Summit Midstream: Where There Is Trouble, There Is An Investment Opportunity

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About: Summit Midstream Partners, LP (SMLP)
by: Long Player
Summary

First-quarter cash flow and EBITDA held up rather well compared to the previous fiscal year.

The market focused on the distribution cut while ignoring the underlying business.

The partnership has several ways to seamlessly change over to growth mode.

A concrete Double E project would aid growth prospects in the Permian.

The DJ basin is growing very fast.

Summit Midstream (SMLP) reported a basically flat fourth quarter for fiscal year 2018 when compared to 2017. The situation worsened a little in the first quarter of 2019 when the decision was made to mothball a gas processing plant once a newer and larger plant was completed. But cash generated by operating activities remained pretty even with the previous fiscal year first quarter. Mr. Market really hated the distribution cut announcement. That was far worse than anything related to the partnership operations.

However, the underlying businesses are doing fine. Cash flow is expected to at least approach the EBITDA of the previous year (adjusted for an asset sale). Plus a new gas processing plant promises cash flow growth soon after operations begin at that plant.

Growth Projects

Probably the biggest growth project with XTO (a subsidiary of Exxon Mobil (XOM)) has not yet been finalized. But preliminary plans are proceeding according to most expectations. That would give this partnership a solid footing in the Permian with a well-established partner.

Source: Summit Midstream MLP & Energy Infrastructure Conference Slide Presentation December 2018.

The DJ basin is growing rapidly and several operators have explained to shareholders that the lack of necessary gas takeaway capacity has constrained production growth. Therefore, the need for a second gas processing plant in the DJ basin is beyond question.

The questionable move was the decision to idle the small plant currently operating. Until the takeaway capacity issues are resolved in the DJ Basin, this decision may prove to be questionable. Most likely the local demand would be enough to assure a reasonable profit while running that small plant.

The Double E project planning appears to be appropriately proceeding. However, financing appears to be the hangup for the partnership. This project appears to be fairly large for the size of the partnership. A stronger partnership unit price would have helped tremendously. However, the ability to fund this should be enhanced by the recent distribution cut.

As these projects become more "concrete" and "visible" to Mr. Market, that visibility should show as an enhanced partnership unit price.

Legacies

But the market worries about operations in non-core areas where production is likely to decline in the future. The market appears to ignore that the company has fee-based long-term contracts. As long as the company reinvests sufficient cash flow in basins with growing production, there should be no long-term worries about overall company prospects.

That does not mean there could be an occasional bump or broken bone. But overall this company should be able to reposition itself by reinvesting sufficient cash flow into high-growth prospects.

Now that the distribution was cut, there is probably little for long-term holders to fear. The partnership is not growing that fast. But the undervaluation created by the distribution cut will disappear over time as the results of the current growth projects begin to appear.

Management probably should have dealt with the legacy issues before now. The delay in handling these issues most likely cost at least one key officer his job.

Source: Summit Midstream MLP & Energy Infrastructure Conference Slide Presentation December 2018.

Some of the worry appears to center around the concern that more than half of the EBITDA is located in the legacy basins. The Piceance appears to have much of the legacy cash flow along with limited activity. This worry appears overdone. As unconventional wells age, their decline rate slows considerably. Plus the company has minimum commitments.

There is also the likelihood that continuing industry innovations could reinvigorate the basin activity. Current basins showing renewed interest include the Cotton Valley and the Louisiana Austin Chalk. It would not be unheard of for one of those legacy basins to become active enough to be considered a core area again.

The movement towards core areas could be accelerated through an acquisition or a sale of some legacy assets. The partnership already netted about $90 million from the sale of one asset. There could easily be more sales in the near future. A sale would have a second benefit of aiding the financing of the joint venture with XTO. That project is likely to have a large capital budget.

Future

Management cut the distribution in half. So Mr. Market nearly halved the stock price as a result. But the distribution is now well covered because the business is still intact. Furthermore, relatively strong oil prices are expected for the rest of the fiscal year. That could easily lead to higher levels of activity than management originally forecast.

The capital structure has now been simplified and the deferred payments issues have been clarified and recorded on the balance sheet. The partnership clearly has the ability to borrow to pay the deferred liability when it comes due next year. Leverage would still be fairly conservative even if the entire payment was borrowed.

The partnership needs to show growth to gain the favor of Mr. Market once again. Regardless of the outcome of the joint venture with XTO, there appears to be plenty of growth opportunities in the future of this pipeline.

The current price of the partnership units clearly under-price the partnership value and its future prospects. This company will actually grow faster in the future with cash to reinvest in its growing and more profitable prospects.

In the meantime, strong oil prices should aid the transition to a growth partnership by providing plenty of incentive for companies to drill and earn a great return. An investor at the current price can look forward to the recovery of these units.

Note that if the partnership units remain at the current level, then the general partner may attempt to take the partnership private. This already happened with American Midstream (AMID) and Buckeye Partners (BPL). Both should be private companies by the end of the year. Both are worth considerably more than they buyout offer price. However, competition to privatize limited partnerships has not been very popular so far.

Conservatively, the partnership units should appreciate about 10% each year and still pay that generous distribution. A faster recovery to previous levels is more likely but definitely not guaranteed.

"Buy straw hats in January" is a good investment mantra that is difficult to execute for many investors. This partnership appears to offer those straw hats in January.

Disclosure: I am/we are long SMLP. 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.

Additional disclosure: Disclaimer: I am not an investment advisor, and this article is not meant to be a recommendation of the purchase or sale of stock. Investors are advised to review all company documents and press releases to see if the company fits their own investment qualifications.