Is There Still Value in Breitburn Energy Partners?

Aug.19.10 | About: Breitburn Energy (BBEPQ)

Recommendation : I would sell BBEP at around 18-19 if I find other more attractive stocks.

Breitburn Energy Partner is a Master Limited Partnership (MLP) which is in the oil and natural gas production business. It buys or leases land or wells with proven Oil and Gas reserves with minimal exploration risk. Also it is structured as an MLP and hence has to distribute all its free cash flow (money that remains after all the operating expenditure) to its shareholders.

This company is my largest holding accounting for 18% of my portfolio. Since the price has run up lately I wanted to revisit the valuation and see if it's still worth holding at the current price. The following is my attempt to use the Discounted Cash Flow mode (DCF) to value the stock of this MLP.

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DCF CalculationClick to enlarge
I have assumed a hedged price per BOE of $58 and an unhedged price per BOE at 47.5 (current prices). Also, I have assumed an 8% discount rate above. In DCF the most tricky part usually is to choose the right discount rate. A wrong choice of discount rate could give a totally different valuation.

For example in case of BBEP:
discount rate 7% gives a value of 21.14 per share.
discount rate 8% gives a value of 19.14 per share.
discount rate 9% gives a value of 17.35 per share.
discount rate10% gives a value of 15.74 per share.

I believe the choice of discount rate should be based on two criteria:

  1. What is the current no risk investment yield? In my case it's less than 1% in the bank account.
  2. What opportunities are out there, given all other variables being equal, which are even cheaper when compared at the same discount rate.

Recently Wells Fargo said this about BBEP:

We are upgrading our rating on BBEP on the heels of a number of positive developments occurring within the partnership. Specifically, distribution growth is poised to accelerate to a subsector leading 7-8% annual rate for 2011 and 2012 (versus 2-3% for the upstream MLP peer group), production is trending towards the high end of guidance, management is back to pursuing acquisitions, and option value tied to BBEP’s prospective Collingwood-Utica acreage in Michigan is steadily gaining visibility.

So it seems like they are using a discount rate between 7.5 and 8.5.

In the above model I have also not assumed anything about natural gas and oil prices. Their future values would significantly impact the present value of the stock. Generally, MLP stocks are held by investors for dividend income and hence valued based on dividend yield. I do not believe in such a narrow minded view. A company should be valued based on the present value its free cash flow would generate. It does not make a difference if that cash flow is paid out to me as dividend or stays with the company for a future investment as long as the management generates more than a dollar for every one dollar invested.

Personally I would sell BBEP at around 18-19 if I find other more attractive stocks.


Disclosure: I hold BBEP currently and my cost basis is $7.46 /share