Examples In MLP Due Diligence - Midcoast Energy Partners

| About: Midcoast Energy (MEP)

Summary

This is the eighth in a series of "due diligence example" articles on MLPs.

I needed to show what bad looks like before I ended this series.

MEP provides the example of what bad looks like.

This is the eighth in a series where I provide my example of "What is good due diligence for MLP (energy Master Limited Partnership) investors?" For many of you, this will appear to be hyper due diligence. You can opt to weed out some of the hyper diligence to arrive at the level that feels right to you. Prune prudently.

This is the first article on a MLP that is not one of the large-cap midstream group. This is one a smaller cap "Gathering and Processing" MLP, and that group is more commodity sensitive - and thus sells at higher yields and lower valuations. Commodity sensitivity leads to poor "historical earnings projection accuracy" and lower credit ratings. With the WTI up in 2016, this group should have superior unit price appreciation in 2016. Let's look at the year to date data for the four midstream groupings of MLPs.

MLP Midstream 6-21-16

The consensus Distributable Cash Flow or DCF projections were last updated on 5-30-16. The distribution Compound Annual Growth Rate or CAGR projections were updated 5-30-16. Yields are based on the Q2-16 distribution. Under the 'year to date' header, the change in the distribution is the change since Q2-15 - or the change over the last twelve months. The change in the target, EPS and DCF is the percentage change in the consensus 2016 projection that has happened since the beginning of 2016. The Dist/DCF number is the ratio of the Q2-16 distribution to the 2016 DCF projection. The 2016 DCF projection is an adjusted average of eleven DCF projections from the major brokerages covering MLPs. The CAGR is intended to be the percentage change in my CAGR projection since the beginning of the year - but I lack confidence that I have the timing of this stat right. The target prices and EPS projections are from Yahoo Finance. EXLP is now APLP. AMID, APLP, KMI, TGP and TOO have 2016 distribution cuts.

Large Cap Midstream Current Distrib/ Q2 Dist Dist/dcf Dist/dcf Year-to-Date Percent Change
Company name Price Quarter Yield 2016 2017 Price Pr+Dist EPS Target DCF Dist* CAGR
Buckeye Partners, L.P. BPL 71.24 1.1875 6.67 89.79 86.84 8.00 11.61 0.24 -1.96 0.38 3.26 0.00
Enable Midstream Partners ENBL 13.98 0.3180 9.10 102.58 100.16 51.96 58.87 -4.88 14.44 -10.79 1.76 -97.50
Enbridge Energy Partners, L.P. EEP 22.80 0.5830 10.23 105.52 100.95 -1.17 3.88 -40.34 -28.41 -3.07 2.28 -86.84
Enterprise Products Partners L.P. EPD 28.67 0.3950 5.51 77.83 74.18 12.08 15.17 -6.85 -4.53 -2.87 5.33 -3.64
Energy Transfer Partners, L.P. ETP 40.53 1.0550 10.41 107.93 91.94 20.16 26.42 -62.76 -19.56 -18.71 3.94 -66.10
Kinder Morgan, Inc KMI 18.79 0.1250 2.66 23.26 21.83 25.94 27.61 -6.67 -3.75 -5.70 -73.96 0.00
Magellan Midstream Partners LP MMP 75.45 0.8025 4.25 80.05 72.46 11.05 13.42 -5.69 0.05 1.01 11.85 -10.11
Oneok Partners, L.P. OKS 39.64 0.7900 7.97 100.32 96.93 31.56 36.81 13.20 14.21 3.28 0.00 50.00
Plains All American Pipeline, L.P. PAA 27.88 0.7000 10.04 137.93 112.45 20.69 26.75 -31.67 -24.07 -24.54 2.19 -96.67
Spectra Energy Partners, LP SEP 47.21 0.6338 5.37 81.00 74.56 -1.03 1.63 6.73 1.74 10.99 3.85 7.69
Sunoco Logistics Partners L.P. SXL 28.00 0.4890 6.99 87.32 72.99 8.95 12.75 -23.26 38.48 -3.03 16.71 -2.11
Williams Partners L.P. WPZ 33.30 0.8500 10.21 90.67 85.00 19.57 25.67 -48.65 0.00 -2.34 0.00 -33.33
Large Cap Average 7.45 90.35 82.52 17.31 21.72 -17.55 -1.11 -4.62
The Alerian MLP index ETN AMJ is 8.97% and with dividends is 10.82%.
The S&P500 index ETF SPY is 2.24% and with dividends is 2.76%.
The Russell 2000 index ETF IWM is 2.18% and with dividend is 2.47%.
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Small Cap Midstream Current Distrib/ Q2 Dist Dist/dcf Dist/dcf Year-to-Date Percent Change
Company name Price Quarter Yield 2016 2017 Price Pr+Dist EPS Target DCF Dist* CAGR

Blueknight Energy Partners, L.P. BKEP 5.09 0.1450 11.39 61.05 58.00 -9.43 -4.27 -84.38 -16.22 11.76 3.94 -38.60
Boardwalk Pipeline Partners, LP BWP 18.07 0.1000 2.21 22.22 20.00 39.21 40.76 10.00 0.89 1.69 0.00 400.00
Columbia Pipeline Partners LP CPPL 14.83 0.1875 5.06 92.59 70.09 -15.16 -13.01 -10.78 -16.07 -10.00 11.94 -14.29
Dominion Midstream Partners DM 28.46 0.2245 3.16 71.27 59.47 -7.18 -5.71 1.64 -1.60 7.69 28.29 -0.71
Genesis Energy LP GEL 37.23 0.6700 7.20 75.07 71.28 1.33 4.98 -22.07 -18.80 -10.75 12.61 0.00
Holly Energy Partners L.P. HEP 35.61 0.5750 6.46 87.12 83.33 14.35 18.05 8.52 9.83 -0.38 6.98 0.00
Martin Midstream Partners LP MMLP 22.96 0.8125 14.16 100.93 97.89 5.81 13.29 -25.00 -28.25 -4.17 0.00 -50.00
NuStar Energy L.P. NS 51.26 1.0950 8.54 92.41 90.87 27.83 33.29 1.78 3.47 -3.66 0.00 -42.86
TC PipeLines, LP TCP 56.18 0.8900 6.34 79.46 74.32 13.02 16.60 8.59 44.23 -1.32 5.95 -10.00
Tallgrass Energy Partners, LP TEP 46.25 0.7050 6.10 81.03 64.38 12.23 15.65 -8.16 -9.64 -1.14 45.36 10.00
Transmontaigne Partners L.P. TLP 40.24 0.6800 6.76 74.52 69.92 50.37 55.46 -16.38 37.50 0.27 2.26 11.11

Small Cap Average 7.03 76.15 69.05 12.04 15.92 -12.39 0.49 -0.91

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G&P Midstream Current Distrib/ Q2 Dist Dist/dcf Dist/dcf Year-to-Date Percent Change
Company name Price Quarter Yield 2016 2017 Price Pr+Dist EPS Target DCF Dist* CAGR

Antero Midstream Partners LP (NYSE:AM) 26.06 0.2350 3.61 61.84 59.49 14.20 16.26 -15.20 1.21 7.04 30.56 -1.41
American Midstream Partners, LP (NYSE:AMID) 12.26 0.4125 13.46 83.33 88.24 51.55 61.74 5.98 -2.58 -1.00 -12.70 -80.00
Cone Midstream Partners LP (NYSE:CNNX) 17.45 0.2450 5.62 71.53 68.06 77.16 82.13 8.96 1.67 7.87 15.57 0.00
DCP Midstream Partners LP (NYSE:DPM) 35.01 0.7800 8.91 96.30 99.68 41.91 48.24 -22.36 4.55 -2.99 0.00 -95.00
EnLink Midstream Partners, LP (NYSE:ENLK) 16.31 0.3900 9.56 89.66 83.87 -1.63 3.08 -91.80 -24.86 -3.87 2.63 -25.00
EQT Midstream Partners, LP (NYSE:EQM) 74.88 0.7450 3.98 63.54 61.07 -0.77 1.21 6.74 -0.72 -5.25 22.13 35.42
Exterran/Archrock (NASDAQ:APLP) 13.52 0.2850 8.43 46.72 42.38 9.83 14.46 -41.67 -27.05 -7.58 -49.33 -16.67
Midcoast Energy Partners, L.P. (NYSE:MEP) 8.77 0.3575 16.31 166.28 238.33 -9.77 -2.42 0.00 -48.09 -30.65 2.88 0.00
Summit Midstream Partners, LP (NYSE:SMLP) 23.13 0.5750 9.94 87.45 76.41 23.49 29.63 -68.67 -59.26 -1.50 1.77 0.00
Western Gas Partners LP (NYSE:WES) 48.81 0.8150 6.68 85.56 77.80 2.69 6.12 7.78 -18.26 3.81 12.41 -2.86

G&P MidStream Average 8.65 85.22 89.53 20.87 26.04 -21.03 -17.34 -3.41

The Alerian MLP index ETN AMJ is 8.97% and with dividends is 10.82%.
The S&P500 index ETF SPY is 2.24% and with dividends is 2.76%.
The Russell 2000 index ETF IWM is 2.18% and with dividend is 2.47%.
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Refinery Logistic MLPs Current Distrib/ Q2 Dist Dist/dcf Dist/dcf Year-to-Date Percent Change
Company name Price Quarter Yield 2016 2017 Price Pr+Dist EPS Target DCF Dist* CAGR

Delek Logistics Partners, LP DKL 26.20 0.6100 9.31 76.73 73.94 -26.59 -23.17 -23.92 -15.40 -5.36 15.09 -18.75
MPLX or Marathon LP MPLX 33.59 0.5050 6.01 83.82 75.37 -14.59 -12.03 -43.33 -35.97 -10.74 23.17 -23.08
Phillips 66 Partners L.P. PSXP 54.05 0.4810 3.56 68.47 54.50 -11.97 -10.40 -17.95 -2.40 0.72 30.00 -10.00
Shell Midstream Partners, LP SHLX 32.00 0.2350 2.94 58.39 48.21 -32.91 -31.93 -1.23 -1.45 0.63 34.29 0.00
Tesoro Logistics LP TLLP 47.40 0.8100 6.84 78.07 72.32 -5.80 -2.58 -2.74 -9.31 -4.60 16.55 0.00
Valero Energy Partners LP VLP 45.96 0.3400 2.96 43.59 41.34 -10.95 -9.63 12.66 -1.39 6.48 22.74 -4.67
Western Refining Logistics WNRL 25.52 0.4025 6.31 83.42 74.54 4.04 7.32 -26.13 -9.40 -13.06 20.87 -4.76

Logistic Average 5.42 70.35 62.89 -14.11 -11.78 -14.66 -10.76 -3.70

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For this update, I will look at Midcoast Energy Partners or MEP. MEP is down 9.77% while the average of this grouping is up 20.87%. Why? When MEP reported Q4-15 earnings on February 16th, MEP provided EBITDA and DCF projection guidance that was much lower than expected. My consensus DCF projection has fallen 30.65% and the price target has fallen 48.09% since the beginning of the year. MEP sells at the highest yield because the distribution is lacking coverage by a significant degree.

Let's move on to earnings. The spreadsheet that follows summarizes key metrics in the income statement and balance sheet since Q1-14:

Midcoast Partners metrics
Q1-2016 Q4-2015 Q3-2015 Q2-2015 Q1-2015 Q4-2014 Q3-2014 Q2-2014 Q1-2014
Revenues 431.9 528.1 661.0 780.1 873.5 1,451.2 1,399.4 1,396.8 1,646.9
EBITDA 23.6 26.6 28.6 24.5 24.4 24.0 20.4 16.7 16.9
DCF dollars 16.500 16.500 18.900 19.400 18.600 11.500 12.300 14.400 12.300
Net DCF dollars 16.170 16.170 18.522 19.012 18.228 11.270 12.054 14.112 12.054
Units 45.2 45.2 45.2 45.2 45.2 45.2 45.2 45.2 45.2
DCF/unit $0.3577 $0.3577 $0.4098 $0.4206 $0.4032 $0.2493 $0.2667 $0.3122 $0.2667
Upcoming Distrib. $0.3575 $0.3575 $0.3575 $0.3525 $0.3475 $0.3425 $0.3375 $0.3250 $0.3125
Coverage 1.00x 1.00x 1.15x 1.19x 1.16x 0.73x 0.79x 0.96x 0.85x
Broker1 DCF/unit $0.36 $0.36 $0.41 $0.42 $0.40
2015 adjusted EBITDA was $104.1 and DCF was $73.4 million. 2016 guidance for EBITDA is $55 to $75 million and DCF of $25 to $40 million
As long as distribution is under $0.359375, 98% of cash flow goes to the limited partners. Thus far, net DCF is calculated as 98% of total DCF
LTM EBITDA 103.3 104.1 101.5 93.3 85.5 78.0
Long Tern Debt 838.3 888.2 820.0 810.0 838.3 888.2 765.0 475.0 250.0
Long Term Debt/EBITDA 8.12x 8.53x 8.08x 8.68x 9.80x 11.39x
Adjusted Debt/EBITDA* 4.06x 4.26x 4.04x 4.34x 4.90x 5.70x
Reported Debt/EBITDA 3.6x
Interest Expense 8.3 8.0 7.6 7.2 6.7 7.0 3.6 2.8 3.3
Interest Coverage 2.84x 3.33x 3.76x 3.40x 3.64x 3.43x 5.67x 5.96x 5.12x
Adjusted Int Coverage* 5.68x 6.66x 7.52x 6.80x 7.28x 6.86x 11.34x 11.92x 10.24x
* Half of total MEP's EBITDA goes to EEP before the MEP EBITDA number - my adjustments account for that - those adjustments may not be enough
Red Flag 1- MEP is working with Enbridge Energy Partners to explore and evaluate a broad range of strategic alternatives - May 2016 presentation
Red Flag 2- Hedging program supports 2016 cash flows (All the E&P MLPs said the same thing in 2014) - May 2016 presentation
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Here is some additional color from the Q1-16 earnings press release: The partnership's distribution coverage for the first quarter was 1.0 times, which reflects just $800,000 of distribution support from their sponsor, EEP. (This implies that $0.8 million of the quarter's DCF came from such support - and that run rate DCF would be $0.8 million lower.) Lower system volumes and lower commodity prices resulted in a decrease of gross margin of approximately 11.6 million to 6.3 million in the gathering, processing and transportation segment. There were three favorable one-time items which aggregate to 7.1 million in Q1-16. (1) MEP received $3 million from a related producer, as payment for not connecting the required number of wells to our gathering system. (2) MEP reduced expenses by 2.6 million for a liability that they would have owed a producer in the Eaglebine, if they had achieved a specific volume level. (3) MEP received 1.5 million of indemnification proceeds related to a legal costs. (This implies that run rate EBITDA would be $7.1 million lower.)

For my run rate DCF, I would subtract both the $0.8 million of support and the $7.1 million of one time events to get (16.5 - 7.9) $8.6 million of $0.19/quarter or $0.76/year.

Using the midpoint of the 2016 DCF projection of $32.5 million - DCF/unit would be $0.72. I currently have four 2016 projections ranging from $0.51 to $1.08 - with an average of $0.80 - the number I use for my consensus projection. I currently have four 2017 projections ranging from $0.08 to $1.15 - with an average of $0.60 - the number I use for my consensus projection. The median 2018 projection is $0.58.

Does the $0.58 projection look so out of line? Keep in mind that the low 2016 DCF projection from MEP is $25 million - which would be (25/45.2) $0.55/unit. Add to that, G&P assets need some growth cap ex to maintain their distribution as old wells decline and new wells need to be connected - and MEP is cutting growth cap ex to survive in the short term.

What can we learn from these numbers?
1. I have verified the DCF/unit (or Distributable Cash Flow per unit) calculations with the DCF numbers from only a single brokerage. The DCF calculation is simple - there is one adjustment to the DCF dollars. Adjustments for 'normalization' have not been done.
2. I have confidence in my DCF calculation because my numbers always match those done by both the MLP and the one professional analysts.
3. DCF/unit change since 2014 has been negative. Most MLPs have faced headwinds due to commodity price falls.
Let's move on to some attributes I know due to producing similar spreadsheets for many other MLPs. As you absorb the data from future articles in this series, you will have the data in which to arrive at similar assessments.
4. DCF/unit numbers by quarter are moderately volatile. They would be more volatile if I adjusted out the GP support.
5. The 'annual' distribution coverage has been extremely poor. Coverage is both a safety and growth attribute.
6. The debt metrics for MEP are still good.

What about a risk assessment?

Historical DCF projection accuracy is terrible. The small amount of debt lacks a credit rating. The distribution lacks coverage by an extreme degree. The valuation for MEP is totally based on promises made by its general partner, Enbridge Energy Partners, L.P. Any company that has announced that are looking at strategic alternatives have confessed that things could get ugly.

The risk assessment should be based on a logical surrender price of MEP in an acquisition by EEP or a third party. If that price is higher than the already depressed price of MEP, then the risk would be lower. If the price is surrender price is lower, then the risk gets higher. For that assessment, let's look at the current Price/DCF data:


DCF / Unit DCF Growth Price/DCF Ratios
Co. 2010 2011 2012 2013 2014 2015 2016 2017 2018 13-14 14-15 15-16 16-17 17-18 2015 2016 2017 2018
G&P MLPs
AM 0.00 0.00 0.00 0.00 0.90 1.13 1.52 1.58 1.94 na 25.56% 34.51% 3.95% 22.78% 23.06 17.14 16.49 13.43
AMID 0.00 0.00 1.90 1.36 1.87 1.89 1.98 1.87 2.57 37.50% 1.07% 4.76% -5.56% 37.43% 6.49 6.19 6.56 4.77
CNNX 0.00 0.00 0.00 0.00 0.00 1.11 1.37 1.44 1.55 na na 23.42% 5.11% 7.64% 15.72 12.74 12.12 11.26
DPM 2.48 2.77 2.68 2.83 3.20 3.57 3.24 3.13 3.50 13.07% 11.56% -9.24% -3.40% 11.82% 9.81 10.81 11.19 10.00
ENLK 1.64 2.00 1.65 1.36 1.54 1.53 1.74 1.86 2.10 13.24% -0.65% 13.73% 6.90% 12.90% 10.66 9.37 8.77 7.77
EQM 0.00 0.00 1.78 2.46 3.40 4.42 4.69 4.88 4.82 38.21% 30.00% 6.11% 4.05% -1.23% 16.94 15.97 15.34 15.54
APLP 2.26 2.50 2.46 2.69 2.83 2.81 2.44 2.69 2.79 5.20% -0.71% -13.17% 10.25% 3.72% 4.81 5.54 5.03 4.85
MEP 0.00 0.00 0.00 0.00 1.24 1.24 0.86 0.60 0.58 na 0.00% -30.65% -30.23% -3.33% 7.07 10.20 14.62 15.12
SMLP 0.00 0.00 2.08 2.08 2.45 2.24 2.63 3.01 3.24 17.79% -8.57% 17.41% 14.45% 7.64% 10.33 8.79 7.68 7.14
WES 2.21 2.40 2.67 2.63 3.24 3.33 3.81 4.19 4.33 23.19% 2.78% 14.41% 9.97% 3.34% 14.66 12.81 11.65 11.27

Average 16.47% 6.10% 6.13% 1.55% 10.27% 13.28 10.96 10.94 10.11
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The MEP Price/DCF based on my consensus DCF projection (which I have already shown looks to be relatively bullish) is 10.20 compared to the sector average 10.96. That does not look that out of line. The problem is in the 2018 Price/DCF number - where MEP is 15.12 while the sector average is 10.11. MEP at its current price is valued 50% above G&P sub-sector average using the 2018 projection. Add to that, "troubled assets" should not be selling above sector average. The troubled G&P MLPs AMID and APLP are selling at Price/DCF ratios near 5. I think it would be overly bearish to say that a surrender price should be a 2018 Price/DCF of 5, like the other troubled MLPs - but it is worth keeping in mind for the creation of a worst case scenario.

MEP is a spin-off of EEP, which has 2016, 2017 and 2018 Price/DCF ratios of 10.32, 9.87 and 8.60. There is no way that EEP would take back MEP at a higher Price/DCF than is on EEP assets. But that is what the market is de facto presuming at the current price of MEP. Put an 8.60 Price/DCF on the 2018 projection of $0.58 and you get a price of $4.99 compared to the current price of $8.77. Remember, that is putting what I expect is a high Price/DCF multiple on the 2018 projection that is above the low point in the 2016 guidance.

You should also remember that this speculation comes from a fellow retail investor - not a full time analyst with years of experience.

MEP is telling us two things that appear to be mutually exclusive. (1) They are saying that EEP will support the MEP distribution through 2017. And (2) they said in the Q1-16 conference call that "Our Board of Directors will continue to evaluate our distribution on a quarterly basis in light of our operations and the cash generation strategies". That second statement sound like a distribution cut is on the table.

This is the point where I usually show my final valuation sheet. I do not think I need to do that here. I have shown the stats that strongly indicate that a logical surrender price is well below the current price. I have shown the quarterly numbers and the MEP DCF projection that support the idea that the current distribution is not sustainable - and only exists as long as the distribution is supported by EEP. And the MEP management has basically warned that a cut in the distribution is coming.

I write for retired investors like me, who are trying to pry loose a growing income from their portfolio without touching capital. Such investors have no logical basis to be owning MEP. I could easily be wrong in my surrender price calculation. But even if it is wrong, the price is well within logical expectations. And such a calculation highlights the well above average risk you would be taking by having an investment in MEP.

Disclosure: I am/we are long EPD, GEL, MMP, MPLX, PSXP, TLLP, SHLX, WES.

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.