Atlas Pipeline Partners (APL) began 2013 at $32.55 and its trading range during the year was $30.69 to $40.06. On January 2, 2014 it was priced at $34.79. The distributions (dividends?) received in 2013 returned a dividend yield of 6.9% based upon the beginning of the year price and the capital gain was 7.2%. Therefore, the total return for unit holders (shareholders?) in 2013 was about 14%.
The S&P Equal Weight Index (RSP) scored a gain of 30% in 2013 and its dividend yield was about 1.9%. Most of RSP's 30% gain was due to levitation resulting from multiple expansions and not profit improvement. At this time, the bulls and the bears have ample fodder for their opposing views regarding the poorly defined performance of the RSP for 2014.
However, it appears that another double-digit total return for APL's shareholders is well defined for 2014 because management's open-ended corporate development program is constructive and distribution increases are probable. With the stock trading at $34.79, the total return in 2014 could easily exceed last year's 14%.
In this article I will delve into APL's fundamental investment merits to see how they score. That will be followed by an appraisal of the stock's technical merits as shown by the absolute and relative action on its price chart. And, I will conclude by telling you why I bought some shares on January 2 at $34.44.
Increasing Earning Power
The chart below shows that APL's principal assets are located in some of the best oil and natural gas producing regions in the country.
The company is currently moving 1.5 BCF of gas and liquids across its five systems. It only moved one-third of that volume two years ago when it had seven processing plants in operation. Since then, it expanded organically and also made four acquisitions to gain entry into additional gas plays. There will be significant volumetric gains during the next two years because of various programs currently underway. By the end of 2014, APL will be operating 17 processing plants.
The management team already did what needed to be done in 2013 to set the partnership up for success in 2014 and beyond. Now, APL is (1) directing capital investments at new and existing producer relationships, (2) diversifying the cash flow streams by expanding into new areas for volume growth, (3) minimizing exposure to adverse commodity price swings by having margin protection through prudent use of hedges, and (4) increasing its fee business.
By making the investments needed to expand its positions in the basins in which it operates, APL will be able to better serve its producing clients. That way, all parties can succeed as development of the producing areas continues. You can bet that APL is not being obliging for altruistic purposes. Each of the capital deployment projects is expected to be accretive to profitable growth in 2014 and 2015.
There are many moving parts regarding capital projects in the six areas shown on the chart above that will contribute to profitable growth in coming years. And any broad generalizations used to describe what management is trying to accomplish would not be very meaningful. So let's get into some of the nitty-gritty details relating to some of the major projects (parts?) and see what the sum of the parts might add up to:
(1) In the Woodford Shale (this is the area referred to as #1 on the chart), two systems will be connected to accelerate volume growth in the area and serve another play that is in Velma's areas of operations. Once the Velma (#5) and Arkoma (#4) systems are connected, they will enable producers in the area to move volumes more easily through each system and have flexibility when moving residue volumes out of the area to different markets. The contracts with the producers will be "fee-based" agreements and they will reduce APL's exposure to commodity price swings.
(2) Another major project is the expansion of the West Texas system (#6) into Martin County to support Permian basin growth from Pioneer and other producers north of APL's current footprint. By extending a high pressure gathering line into Martin County, APL will be able to gather incremental volumes on its system to fill processing capacity at a faster pace than previously achieved. As volumes grow and the plant increases its utilization rate, APL will likely have to add additional processing capacity in Martin County.
(3) There is a high level of rig activity around APL's asset positions. And, such could provide an abundance of high-return, organic growth opportunities for the company. Examples of such are the ongoing construction of new processing facilities for 120 million cubic feet a day in Arkoma (#4), 200 million cubic feet a day in South Texas (#3), 200 million cubic feet a day in West Texas (#2), and the addition of roughly 50 million cubic a day of new capacity for WestOK (#1) processing facilities.
(4) Q3 2013 was the first full quarter of operation in which the Waynoka (#3) facilities were connected to the DCP Southern Hills NGL pipeline. This connection allows for the optimal production of NGLs from APL's facilities and provides it and its producer partners with a connection to the Mont Belvieu, Texas NGL hub.
(5) Because of low ethane prices, the Waynoka facilities operated in an ethane rejection mode throughout Q3, resulting in an estimated 9,200 barrels per day of ethane being "rejected" and marketed as residue gas production. The Waynoka plants are highly efficient and their design limits the degradation of propane recoveries while operating in ethane rejection. Although ethane recoveries were reduced to 24%, the plants recovered 93% of the propane received into the facilities. Maintaining high recoveries of propane and other NGLs, while operating during ethane rejection, maximize the processing margin for Atlas and its producer partners.
(6) Propane is an important product for ALP and it makes extensive use of hedges to protect its profitability. In Q3 propane hedges had a weighted average settlement price of $1.24 per gallon and about 70% of APL's equity production was hedged at that price. When the price only rose to $1.20, it only impacted the 30% portion of propane that was not hedged at a $1.24 per gallon. While that was not substantial, the rise in price provided an opportunity to elongate and deepen the 2014 and 2015 propane positions at prices north of $1 per gallon. Just as a recent rise in propane price did not have a significant positive impact on operating results, neither would any decrease in price below about $1 per gallon in coming quarters and that is the ultimate goal. This is important because propane makes up about 25% of the processing margin. At the end of Q3, the propane position was 83% protected for Q4, 72% protected for 2014, and 39% protected for 2015. APL does not use hedges for ethane production.
(7) Growth in production in the WestOK system is expected to continue because of active rig activity in the Mississippi Lime formation. In addition to having the potential for adding drilling rigs, producers on the system are transitioning into drilling multiple wells in multiple zones from a single well pad. This will have a favorable impact on WestOK volumes and APL is evaluating opportunities for processing expansion on this system. Recently, plant efficiency projects were completed to increase total system processing capacity from 485 to 500 million cubic feet a day. This will allow APL to eliminate the bypass of production and reduce third-party processing offloads.
The facility is being built in two phases; the first phase will provide 120 million cubic feet of new capacity in Q1 of 2014. The second phase will add 80 million cubic feet a day and it will be completed when needed. Because of the operational set up of APL's assets in this area, the capital required to build out the full 200 million cubic feet a day of processing capacity is much less than that would typically cost to build this type of facility.
(11) In South Texas, there is active drilling around the SouthTX system both within APL's dedicated acreage and in-close proximity to its plant facilities. There are currently 19 dedicated rigs drilling on SouthTX system. APL's SouthTX commercial team has made significant progress during the quarter and it is encouraged by the customer feedback regarding service offerings. It is confident it will be capturing additional supplies in the near term. During the third quarter, gathered volumes totaled 141 million cubic feet a day and we produced 17,990 barrels per day of natural gas liquids. Volumes continue to fluctuate on the system as a result of a portion of production being interruptible. As of October 29, APL was processing 153 million cubic feet a day and producing more than 19,000 barrels of NGLs per day. This system is anchored by long-term fixed fee contracts with Statoil (STO) and a Talisman (TLM) JV. These contracts have a deliverable pay provision which provides earning stability. APL is focused on executing its growth strategy for these assets and it expects to build both the Silver Oaks I and II plants by the end of 2014.
(12) A lot of good things are happening in West Texas. In Q3 the volume growth in the West Texas system continued unabated with gathered production exceeding 383 million cubic feet a day, a 9% increase over the prior quarter and a 33% increase from the third quarter of 2012. There continues to be a high producer interest in the formations underlying the system with 61 rigs currently dedicated to this system. During Q3, the WestTX system connected a total of 46 new wells. Similar to development system volume growth is attributable to new well connections and increased volumes through existing delivered points as a result of producer in-fill drilling and recompletions. NGL production climbed 20% to 47,660 barrels per day in the third quarter despite operating and partial ethane rejection as a result of economic and operational considerations. Ethane recoveries were 51% and by operating in partial ethane rejection, the system was able to maintain propane recoveries in excess of 96%. The reduction in ethane recoveries amounted to an estimated 7300 barrels per day of ethane being rejected throughout during Q3. As of October 29, the WestTX plants were processing 390 million cubic feet a day which is 85% of nameplate capacity of 455 million cubic feet a day. In less than two quarters of operation the 200 million a day driver plant is 68% utilized.
And (13) volume growth has been exceeding management's expectations due to the transition to horizontal drilling by Permian Basin producers. In July, APL announced plans to construct the Edward plant, a 200 million cubic feet a day processing plant that will come into service in the second half of 2014. This plant will be constructed on the southern end of the WestTX gathering system in close proximity to the Benedum plant. Management is optimistic about installing additional organic growth projects in the WestTX area as indicated by the recent announcement of the expansion of its gathering infrastructure into Central and Northern Martin County. The plant producer activity in this area and all across the system continues to suggest that APL will need a new 200 million cubic feet a day processing plant every 18 to 24 months to keep up with the increase in volumes dedicated to the system.
Growing the Dividend
APL increased its distribution (dividend?) to shareholders 10 times during the last 12 quarters: from 35 cents per share in Q4 of 2010 to 62 cents in Q3 of 2013, for an average "quarterly" increase of about 2.7%. The four distributions during 2013 totaled $2.24. The payout was not increased in Q4 because of non-recurring charges. There are several reasons why the dividend increases will resume in 2014: (1) the distribution in Q4 of 2013 was maintained at 62 cents per share. That reflected the fact that APL's quarterly results in Q3 were similar to those for Q2 in terms of the adjusted EBITDA and distributable cash flow (DCF). However, based on the volumes and cash flows achieved in the latter half of the quarter and excluding some non-recurring charges, the distribution could have been 65 cents.
(2) Once APL distributes $0.65 or more per limited partner unit in 2014, the general partner will not receive an IDR payment until the distribution gets to $0.70 per unit. That will increase the amount of DCF available for APL's unit holders.
(3) Profitable growth is indicated in each of APL's operating areas, particularly in South Texas, West Texas and the Arkoma basin in Oklahoma. Those areas have or will have additional processing capacity early in 2014. Therefore, a sizable increase in the DCF in the immediate future appears to be a foregone conclusion at this time.
I think it is likely that the quarterly distribution will be increased in steps to 70 cents by the end of 2014. That would make the indicated annual rate $2.80. But for the full year the total payout could total $2.70 for a gain of 12% from 2013's $2.41 (which was 8% above 2012's $2.24). Furthermore, management's DCF guidance for 2014 is $2.75 to $2.85; so my estimate of $2.70 could even be conservative. With the stock priced at $34.79, the $2.70 in distributions would produce a yield of 7.7% while $2.80 would yield 8.0%. That is about four times more than the dividend yield on the RSP market index. It is also 51% more than the current indicated yield on my index of 18 prominent MLPs.
The current indicated dividend yield on the stock is 7.2%. The next ex-dividend date will be about February 15.
Let's Look at the Current Technical Reading on the Stock's Price Chart
The chart below was constructed from data in my workbook.
(1) The bold black line on top is price and the bold pink line below is relative strength. (2) The three dotted lines (black, blue, and red) are moving averages. There is a set of those for price and a similar set for relative strength. They are used to define trends and detect trend reversals. (3) The 5 sets of dotted-orange parallel lines and the 10 sets of orange parallel lines (the two overlap half of the time) that frame the price action are 22-day and 11-day trading ranges, respectively. Their progression shows how the trading ranges shifted during the 110 days charted. And (4) the two wavy-blue hashed lines that straddle the price line are Bollinger Bands. They are used to detect overbought or oversold situations.
Any of the items listed as (2) or (4) is independent of the others and it could be used as a valid technical indicator for making buy or sell decisions. But in order of importance, the moving averages are of primary importance while the trading ranges and the Bollinger Bands are of secondary and tertiary importance, respectively.
Despite the stock's high dividend yield and management's constructive corporate development program as detailed above, APL has been a poor performer in the market during the past six months. After reaching its high at $40.06 in October, the price line broke below its moving average trend lines and trended lower as the trading ranges shifted downward. The breakdown of the relative strength line confirms that the stock was out of favor with the investment community and therefore underperformed the market. When speculative interest in a stock waxes, its price goes up; and when speculative interest wanes, its price goes down. Obviously, speculative interest in APL waned and there is no current indication on the price chart of a reversal.
I bought a few shares of APL on January 2 at $34.44 for the following reasons. (1) The fundamental investment merits of the company are stellar and profitable growth is well defined for 2014. (2) The current dividend yield on the stock is 7.2%. Distribution growth should occur in coming quarters and total $2.70 for the year, making the four-quarter dividend return 7.8%. (3) The price chart shows technical weakness but it really isn't too bad. (4) I would like to accumulate a large position in APL and intend to do so whenever market conditions permit. And (5) I think the market looks toppy at this time, and I am exercising caution when buying stocks. Moreover, I am a fanatic who is quick on the trigger when the price action of a stock I buy goes against me so I ready to cut my losses short. Therefore, if the stock drops below $33.75 I will give serious consideration to selling the newly bought shares. With me, a 2% loss on a position is just a cost of doing business in the stock market. I do not buy and hold stocks for the long term. But if I held the $34.44 shares and collected $2.70 in distributions during the year, they would offset any loss down to $31.74.That is something that I will also consider.
I have not been ordained to preach, so I am not going to pound the table and tell you (the reader) that you must do as I do. I just wrote the article on a company I think has considerable investment appeal and told you what I am doing with the stock. It is up to you to discount what I wrote as you see fit and make your own decision according to your personal investment criteria.