Will Midstream IPO Save Inergy?

| About: Crestwood Midstream (CMLP)

Tuesday brought a new development to shareholders of Inergy L.P., as the MLP announced plans of an IPO for the northeast midstream storage and transportation assets. The new company, named Inergy Midstream, will own and operate the Stagecoach storage facility and its pipelines, the Steuben and Thomas Corners storage facilities, the Seneca Lake facility and its East and West Pipelines, as well as the Finger Lakes NGL storage facility, and the proposed Marc 1 natural gas pipeline. These assets total about 41 billion cubic feet of natural gas storage capacity and about 825 million cubic feet per day of transportation capacity, upon completion of the Marc 1 and North-South expansion projects. The proceeds of the IPO will be used to pay down debt at Inergy, which will retain a "substantial majority" of units in Inergy Midstream, as well as the incentive distribution rights. There has not been a registration statement for the IPO filed yet, although Inergy says it expects to file one.

In addition to the filing about the Inergy Midstream IPO, Inergy also reported its Q3 results. After taking a $49.6 million charge for early extinguishing debt in Q2, Q3 was pretty much in line from last year on the propane side. Retail propane gallons sold increased slightly, by 0.7 million gallons, as did gross profit excluding certain items, by $0.8 million. That's a less than 2% increase in each business, although Q3 is a seasonally weak quarter. Gross profit from other propane operations decreased 2.5% from a year ago. Gross profit from the midstream operations was a bright spot, coming in at $44.8 million, up 36.5%, from the $32.8 million in gross profit a year ago.

The year-to-date results show a similar dichotomy in how Inergy's two businesses are operating. For the first 9 months of the year, retail propane gallons sold decreased to 282.5 million, from 294.7 million gallons in the same time last year. Gross profit for the segment, excluding items, actually increased to $345.6 million, up from $336.6 million last year. Gross profit from other propane operations decreased slightly to $85.5 million, from $86.8 million. Meanwhile midstream operations saw gross profit increase to $133.1 million in the first 9 month of the year, up from $95.3 million last year, a 39.6% increase.

As a holder of Inergy, I have a mixed reaction to these announcements. First and foremost, units in Inergy have underperformed both the sector and the market, and are currently trading just above their 52-week low. The market is clearly discounting the growth potential of the midstream assets, which are quickly growing toward providing 40% of EBITDA. However, Inergy just completed buying out its General Partner last November, a transaction that was suppose to streamline the business, lower G&A costs from having two public companies rather than one, and lower the cost of capital. Now Inergy is planning to split off Inergy Midstream, saying the restructuring will lower the future cost of capital, strengthen the balance sheet, and help Inergy execute on its growth strategies. I'm not sure how Inergy can justify one merger by citing lower G&A costs by combining public companies, and then turn around and split into two public companies again 9 months later. Without more concrete details about the size of the IPO or amount of money it will raise, it is difficult to say if Inergy is receiving a strong price for the company, so the financial aspects of the deal will have to be addressed at a later date.

Overall, I think shareholders would have been better served with an announcement splitting the MLP in two, since I believe both MLPs would be small enough to be purchased by larger competitors. Given that this is not the case, and without more concrete details on the IPO, I'm still unsure about Inergy. The units are down $10 since I wrote about the company June 1, even as the Midstream assets continue to perform well. Distributable cash flow is growing, albeit not at a rate that inspires confidence of distribution growth, which I think may be part of the reason the stock has been hit. However an 11% yield is a powerful incentive to wait and see how the IPO of Inergy Midstream pans out, so I am going to stay in the name. The assets in the northeast, so close to the Marcellus shale and the population centers of New York, Philadelphia, and Boston, will be crucial to energy infrastructure of the US in the coming decades. The prospects for those assets, and the 11% yield, are enough to keep me in Inergy.

Disclosure: I am long NRGY.