The hydraulic fracturing and the horizontal drilling have been a boon for the North American economy during the last three years. To me, that was a life jacket that helped the economy emerge more quickly from the crisis of 2009. The current glut of natural gas can be crucial for North America, going forward. There is nobody in the world that can compete with the low-energy costs provided by the domestically produced natural gas when much of the rest of the world is using crude or extremely high-priced natural gas for energy-intensive industrial uses, such as manufacture of fertilizer, methanol, petrochemicals or steel. This gives North America a huge competitive advantage over the rest of the world.
The midstream companies belong to the beneficiaries of this booming shale oil and gas production, along with companies from the industrial and other sectors, analyzed in my articles here, here and here.
In this series, I analyze the small midstream companies. I determine as small midstream companies those with market cap of up to ~$5 billion. I call them the "Davids" of the sector, and the first Part is here.
Few days ago, I also analyzed all the intermediate and the major midstream companies which are obviously the "Goliaths" of the sector. Once I am done with these three groups (small, intermediate, major midstream firms), I'll unearth some unknown midstream companies, which are brand new entrants into the midstream sector, flying 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 following five small midstream companies:
EV: Enterprise Value
CF: Annual Cash Flow
EQ: Stockholder Equity
Atlas Energy LP (ATLS) has the worst balance sheet among the five companies above. Atlas Energy LP is overly leveraged, and the low operating margin does not give the company a lot of breathing room to improve its balance sheet on the short term without an asset sale or a significant dilution. It is also very worrisome that the company's operating margin has been decreasing on a year over year basis since 2010.
After all, the losses of 2012 do not surprise me. What surprises me is why the market gives Atlas Energy LP such a high premium (PBV=4.79). From a fundamental perspective, this is quite inexplicable, because the company does not hold any special intellectual property or a unique hi-tech technology. If this fundamentally ugly situation continues, I expect a dividend cut. This will be the company's first step to restore partly its balance sheet.
Things look better overall for Atlas Pipeline Partners (APL) in comparison to Atlas Energy LP. Nevertheless, Atlas Pipeline Partners also suffers from a very low operating margin, which has been decreasing on a year over year basis during the last three years.
This does not give much hope for a significant rise of the bottom line in 2013 that can bring the current high PE down to decent levels. From a debt perspective, Atlas Pipeline Partners is obviously stretched because its long term debt more than doubled in just one year.
The eye-catching operating margin and the appealing annual yield of Inergy Midstream (NRGM) is offset by the company's high debt metrics and the high PE. Furthermore, it is worth noting the company's operating margin has remained stable during the last three years. However, the long term debt has grown by leaps and bounds during the last nine months, which must concern any prudent potential buyer.
From a fundamental perspective, things look better for Inergy (NRGY) in comparison to Inergy Midstream. However, do not be overly optimistic about Inergy, because the low PE is a result of a one time gain on disposal of the company's retail propane operations in FY 2012. Additionally, Inergy has a low operating margin which remains below average levels for three years now, while its debt metrics are not attractive either.
On a last note, Inergy Midstream has zero cash, while Inergy's cash is only $1.8 million in Q1 FY 2013. Inergy's cash has been on a downtrend for several quarters now.
SemGroup Corporation (SEMG) has risen a lot since last summer. Should it rise so much? To me, the fundamentals do not support this exponential movement that brought the PE close to 100. The company has low operating margin which has been stable for three years now, and the top line has been declining since 2010. SemGroup does not trade at a discount currently, and apparently the momentum traders have been in charge of this exponential rise during the last months. When they decide to leave, the stock will plunge.
In early 2013, SemGroup announced that it expects to pay a quarterly cash dividend to common shareholders beginning in the second quarter of 2013. This just sugarcoats the current inflated valuation.
I know that my bearish calls above do not sound good to many bulls. However, I have to be objective, warning the bulls and the potential buyers about the increased fundamental risks of the aforementioned companies.
My latest bearish calls were published in early March. The eight out of the ten companies mentioned in those articles have dropped from 10% to 700% in just one month. The remaining two companies hover at around the same levels. One of these bearish calls was for GMX Resources, which went broke few days ago. I have been repeatedly warning about GMX Resources since late 2012. Hopefully, those who followed my bearish recommendations drank a beer for me too. To prove my calls, my latest bearish articles are here and here.
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 May 2012, SemGroup Corporation announced plans to construct a new crude oil gathering system in the Denver-Julesburg Basin in Colorado. The project will support Noble Energy (NBL) to move its production away from the wellhead. The new gathering system, to be called the Wattenberg Oil Trunkline, will have 200,000 barrels of operational storage, and it is expected be operational in Q3 2013.
In late 2012, SemGroup also completed the acquisition of a 25% share of Glass Mountain Pipeline LLC previously owned by Chesapeake Energy (CHK). Following this purchase, SemGroup Corporation now owns 50% of Glass Mountain Pipeline which has an initial capacity of 140,000 bbl/d and 440,000 barrels of intermediate storage.
2) In 2012, Inergy Midstream announced plans to jointly market and develop a new interstate natural gas pipeline known as the Commonwealth Pipeline with UGI Corporation (UGI) and WGL Holdings (WGL). The proposed 200 mile, 30-inch pipeline is expected to transport at least 800,000 dekatherms per day of natural gas when it is placed into service in 2015. The Commonwealth Pipeline will provide a path for bringing natural gas produced in the Marcellus and Utica Shale plays to growing natural gas markets in central and southeastern Pennsylvania and the greater Mid-Atlantic region.
3) In late 2012, Inergy and Inergy Midstream completed the acquisition of Rangeland Energy, the owner and operator of the COLT crude oil rail terminal, storage, and pipeline facilities for $425 million. The COLT Hub is strategically located in Williams County, North Dakota, in the heart of the Bakken and Three Forks shale oil-producing areas, providing producers, refiners, and marketers with the largest open-access crude oil distribution hub in North Dakota. With 720,000 barrels of crude oil storage and two 8,700-foot rail loops, the COLT Hub can accommodate 120-car unit trains and is capable of moving more than 120,000 bbl/d by rail.
4) In late 2012, Atlas Pipeline Partners acquired Cardinal Midstream LLC, a privately owned midstream operator, for $600 million in cash. The owned and/or operated assets will include three cryogenic processing plants totaling 220 MMcfd in processing capacity, 66 miles of associated gathering pipelines, and a gas treating business that includes 17 treating facilities located in numerous hydrocarbon basins. Over 80% of Cardinal's current gross margin is derived from fixed fee contracts.
5) Atlas Energy owns and operates the general partner of Atlas Pipeline Partners, L.P., through all of the general partner interest, all the incentive distribution rights and an approximate 9% limited partner interest. Additionally, Atlas Energy owns all of the general partner Class A units and incentive distribution rights and an approximate 44% limited partner interest in its upstream oil & gas subsidiary, Atlas Resource Partners (ARP). This is why, we need to check out the latest major growth initiatives of Atlas Resource Partners as well.
In late 2012, Atlas Resource Partners, L.P. acquired DTE Gas Resources, LLC, which owns approximately 35 MMboe of proved reserves (57% oil and liquids) in the Fort Worth basin in Texas for $255 million.
There are also two more parts coming to cover all the remaining small midstream players of North America, including the Canadian ones. Once I provide the data and the potential upside catalysts for all the small midstream players, I'll express my opinion overall 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.