Before I invest my money in an investment, I work hard to do my own "due diligence" so I have no one else to blame but myself.
Part of that process involves getting opinions and analysis from people I believe are smarter than myself and have a fairly good track record.
Before I bought two helpings of Atlas Pipeline Partners LP (APL), I read everything I could get my hands on including the company's own web site. I wanted to understand the "key statistics", especially the balance sheet numbers.
Master Limited Partnerships (MLPs) can be very tricky to understand and analyze. That makes the "due diligence" process both important and more difficult.
Frankly, I've been terribly disappointed with the results of my investment in APL, and I'm humbled by the fact that even when we try to know what we are doing and what we are buying, we sometimes get "burned". Look at the awful 1-yr. chart below:
Today's wretched economy and perilous stock market means both "danger and opportunity" for investors, but right now we are feeling the "danger" side and it is painful.
Many times there are forces beyond our control and unforeseen events that can make even the best "value" stocks plunge in the aftermath of a decent quarterly earnings report.
So it has been with APL, and the lessons I'm learning are myriad. First of all maybe we have reached a time where trailing stop-losses are more essential than ever.
Secondly, there are no opinions and analysis that are fool-proof, so don't invest in any company or human-directed enterprise where you can't afford to experience the results of "mistakes and miscalculations". Caution and circumspect are always essential.
When it comes to what to do now, I can't say it any better than one analyst has said it today. Chris Mayer who writes the newsletter Capital & Crisis explained to his readers his own frustration and lessons learned from APL.
Thank you Chris for allowing me this chance to share it and I hope it increases the number of readers who are interested in your work. For those of us who own APL, what you've written is more instructive than anything else I could find on the worldwide web today. Here's how Chris summed it up on March 5th:
Atlas Pipeline Partners
We got an earnings report from APL this week. APL owns and operates approximately 1,600 miles of natural gas pipelines in Appalachia. APL also owns 7,870 miles of gathering systems, a 565-mile interstate gas pipeline, seven processing plants and one treating facility.
You have to have a strong stomach to own APL. The stock has been cut nearly in half this week -- falling from $6 to about $3.30 as I write. There are a lot of things going on here. I will get into all of that more below.
But first, I want to say that I made two mistakes with APL initially. The first was that I compromised on my CODE system by admitting a company with such leverage -- APL has about a $1.5 billion in long-term debt, though none of it is due until 2013. It did not meet the “E” for excellent financial condition. I knew that. I rationalized it by looking at APL’s ample cash flows. And I was bullish on energy prices. Instead, energy prices tanked, and with them APL’s cash flows -- which gets to the second mistake.
The second mistake was not fully appreciating the commodity risk and complexity inherent in APL’s business. It is not as simple as pipelines would seem to be.
However, I’ve sorted through these things since we’ve owned it. And even though I don’t think we’ll see $40 per share for a long time, the current shares seem well below intrinsic value, assuming APL pulls through. I believe it will. While we wait, APL pays a sustainable distribution of 38 cents a quarter, or $1.52 per year -- assuming commodity prices fall no further . In a better commodity environment, APL has the potential to pay two or three times that.
A big part of APL’s cash flows is linked to the price of oil. That’s because a big part of its business is taking natural gas and turning it into natural gas liquids (NGLs) -- things like butane and propane. NGL prices tend to follow oil prices, averaging maybe 60% or so of the price of oil. Of late, that spread has widened even further, to little more than 50% of crude oil. This reflects lower demand from petrochemical companies and refineries -- the primary users of NGLs. Bottom line: This is hurting APL’s margins.
Lower natural gas prices also don’t help. Some of APL’s contracts give it 16% of the price of the natural gas that flows through its pipelines. Also, lower natural gas prices mean less drilling and fewer new wells connecting to APL’s pipelines.
And since APL has quite a bit of debt, the worry is that APL is going to have some financial trouble. The consensus is that APL will not meet its debt covenants. If that happens, the creditors come over the walls and extract their pound of flesh from the unitholders.
However, results from the latest quarter, guidance from management about APL going forward and a slate of impending asset sales mean that APL should meet all of its covenants and keep its creditors at bay.
Let’s take a quick look at each of these.
In the last quarter, APL generated distributable cash flow (DCF) of $75 million -- that’s after interest expense of $23 million. It’s also after some one-time gains. Back out the one-time gains and APL generated DCF of $37 million, or 80 cents per unit. This covered the distribution of 38 cents about twice. Volumes were up, and should be up again in 2009.
APL also wrote off all of its goodwill -- a noncash charge that led to the reported loss. Now book value is almost entirely made up of APL’s infrastructure assets with useful lives of 20-40 years. Book value per share is $16. That book value is a historic cost. The cost to build APL’s pipelines and processing plants today would be far greater than book.
Let’s turn to management’s guidance. Management anticipates $300 million in gross margin in 2009 -- even after the asset sales. If that turns out to be true, APL will be fine. The market doesn’t believe it. Management also maintains its current distribution of $1.52 annually is sustainable and “very likely to increase in the coming years.” It also said it expects to comply with all covenants with the asset sales.
Let’s move onto the potential asset sales, which include a 50% interest in APL’s Nine Mile processing plant, all of its Ozark assets and a portion of its Appalachian assets. These deals are not final. But management says we could expect to see them in a “few weeks.” APL also said that the deals would significantly delever APL.
Management did not give a dollar amount for these sales, so we can’t make too much of this right now. I don’t even want to speculate on how much these sales might raise. I suspect APL won’t get great prices in this environment, but we’ll see.
So what does it all mean and what do we do?
I’m leaving APL at buy, but realize it’s speculative. You have to have a strong stomach to own this thing. And if commodity prices go lower and stay there for a few months, APL is going to have problems. What ails APL is a heavy debt load and low commodity prices.
But it’s too cheap to sell at this point -- the distribution of $1.52 and the book value of $16 make the current price of $3.50 look absurd unless APL turns out to be a zero. Based on management’s guidance and the potential asset sales, I don’t think it will be a zero. Also, natural gas and NGL pricing has been destroyed. Any bounce here would greatly help APL’s business.
And for what it’s worth, Leon Cooperman, the longtime successful investor, added to his position in the fourth quarter. He is the largest stockholder and owns nearly 10% of the units.
The last lesson I'm learning from all this is "keep our investments very, very simple". Part of the big problem evidently with MLPs is that they have a more complicated internal structure and company set-up. It's not about how many units of natural gas or barrels of oil can they sell or move.
Analysts like Chris Mayer have a tough job and I'm convinced they do the best they can with the knowledge they are given. But even the sharpest minds (think Warren Buffett buying lots of Procter & Gamble (PG) or ConocoPhillips ) overlook certain factors that can be very costly to investors and to themselves.
On a day like today when the Dow closes below 6,600 and the Nasdaq below 1,300, we need all the encouragement and lessons-learned that we can find. So many "bargains" and "unprecedented opportunities" have turned into "quick-sand" that it's making us downright "gun-shy".
Hopefully we won't loose our resolve, we will separate our emotions from reality, and we will end up much smarter investors in the long-run.
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Disclosure: Long APL, COP, EPD, ESV.