Niska Gas Storage Partners LP (NKA) is the largest natural gas storage firm in North America. As it operates under a master limited partnership (MLP) structure, investors are accustomed to receiving outsized distributions, but at a current yield of 9.0%, the following picture may accurately depict some investor's reaction to the current high yield:
Niska Gas Storage Partners LLC owns and operates natural gas storage assets in North America. It primarily operates the AECO Hub comprising the Countess and Suffield gas storage facilities in Alberta, Canada; the Wild Goose gas storage facility in California; and the Salt Plains gas storage facility in Oklahoma. The company owns or contracts approximately 250.5 billion cubic feet of total natural gas storage capacity. It serves financial institutions, marketers, pipelines, power generators, municipalities, utilities, and producers of natural gas. Niska Gas Storage Partners LLC was founded in 2006 and is headquartered in Houston, Texas.
Where there is extremely high yield, there most likely is fire. NKA is not without its problems that could cause share prices to burn closer to the ground. However, it is first important to understand the business of natural gas storage.
CME Group offers a primer (pdf) in the economics of gas storage with the most basic description:
The storage industry continues to evolve both in capability and in its prominence within the delivery chain. What once was a seasonal crossover point is now an active warehouse with optionality as the predominant market premium. The use of storage is fundamental to the management of natural gas.
In addition, the CME primer explains in detail the nuances of natural gas futures hedging and the role storage plays in the various configurations of this activity.
Niska also offers a storage fundamental primer (pdf):
Underground natural gas storage facilities are a vital and complementary component of the North American natural gas transmission and distribution system. While mainline gas transmission lines provide the crucial link between producing area and marketplace, underground gas storage facilities help maintain the North American natural gas transmission and distribution system's reliability and its capability to transport gas supplies efficiently and without interruption. Natural gas storage facilities are essential to balance the dramatic divergence between the seasonal and daily variability of gas consumption and the inflexibility of gas production in North America.
The EIA offers its own primer and a bit outdated 2004 diagram of 400 active storage locations shown below.
Natural gas storage has become as integral to the industry as pipelines and processing plants, but often times does not get the recognition it deserves. Pipeline and midstream firms or gas distribution utilities own the majority of storage facilities.
Prior to Dec 31, there were two publicly traded storage firms, PAA Natural Gas Storage (PNG) and NKA. PNG was partially spun-off from its parent Plains All American (PAA) a few years ago, but was recently repurchased and merged back into PAA. The merger was completed as a stock transfer with a value of 0.455 shares of PAA for every share of PNG, or a total valuation of $1.48 billion.
This leaves just NKA as the sole independent storage survivor.
As the only current example of a publicly traded storage company, how would NKA stand up to the valuations paid by PAA for PNG? Reviewing the most recent nine-month 10-Q for both PAA and NKA, the comparison would be as follows:
- PAA paid 4.95 times 9-month revenues
- PAA paid 16.55 times 9-month EBITDA
- PAA paid 18.41 times 9 month distributable cash flow
For the nine months ending Dec 2013 (NKA has a fiscal year ending March), NKA generated $119.8 million in revenues, $84 million in adjusted EBITDA and $35.7 million in distributable cash flow. This compares with $299 million, $89.4 million and $80.4 million, respectively, for PNG. The vast difference between the two is the larger debt and depreciation levels NKA carries on its books over PNG. NKA has $656 million in long-term debt. Based on multiples of revenues and EBITDA, a similar valuation for NKA would be between $17 and $19 a share.
Prior to announcing the merger, PAA was trading at $20 to $21, or about 12% below the eventual merger price. A similar pre-merger valuation for NKA would put it trading at $15, or about where it currently sits.
However, NKA is having big issues with its business. From the most recent earnings press release, with the bold added by the author:
As we look ahead to fiscal 2015, seasonal storage spreads are increasingly challenging and are currently narrower than at this time in prior years," continued Mr. Dupéré. "These market conditions affect the prices we are able to charge for contracted storage services as well as revenues realizable by us in our optimization activities. If these market conditions persist, our revenues could be adversely impacted to a material extent. However, the markets are typically most dynamic at this stage in the storage year, and we continue to evaluate each of our storage markets and related commercial strategies. In addition, our largest volumetric customer is party to a storage agreement with us, which contains an option to terminate (by either party) every five years with one year's notice. This option is exercisable as of the beginning of fiscal 2015 and it is unclear at this time whether the customer will exercise its option. If the contract is terminated, and a new contract is negotiated, we would expect that the terms of the new contract would be more favorable to the customer than current terms. If the customer were to exercise its option to terminate the contract, it would be subject to a substantial early termination fee. Because of the requirement of one-year's notice, any adverse effects of the termination would not impact the results of our operations until fiscal 2016".
Mr. Dupéré concluded, "In response to these market conditions, we have recently secured approximately 25 billion cubic feet ("Bcf") of contracts averaging almost five years in duration at prices that are significantly favorable to current rates for shorter-term contracts. Longer-term, we believe that a number of factors will reinforce the need for, and value of, natural gas storage. These factors include exports of North American liquefied natural gas, or LNG, construction of new gas-fired power plants with sustained coal-to-gas switching, and overall increases in economic activity, which drive base-load industrial demand. While we can't predict timing or impact of these factors on natural gas storage market conditions, we are confident that they will reinforce the critical nature of Niska's storage services and enhance the value of our assets."
"As in prior years, we expect to provide fiscal 2015 guidance in approximately three months, during our annual earnings update."
The most recent conference call transcript can be found here.
In recap, if market conditions do not improve, revenues, along with earnings, will be negatively affected. In addition, their largest customer can cancel or renegotiate at lower prices within the next few months. Neither of these would seem to have favorable outcomes for investors. By giving notice, management is completing their fiduciary responsibility of notifying investors of the strong potential of future bad news.
Currently the Street does not much like NKA as demonstrated by the recommendations of the following firms (from streetinsider.com and finviz.com):
Market Perform from Outperform
Hold from Buy
Sell from Neutral
Equalweight from Underweight
Neutral from Sell
Some of the analyst comments from streetinsider.com:
The downgrade relates to valuation. (Wells Fargo) Analyst Michael Blum said, "NKA has traded up recently on strengthening prices at the AECO Hub, which should support cash flows necessary to maintain the distribution. However, natural gas storage fundamentals remain challenging, which is likely to impede management's ability to increase the distribution in the near term, in our view. We are increasing our FY2014 and FY2015 DCF/unit estimates to $1.85 and $2.09, respectively, from $1.83 and $2.03 to reflect our revised forecast for a resumption of distribution growth in FY2015 versus FY2014 previously, which results in lower payments to the GP."
Commenting on news, (Goldman Sachs) analyst Theodore Durbin said, "With risk of a distribution cut now largely off the table, we believe NKA valuation will re-rate closer to the MLP group average yield, and see limited catalysts for further downside. In our view, the sponsor's unanticipated sacrifice takes the risk of a distribution cut to common unit holders off the table, which was a key component of our Sell thesis. However, we do not recommend investors buy the units, as we remain bearish on natural gas storage industry fundamentals," added Durbin.
The news referred to by Durbin is the equity restructuring that took place last April. The private equity firm Carlyle/Riverstone Funds owed about 75% of NKA through its ownership of the subordinated units plus 50% of the publicly traded units. In addition to being the sponsoring entity, the PE firm is also the operating General Partner. Last April, the PE firm agreed to a restructuring whereby the subordinated units went away in favor of higher incentive distribution rights IDR. Below outlines this change from the company's May 2013 investor's presentation.
Going forward, the PE firm is entitled to 48% of all cash distributions over the current minimum payout of $0.35 per quarter. As with most MLP IDRs, investors need to feel comfortable with the amount of cash flow that goes into the pockets of the GP rather than to unitholders.
Management not only charges a fee for storage of third-party owned natural gas, it also participates in buying, storing and selling natural gas for its own account. This business is known as "propriety optimization activities". Over the next few years, optimization revenues are expected to grow from $85 million in FY2014 to $126 million in FY 2017. However, fee-based revenues are expected to decline from $128 million to $88 million, respectively. This will create stagnate annual revenues of around $215 million.
However, the change from a fee-based business model to a proprietary optimization model increases the business execution risk.
While a 9.1% yield would seem very attractive, it may be best to wait for the resolution of the upcoming contract negotiation with NKA's largest customer.
It would be a shame if your eyes bugged out not from looking at the current yield but from a precipitous drop in share price after you bought into the high yield.
Author's Note: Please review important disclaimer in author's profile.