has not rewarded us for our efforts,” Enterprise Products Partners CEO Michael Creel said during a conference call. Shares of Houston-based Enterprise Products Partners also have fallen 20 percent in 2015.
The sector-wide equity slide has thrown into the spotlight the debate about how much the value of midstream companies should be tied to the price of commodities they transport.
On one side are the midstream sector’s most outspoken leaders, who have structured their companies precisely to avoid the vagaries of the commodities markets. On the other side are bearish investors, wary of anything connected to the oil and gas bust.
And in between are most analysts, who see the challenges facing the industry and differ on how well it can meet them.
One thing that’s beyond dispute is that midstream companies haven’t been this cheap in years.
The Alerian MLPIndex, which tracks 50 large and medium master limited partnerships, has fallen by about 33 percent in 2015. U.S. crude oil has fallen by about the same amount since Jan. 1.
Many midstream companies are master limited partnerships, a corporate structure that offers tax benefits and requires that the companies pass along most of their cash flow in dividend-like payments to investors called unitholders who often are seeking steady income streams.
While weighing the Alerian MLP Index against the price of crude is of limited value because of the many variables affecting both, other midstream metrics have dropped as well. A common one is the ratio of enterprise value — a company’s debt plus the combined price of its outstanding units — to its earnings before interest, tax, depreciation and amortization.
The calculation essentially compares what it would cost to buy the company with its annual profit. Among midstream partnerships, this multiple has fallen near levels not seen since the financial crisis of 2008-09.
Midstream companies have traded at an average enterprise value about 11.4 times their EBITDA over the past nine years, said Greg Reid, a managing director at Salient Investment Partners. In June, the sector’s average multiple was 10.4, and recently that’s fallen to about 10. ‘Worst-case scenarios’
Reid believes those values are too low. A large part of the value of a midstream company today is its promise of a steadily rising dividend. Yet investors seem to be pricing midstream companies as if they won’t be growing much at all, Reid said.
“Investors perhaps have assumed worst-case scenarios,” he said. “They’re almost treating MLPs like there’s no growth right now. Historically, that hasn’t been the case. MLPs have grown dividends by about 7 percent annually.”
Reid’s view is common among analysts who have seen midstream companies approach prices of 2008 and 2009 and don’t think the current bust is as threatening. “2008 was far worse,” said Riccardo Bertocco, a consultant at Bain & Co. “The concern from the market is a bit overstated.” Not unscathed
But that doesn’t mean midstream investors or executives should expect to weather this oil slide unscathed, both Bertocco and Reid said.
Cutbacks by producers mean less need for new pipelines, and not all of the midstream sector is immune to low prices. Companies that own pipes closest to the wellhead are most at risk when the oil or gas dries up, and a few other companies take on more risk by owning the liquids they process.
Earnings growth is likely to slow somewhat in the short term, Bertocco said, and valuations need some adjustment.
“But the fundamentals are still there,” he said.
Others argue that cutbacks in drilling and pain in the upstream sector will have a larger impact on the midstream sector.
“I don’t think that as a whole the sector is extraordinarily cheap,” said Praveen Kumar, an executive director at the C.T. Bauer College of Business at the University of Houston. “Oil and natural gas prices are not going to head north anytime soon.”
And in addition to an oil bust, midstream companies are facing competition for yield-focused investors for the first time in years, Kumar said. The last time prices tanked in 2009, Kumar said, midstream companies rebounded well because low interest rates meant that the companies were among few good options for investors who were seeking yield and a steady, incremental return.
Today, the Federal Reserve is inching toward a rate increase, which will give investors other opportunities for reliable rising returns.
“The low interest rate environment was a very big factor in the stock performance of these companies,” Kumar said. “Once that moves away, it’s a negative signal for equity valuations.”
Some of those signals already are coming. Lowered outlook
On Aug. 17, debt rating firm Moody’s Investors Service lowered its outlook for the midstream industry from positive to stable.
Moody’s said midstream earnings growth will fall this year and next into a 3 percent to 5 percent range. Growth ranged from 15 percent to 18 percent at the height of the shale boom.
Moody’s analyst Andrew Brooks said the midstream industry already has built the most profitable pipelines, which means growth may diminish as new investments bring lower returns.
“In the back of our minds, we’ve wondered how long this growth and spending can be sustained before you have infrastructure needs largely met,” he said.
Moody’s assessment isn’t apocalyptic. A stable rating means the firm expects things to get neither better nor worse in the energy infrastructure space. That’s a better outlook than Moody’s has given oil and gas drillers.
“On a relative basis,” Brooks said, “they’ve held up pretty well.”