After successive waves of indiscriminate selling and buying, the easy money has been made in midstream master limited partnerships (MLP). Going forward, investors must have a firm grasp on underlying fundamentals to achieve differentiated returns.
Midstream operators continue to face operational headwinds, including volumetric declines in some basins, the general lull in demand for incremental takeaway capacity after the recent construction boom and the debt hangover from this period of rapid growth.
But investors shouldn't overlook three growth drivers as they position their MLP portfolios for the next few years:
- Volumetric growth in the onshore plays (primarily the Marcellus Shale, the Permian Basin and the Anadarko Basin) that are best-positioned to take market share in a challenging pricing environment,
- Mexico and US utility's growing appetite for inexpensive natural gas from America's prolific shale plays, and
- the expansion of the US petrochemical complex on the Gulf Coast.
We upgraded EnLink Midstream Partners LP (NYSE: ENLK) to a Buy in the comprehensive guide to midstream master limited partnerships (MLP) that we published on Aug. 23, 2016, coming full circle on a former Portfolio holding that we exited for a slight loss in June 2015. This sale proved timely, helping us to avoid another 20 percent of downside - and that's after the stock rallied from its February 2016 nadir of $7.71 per unit.
The partnership generated enough cash flow to cover its third quarter distribution by 1.06 times and continues to lay a foundation for future growth through ongoing investment in Oklahoma's Anadarko Basin as well as the Permian Basin in West Texas.
These basins offer superior economics and continue to attract drilling activity, while EnLink Midstream Partners' close relationship with its sponsor Devon Energy Corp (NYSE: DVN) provides leveraged exposure to the upstream operator's accelerating drilling and completion activity in these plays.
Devon Energy increased the number of rigs working in the so-called STACK play to five from two in the third quarter and plans to add a sixth unit by the end of the year. Including rigs run by other producers, management expects 12 units to be drilling actively in EnLink Midstream Partners' service territory by the end of the year.
Devon Energy also expects to grow its US oil production by 10 percent next year and its output in the STACK and Permian Basin by at least 30 percent in 2018.
Since acquiring and integrating privately held Tall Oak Midstream earlier this year, EnLink Midstream Partners has grown the throughput volumes on its gas-processing plants in central Oklahoma by about 85 percent. The start-up of the Chisholm II plant will give the MLP 800 million cubic feet per day of processing capacity in the region, up from 350 million cubic feet per day in 2015.
Management has started to consider adding another 200 million cubic feet per day of processing capacity and noted that another plant could be needed in two to three years if development of the STACK accelerates.
And EnLink Midstream Partners' exposure to growing production of natural gas liquids (NGL) bodes well for the MLP's Cajun-Sibon system in Louisiana, which fractionates the mixed NGL stream into discrete components and provides connections to key end-markets on the Gulf Coast.
This tailwind should help the Cajun-Sibon system to operate at full capacity in the second quarter of 2017 and create additional growth opportunities.
These growth stories should offset ongoing weakness in EnLink Midstream Partners' legacy gathering and processing assets in the Barnett Shale, a mature play in the Fort Worth area that has fallen out of favor.
Management estimates the decline rate in this area at 10 to 12 percent per annum, though the MLP has helped to mitigate this challenge through cost controls, adjusting the pressure on gathering lines and securing business from new customers.
These efforts limited the year-over-year decline in throughput volumes to between 5 and 7 percent. Devon Energy's minimum volume commitments in the Barnett Shale also expire in a few years.
But this weakness in the Barnett Shale and declining volumes on the Victoria Express pipeline in the Eagle Ford Shale should be offset by growth opportunities in the Permian Basin, where EnLink Midstream Partners has established midstream footprints in the core of the Midland and Delaware Basins.
The MLP will bring its Lobo II gas-processing plant pipelines onstream in the Delaware Basin later this year, and the Greater Chickadee oil-gathering project in the Midland Basin will become fully operational in the first quarter of 2017.
EnLink Midstream Partners has also started to explore the sale of its one-third interest in Howard Energy Partners LP, a privately held entity with a leading midstream platform in the Eagle Ford Shale. Monetizing this asset would provide additional cash to invest in growth projects.
Yielding 9.5 percent, EnLink Midstream Partners offers significant exposure to volumetric growth in two of the leading rate-of-change shale plays. The stock also appears overdue for a re-rating now that it's no longer a drop-down story.
Disclosure: I am/we are long ENLK.
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.