The midstream companies of North America belong to the beneficiaries of the booming shale oil and gas production, and their stocks have risen significantly during the last six months. Investors are seeking yield in an industry they predict has a stable growth outlook. Several other beneficiaries from the ongoing North American production boom were also analyzed here, here, and here.
However, this flight to blue-chip dividend-paying stocks seems to be running on nothing but thin air. In most cases, the fundamentals are absent among the midstream companies. Ignoring the fundamentals, and investing as if there is no tomorrow is a recipe for disaster. The careful examination of the key metrics of the balance sheet combined with the growth catalysts for each case separately, is a must for me.
I know I am moving opposite to the trend currently, but all my bearish calls since September 2012, when I started writing for Seeking Alpha, have yielded a lot of money to those who followed them. Even my recent bearish calls on GMX Resources (GMXR), James River Coal (JRCC), Africa Oil (OTCPK:AOIFF), BPZ Resources (BPZ), AK Steel Holding (AKS), Capstone Turbine (CPST) have yielded from 10% up to 80% in a very short period of time. The recent performance of the aforementioned stocks speak volumes. To prove my point, my bearish articles are here, here, and here.
In this series, I'll analyze the major midstream companies. I determine as major midstream companies those with market cap from ~$15 billion and higher. This is the first part of this series. The small players of the midstream sector will follow later.
Once I am done with these three groups (small, intermediate, major midstream firms), I'll unearth some additional midstream companies, which are brand new entrants into the midstream sector and fly under the radar currently. This group of brand new entrants could hide the firms with the highest potential along with some acquisition targets. This is why, I believe that these articles will be very interesting for the proactive investors.
Let The Numbers Speak For Themselves
Now that the annual reports are out, let's check out the key metrics of the first five major midstream companies:
EV: Enterprise Value
CF: Annual Cash Flow
EQ: Stockholder Equity
I do not like companies with marginal or low operating margins, let alone cases where the low operating margin is combined with high D/CF ratio. Add to this a high PE, and the whole package is scary to me. This is the case for Energy Transfer Equity (ETE). Energy Transfer is in the worst situation among these five companies, followed by Energy Transfer Partners (ETP) and Kinder Morgan (KMI). This is why the high dividend yield of Energy Transfer Partners does not mean anything to me. Energy Transfer Partners is in a very bad shape fundamentally.
The long-term debt for each of these three companies doubled in just one year. All three of them have outrageous valuations currently, as the table above proves. They are the major players of the sector, and a decent premium could likely be justified. The current huge premium is inexplicable. It seems that the momentum traders are more than the fundamentalist investors currently, pushing these stocks higher and ignoring the horrible fundamentals.
Kinder Morgan Energy Partners (KMP) lost money in 2012, and its debt metrics should worry any prudent investor. Apparently, the company's satisfactory operating margin is not enough to beautify the whole package. Kinder Morgan Energy Partners has a lot of work to do to improve its balance sheet, which is being loaded with new debt after the latest acquisitions mentioned below.
Enbridge (ENB) is a very mediocre case overall. Low operating margin, high D/CF ratio, high PE and low dividend yield create an unattractive compound currently.
Potential Upside Drivers
To give all a more complete idea for the aforementioned companies, I will also provide the most significant growth catalysts for each one of them, on a going forward basis.
1) In 2012, Kinder Morgan acquired El Paso, adding 44,000 miles of natural gas pipelines to its network and overloading its balance sheet with a ton of debt.
In January 2013, Shell (RDS.A) and Kinder Morgan announced their intent to form a limited liability company to develop a natural gas liquefaction plant in two phases at the existing Elba Island LNG Terminal, near Savannah, Ga. Shell and Kinder Morgan have agreed to modify Elba Express Pipeline and Elba Island LNG Terminal to physically transport natural gas to the terminal and to load the liquefied natural gas onto ships for export.
In March 2013, Kinder Morgan Energy Partners completed the acquisition of 50% of El Paso Natural Gas Company, L.L.C. (EPNG) and 50% of former El Paso Midstream assets in Utah and South Texas from Kinder Morgan. Kinder Morgan Energy Partners now owns 100% of both EPNG and the midstream assets. Through this transaction, Kinder Morgan "acknowledges" its debt problem that I pointed out above, and it intends to use the proceeds from the dropdown to pay down its debt.
In early 2013, Kinder Morgan Energy Partners acquired Copano Energy LLC, which has interests in about 6,900 miles of pipelines and nine plants.
In January 2013, Kinder Morgan Energy Partners entered into long-term contracts to support construction of an additional 1.2 million barrels of merchant storage capacity at Trans Mountain Pipeline's Edmonton terminal in Strathcona County, Alberta. Construction of the new tankage is scheduled to commence this spring with completion expected in late 2014. Construction of Phase 1 of the expansion, which consists of 3.6 million barrels of new storage, is well underway and all of that capacity is expected to be in service in late 2013. The new tanks will serve Trans Mountain's Edmonton hub, contributing in the export of Western Canadian crude oil to new markets.
In January 2013, Kinder Morgan Energy Partners also announced an expansion project and acquisition that will provide additional infrastructure to help meet growing demand for liquids storage and dock services along the Gulf Coast.
3) In 2012, Energy Transfer Partners acquired Sunoco's 7,900 miles of crude-oil and refined-fuel pipelines, which will give the Dallas-based company a toehold in the Marcellus and Utica Shale regions in Pennsylvania and Ohio. This was the primary reason why the company's debt skyrocketed in 2012 versus 2011.
Few weeks ago, Energy Transfer Partners and Energy Transfer Equity sold Southern Union Gathering Company to Regency Energy Partners for $1.5 billion. Both Energy Transfer Partners and Energy Transfer Equity will utilize the cash proceeds to repay debt. However, this sale does not mitigate my debt concerns mentioned above, as their debt is still very high.
4) In early 2013, Enbridge completed the expansion of the Seaway Crude Oil Pipeline that transports crude oil from Cushing to the Gulf Coast. The capacity is now 400,000 bbl/d from 150,000 bbl/d in 2012. Seaway is a 50/50 joint venture owned by Enterprise Products Partners (EPD) and Enbridge.
In late 2012, Enbridge announced a $6.2 billion program to expand access to markets for growing volumes of North Dakota and western Canada light oil production. More details and maps about the company's Light Oil Market Access Program are found in my article that discusses "The Silver Bullets of the North American Energy Transport Infrastructure".
There is also a second part coming. That will be the last part of this series. Once I provide the data and the potential upside catalysts for all the major midstream players, I'll express my opinion about the undervalued and the overvalued ones along with a capital allocation strategy.
Disclaimer: Data, facts and premises were determined through review of public documents, SEC filings, news releases, and transcripts. The conclusions are my own. Readers may come to different conclusions using the same information. This analysis is not intended to offer investment advice to buy or sell specific stocks.