Can CorEnergy's Rent Roll Survive Energy XXI's Bankruptcy?

Summary

EXXI has now filed for bankruptcy protection.

EXXI is a key tenant for CORR.

The real test is here.

Image Source: Corenergy Click to enlarge

A few weeks ago I suggested that real estate investment trust, or REIT, CorEnergy (NYSE:CORR) was about to see its unique business model stress tested by the market. That's now gone from a risk to a sure thing. And, so far, the news is... not as bad as it could have been.

Belly up

The problem that CorEnergy faces is that it owns oil and gas infrastructure assets at a time when the customers of such assets are hitting the skids. Case in point is Energy XXI (EXXI), which just succumbed to bankruptcy. The offshore pipes that CorEnergy leases to Energy XXI account for a massive 40% or so of the REIT's assets. So this is a very important customer. In fact, it's the single largest customer the REIT has.

In other words, investors are right to be concerned about Energy XXI. There were some really great discussion of what an Energy XXI bankruptcy might mean on the last article I wrote. (Steve Rasher did a wonderful job of highlighting some of the finer points of bankruptcy.) The end result, however, was that we'll just have to wait and see how it all falls out. And now that Energy XXI has filed for bankruptcy that time is now.

Better than it could have been

The first thing to point out about Energy XXI's bankruptcy is that it went better than it could have for CorEnergy. That's because the actual business entity that leases CorEnergy's pipes wasn't included in the filing. So, technically speaking, CorEnergy's tenant didn't go bankrupt-it's parent did. While that may sound like mincing words, it's probably about the best outcome that CorEnergy could have hoped for in an Energy XXI bankruptcy situation.

Now, that said, Energy XXI is the guarantor on the lease with CorEnergy. And, "...its failure to make interest payments to its creditors within the applicable cure period, would have constituted defaults under the terms of the GIGS Lease." CorEnergy granted the company a "conditional waiver" to help Energy XXI's restructuring process along. "Conditional waiver" is a vague term, but my guess is it means as long as the rent gets paid, CorEnergy won't make waves. So far, rent is getting paid.

What next?

The only thing to do now is to sit back and wait to see how the bankruptcy proceeds. There's two things going for CorEnergy coming out whole. The first is that the actual leasing entity didn't get sucked into the bankruptcy filling. But the second is probably the more important issue: Energy XXI can't replace the oil pipelines its leasing from CorEnergy and, as such, it needs them it if wants to keep making any money from the wells to which they are attached. These aren't optional expenses.

However, there's a third and perhaps equally important issue at play. Energy XXI isn't the only customer for those pipes. They also serve another oil company you may know, Exxon Mobil (NYSE:XOM). To be fair, Exxon only operates one of the seven fields that the pipes touch, Energy XXI runs the rest. But knowing that Energy XXI has an obligation to a third party oil company to provide pipeline services is a good reason for the company to ensure that CorEnergy's rent gets paid.

And that's the thing, these aren't assets that Energy XXI can just walk away from like, say, an office building. An office can be set up anywhere there's a desk, but oil pipelines attached to producing oil wells not so much. Moreover, there's no good alternative options for getting that oil to market. So, even if Energy XXI has to work through a difficult bankruptcy process, it will want to make sure those pipes stay open so it can generate revenue. That will remain true even if someone else winds up owning the oil fields because of this process, since the oil projects aren't viable without the pipes.

The risk?

So, in some ways, CorEnergy's Energy XXI problem looks like a smaller issue than it might at first seem. And, thus, the fat dividend yield looks extra enticing. But it's still only appropriate for investors with a high risk tolerance. Why? Because, if oil prices stay low long enough, there's a risk that the fields could get shut or, more likely, that Energy XXI could push for lower rent.

Clearly if the wells stop pumping, CorEnergy has a big problem. If the lessee just wants some rent concessions, well, it would hurt, but at least they'd still get something. The problem with the assets that CorEnergy owns is that the REIT is almost as reliant on its tenants as its tenants are on the REIT. That means both sides are going to be willing to work things out, but it also means that CorEnergy can only be just so aggressive while it's negotiating.

Image Source: Communications Sales & Leasing Click to enlarge

It's the reason why I don't like Communications Sales & Leasing (NASDAQ:CSAL). Even after an important acquisition, this telephone line REIT will still be reliant on its former parent, Windstream, for 85% of its revenues. How do you negotiate with a customer that large? Carefully! And the real problem comes down to the assets, which can't easily be leased to someone else. In the case of CSAL it's telecommunications assets and for CorEnergy it's pipelines.

On the one hand, having a tenant who can't easily go elsewhere is a great business model. But as Energy XXI shows, it can quickly turn into a liability, too. I'm not yet convinced that CorEnergy's business model works. Perhaps at a larger scale the risk of a single tenant would be reduced enough to not matter so much. But, right now, this is a highly focused REIT with an important tenant hitting the skids. Most investors are better off on the sidelines-I'd say the same thing of CSAL, even though Windstream isn't as troubled as Energy XXI.

That said, if CorEnergy can make it through this period without taking a rent hit, acquisitions might make it a compelling story in the future. Which is why it's worth watching this drama, even if you don't buy into it.

Disclosure: I am/we are long XOM.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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