By Jason Born CFA
We appreciate companies that manage their balance sheets conservatively and return a lot of cash back to investors. BreitBurn Energy Partners LP (BBEP) seems to be just such an animal and so today, we take a look at what they are doing that may encourage a bidding up of their unit price.
BBEP is one of a myriad of companies structured as a limited partnership in the domestic energy space in the U.S. It is different from the most famous of those limited partnerships in that it does not compete in the midstream realm of moving natural gas or oil from one place to the next for a toll. Rather, BBEP is an upstream exploration and production company. As you read this, please remember that this fact means that BBEP will be more reactive to the actual prices of the commodities it produces when compared with its midstream cousins.
A second important factor to understand about BBEP's business is its mix of natural gas and oil. BBEP is heavily reliant upon natural gas in producing its revenues. Most recently, approximately two-thirds of its revenue came from natural gas. Many of its upstream peers compete on a more level footing as they produce revenues from a more liquid-based stream.
Heretofore, BBEP has been successful at hedging its production, effectively stabilizing revenues in the face of a tremendous price decline of natural gas over the past several years. Increased supply via "fracking," is, of course, the culprit with regard to the drop in the value of natural gas. But it must be pointed out that BBEP's success at shaving the volatility of its revenue via the futures market has a limit and as contracts roll, the lower prices for its chief product will eventually flow into its financial statements.
We, however, are not cowed by lower natural gas prices -- which firmed slightly in the last six months. We believe that demand will find this supply. Period. In an era when companies look for cheap sources of energy and when the Federal Government hastens the closure of coal-fired power plants, the easiest, cheapest, cleanest, and most readily available alternative energy source will be natural gas. Should the Federal Government under the present administration decide to put a lid on "fracking" because of environmental concerns, so much the better for our thesis of natural gas, as a large amount of supply would disappear.
So to summarize our forecast for BBEP's revenues, we believe that short-term pressure (one to two years) on revenue will eventually abate and growth will occur once again . We have not discussed the one-third of the company's revenue from oil, which will help absorb some of the shock from lower natural gas prices.
The company is acquisitive, making one or two add-on buys each year. It makes these purchases with cash raised from operations and unit issuance. The balance sheet for BBEP is very conservative (debt to total capital is a low 37%). As an upstream player, it ought to have less debt in its capital structure than those involved in the midstream world, but BBEP has a considerably lower amount of debt even versus its upstream competition. A limited partner purist may say that this is a strike against the company. Such a purist may say that it should issue more debt rather than shares to make acquisitions and make additional distributions to partnership units. We won't argue with this position. We note, however, that the current conservative structure allows us to buy into this company in the face of decreasing natural gas prices with confidence that a liquidity crisis will not force asset sales at an inopportune moment. Conservative is always better in our minds and in any event, management can always decide to ramp up debt when they feel prices will improve over time.
Since most readers taking the time to look over our words want yield, yield, and more yield, it is prudent to discuss the distribution. The dividend WILL be more volatile than that of midstream companies. For 2012, the annual rate will be about $1.80, or just under 10%. Moving forward we think the bottom for the dividend may be $1.00 per share, or 5.5% as natural gas prices bite and current weaker oil prices ripple through . This lower yield puts it in line with its midstream friends. However, recall that we see an improving situation on the horizon, so we expect an increase from there.
In sum, we believe BBEP has shown that it is capable of navigating the treacherous world of the current natural gas business. We believe that a bottom yield of 5.5% ($1.00/$18.30) is fair for long-term investors, and would begin to accumulate units in this range. If the market price drops to the $17, or even $16 range, we would confidently add more. Conversely, should the market gods decide to bid them up closer to $22 for some inexplicable reason, we recommend investors sell their position at a handsome profit.
Disclosure: I am long BBEP.