Last week, we attended the 2019 MLP and Energy Infrastructure Conference (MEIC) in Las Vegas. We heard from stakeholders across the sector, from buy-side investors to Federal Energy Regulatory Commission Chairman Neil Chatterjee to midstream management teams. Here are some of the biggest questions raised in Sin City last week and the consensus take from the conference on these issues.
Where's the love for midstream from generalists?
At easily the most well-attended session of the week, a panel of representatives from buy-side firms discussed why MLPs and energy infrastructure companies have struggled to attract investor interest and what changes management teams can be making. In some ways, the space has already made progress in key areas, but there is also more work that can be done to improve corporate governance and balance sheets. In general, midstream companies have become more investable in the last 18-24 months by focusing on reducing leverage, self-funding equity capital expenditures, simplifying their corporate structures, and reporting more generalist-friendly financial metrics such as free cash flow (read more on MLP valuation metrics here). As one management team put it, MLPs need to become bilingual in both MLP and generalist metrics to effectively communicate with investors. While it will take time for generalist interest to gain traction, the panel's outlook was constructive given the improvements that have already been made, which show that management teams are listening to investors. The fruit of these changes is starting to appear as distributions stabilize, and the outlook for distribution growth has become more constructive. To attract generalists and new investors, midstream companies will need to continue to demonstrate to investors that they can deliver on sustainable distribution growth, improved capital discipline, stronger balance sheets, and better corporate governance.
So, what are some of the factors still holding investors back? First, value stocks are simply out of favor. Since the financial crisis, growth stocks have outperformed value stocks, and the energy industry has broadly underperformed since the oil downturn in 2014. As of Friday, energy only represented 5.1% of the S&P 500 Index - a level that is low enough to give benchmark-focused investors a choice of whether to invest in the sector. In other words, energy is not a must-own sector today for these investors. Currently, there are three midstream companies in the S&P 500 - Kinder Morgan (KMI), ONEOK (OKE), and Williams Companies (WMB). Many midstream names are not in broader market indices for various reasons (structure, size, etc.); however, these companies are still negatively impacted by the broad underinvestment in energy reflected by its weighing in the S&P 500.
What's going on with M&A?
In nearly every company presentation we attended last week, management teams were asked about M&A opportunities as both a potential buyer and seller. M&A conversations were in focus given the recent announcement that Buckeye Partners (BPL) agreed to be acquired by Australian investment manager IFM Investors (read more). M&A appetite varied by company, but nearly everyone seemed to agree that it's a great time to be an asset seller, especially given the premium that private markets are placing on midstream assets relative to public markets (read more). At the right price, management teams are certainly open to selling assets as has been demonstrated, with proceeds being used to reduce leverage or fund growth capex. In terms of pursuing potential acquisitions, midstream companies emphasized the need to be judicious in purchasing assets that integrate well with their existing footprint. In evaluating acquisitions, management teams are also exploring how they can expand or rework existing assets in a way that minimizes costs but enhances synergies. With M&A transactions largely opportunistic and situational, companies in the meantime are focused on executing their organic growth project backlog.
Will ESG finally get the attention it deserves?
While the energy infrastructure sector has lagged other sectors on environmental, social, and governance (ESG) issues, it appears that midstream management teams are beginning to put a higher priority on ESG. MEIC hosted a panel featuring management from Crestwood Equity Partners (CEQP) and OKE, as well as representatives from an asset manager and a large indexing and analytics firm, who both acknowledged being pleasantly surprised to be asked to speak at an energy infrastructure conference. The panelists discussed the importance of management teams increasing their disclosure of ESG metrics and the necessity for uniform ESG standards for the sector to improve comparability between companies. ESG is becoming increasingly important in investment decisions, and some panelists argued that adhering to ESG standards, especially good governance, can lead to outperformance. Additionally, ESG came up in nearly all the company presentations we attended, whether brought up by management or included in an audience question. With ESG gaining in importance for investors, it should be important to management teams, and we would expect more midstream companies to report ESG metrics in the future.
Is water infrastructure the next big thing in midstream?
One of the surprises of the conference was the interest in water infrastructure, both supplying water for fracking wells and removing wastewater (read more). Most likely, this was buoyed by NGL Energy Partners' (NGL) announcement of an $890 million acquisition of Mesquite Disposal Unlimited's water infrastructure business on the first day of the conference. In the company's MEIC presentation, management expected NGL's Water Solutions segment to account for 40-45% of the company's fiscal year 20191 EBITDA, with the majority of that coming from the Delaware Basin. For companies with existing footprints in a basin and the ability to leverage relationships with producers, water services may represent an attractive growth opportunity. In a well-attended discussion on water infrastructure, privately held WaterBridge Resources highlighted the growth potential of water services, comparing it to the opportunity set for crude gathering infrastructure 25 years ago. On Friday, the Wall Street Journal reported that Singapore sovereign-wealth fund GIC purchased a 20% stake in WaterBridge in a transaction that valued the company at nearly $3 billion, underscoring the attractiveness of water-related midstream assets. Growing US oil production will support increased demand for water handling, which represents an opportunity for midstream companies aiming to diversify their cash flows.
The persistent theme across the midstream space continues to be the need to attract new investors and new money. Companies have made notable progress in terms of improving balance sheets, moving towards self-funding equity, simplifying structures, and executing operationally. These incremental changes are steps in the right direction, though admittedly, more can be done. In addition to making progress on these initiatives, companies will need to continue to execute each quarter to build a track record that will give new investors comfort and confidence.
1 NGL’s fiscal year 2019 began on April 1, 2019.
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Bryce Bingham is an Energy Research Analyst at Alerian, which equips investors to make informed decisions about energy infrastructure and Master Limited Partnerships (MLPs). Mr. Bingham seeks to promote understanding of the Alerian Index Series and support broader understanding of the role that midstream assets play in North American energy markets. Mr. Bingham previously worked as an Equity Research Intern at Hodges Capital Management in Dallas for three consecutive summers. Mr. Bingham graduated from the Mays School of Business at Texas A&M University with a Bachelor of Business Administration in Finance.