CNMX: The Little MLP That Could

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About: CNX Midstream Partners LP (CNXM), Includes: CNX
by: James Coleman
Summary

CNXM is a $894.1M market capitalization under the radar midstream master limited partnership which deserves consideration primarily for value investors interested in establishing and/or diversifying their exposure to MLPs.

Based on the company's history of increasing dividends for shareholders  the improving financial metrics of their sponsor CNX Resources Corporation (NYSE: CNX)  suggest that this trend is likely to continue.

CNXM's strong 2019 Q1 performance and ROIC have attracted the increased attention of institutional holders which have recently added to their positions in the company.

CNX Midstream Partners, LP (NYSE: CNXM) and formerly known as CONE Midstream Partners, LP became a sole-sponsored MLP on 1/3/18. Although the company's stock price has been suboptimal since then, CNXM recently has made strides to derisk and delever their financials and is poised to achieve sustained distributable cash flow and distribution growth as detailed in this article.

Company background

CNXM is a growth-oriented MLP focused on the ownership, operation, development and acquisition of natural gas gathering and other midstream energy assets. The company's focus on the Marcellus Shale and Utica Shale in Pennsylvania and West Virginia, which are among the largest natural gas fields in the United States bodes well for their performance going forward.

Improving 2019 Q1 performance

CNXM reported a solid 2019 Q1, compared to the corresponding time period in 2018 as highlighted by the following key financial metrics:

  • Net income of $35.1M as compared to $27.8M (+26%)
  • Net cash provided by operating activities of $49.9M as compared to $41.9M (+19%)
  • Adjusted EBITDA (non-GAAP) of $54.4M as compared to $34.8M (+64%)
  • Distributable cash flow (non-GAAP) of $43.0M as compared to $29.2M (+ 47%)

These data points represent demonstrable improvement in the execution of the company’s business plan, and in the author’s view a positive catalyst for the remainder of 2019 and beyond.

Macro buy thesis

Since their introduction in 1981, MLPs have appealed particularly to high-net- worth individuals seeking robust after-tax income, with the potential for capital appreciation and income growth. Investors interested in estate planning alternatives with a sharp focus on tax efficient wealth transfer were also drawn to MLP products.Some less well-heeled individuals also had a fondness for MLPs. When the Boston Celtics formed a MLP shortly after the team won the 1985-86 NBA championship, local folklore is that a close group of new CPA firm employees who patronized the Scotch & Sirloin, (a popular pre-game and post-game sports fan hangout) increased their “cred” post haste by taking a small position in the Celts $48M IPO and boasting that they had “limited partner” status. The present landscape of MLP ownership has evolved significantly through a series of changes to the IRS code and other events, and the author believes that MLP’s are best suited for older investors seeking income. There is value in the sector, but the risk factors also need to be given serious consideration. A focus on discipline about what you buy, when you do so and what percent of your portfolio you allocate are serious issues. Sector diversification is also a primary concern in order to minimize risk, especially as one approaches retirement.

Micro buy thesis

The author’s due diligence in the preparation of this article included reviewing CNXM company and SEC filings, SeekingAlpha articles (see below for prolific contributor Dividend Sensei’s article) and a recent comprehensive company research report made available to Fidelity Investments brokerage clients. Based on his analysis, the author believes that CNXM is currently undervalued and has the potential to outperform many of its competitors on a long-term basis. The remainder of this article focuses on three specific catalysts which are worthy of consideration regarding investment in CNXM stock.

Improving financial metrics

The author considers annualized return on invested capital ((NASDAQ:ROIC) to be particularly critical when analyzing MLP’s as in his view it is a much better predictor of company performance than either return on assets or return on equity. This is where CNXM shines as his review of 32 midstream MLPs whose primary activities are in the oil and gas segment indicates that the company’s ROIC of 17.9% is among the “best in class.” CNXM also has a gross margin % that is much higher than 90+% of its industry peers as well as higher net margin profitability ratios. It is important to note that CNMX Q1 2019 revenues “beat” consensus estimates when the company reported results on April 30, 2019. Revenues of $72.2M were $3.7M (or ~ 9.5%) more than the consensus estimate of $68.5M and EPS of $0.47, which were $0.02 (or ~ 4%) less than analyst estimates of $0.49. The author’s “deep dive” into the company’s 10-Q indicates that the principal reason for this EPS “miss” was largely attributable to two significant “1 offs and non-repeats” (to borrow a favorite phrase of GE CFO Jamie Miller) totaling $10M which impacted CNXM’s bottom line. The company abandoned the construction of a compressor station that was designed to support additional production within certain areas of the Anchor Systems, incurring a loss of $7.2M and the sale of midstream assets resulted in a loss of $2.8M. CNXM also provided updated guidance that 2019 capital expenditures are expected to increase to approximately $310-$330 million, compared to the previous guidance of $250-$280 million due to the construction of the planned Buckland compressor station and its related discharge lines and interconnect facilities. In addition, the company noted that their omnibus agreement with CNX will require payment of an annually-determined administrative support fee of approximately $7.9M for the year ending December 31, 2019 (compared to $1.9M for the year ended December 31, 2018) for the provision of certain services by CNX and its affiliates, including executive costs.

This increase in SG&A expenses, while significant, is expected to be mitigated to some extent since CNXM has recently amended its revolving credit facility and extended its maturity to April 2024 from March 2023 and also received an annual interest rate reduction of 0.25% on borrowings compared to the original agreement. And since on April 17, 2019, the Board of Directors of the Partnership’s general partner declared a cash distribution to the Partnership’s unitholders with respect to the first quarter of 2019 of $0.3732 per common unit. This vote is an affirmation of CNXM’s cash flow metrics going forward and is the sixteenth consecutive quarter that the company has increased the dividend.

Seeking Alpha’s coverage of MLPs

On October 29, 2018 a SeekingAlpha article entitled Dividend Sensei's Portfolio Update 57: The 11 Stocks I'm Buying During This Correction” included a recommendation of CNXM, which was then trading at $16.42 as a “highest conviction” buy. Based on the author’s professional training received working at The Motley Fool's energy desk specializing in midstream MLPs and his #22 ranking out of 6,848 bloggers (top 0.003%) on TipRanks. The author of this article considers CNXM a low risk stock with a stable outlook at this depressed level of $13.92.

Increased fund and institutional holdings in 2019 Q1 and Q2

According to SEC 2019 Q1 Form 13F filings, there were several fund and institutional holders which increased their holdings in the company, including OppenheimerFunds, Inc. and Clearbridge Investments, LLC, both of which were already among CNXM’s largest shareholders. A Boston- based hedge fund which the author has followed for some time more than doubled their already sizable position in CNMX in Q2 and since hedge fund managers are historically considered patient investors, the author believes that this is another reason for optimism re CNXM for the foreseeable future.

Improved sponsor stability

Since CNMX reported 2019 Q1 earnings on April 30, 2019, CNX’s stock price has decreased from $8.96 to $7.10 (or ~ 21%). During the same time frame CNXM has gone down from $15.51 to $13.92 (or ~ 11%. However a July 5, 2019 article on Yahoo! Finance which quoted an American City Business Journals article by Paul J. Gough regarding the region's only 100 percent-electric hydraulic fracturing unit is up and running on a CNX Resources Corporation well pad in Greene County, PA which is located in the The Appalachian Basin and is the "biggest, baddest basin there is" in terms of natural gas production according to analysts with U.S. Capital Advisors LLC (USCA).The article states in part:

For CNX and Evolution, that means that about 14 people per shift are needed instead of at least 25. And as a feedstock, instead of buying diesel and using many more trucks and pumps, CNX uses the natural gas that it is producing for a big cost savings. CNX EVP Tim Dugan said that it's about a 95 percent savings on fuel cost. That translates into an estimated $12 million to $13 million in diesel fuel every year.

The author of this Seeking Alpha article notes that a 44% (or more) decrease in payroll expenses would also represent a sizable cost savings and further evidence that this disruptive technology may be the proverbial “game changer” for both CNX and CNXM and result in a pronounced competitive advantage.

Conclusion

CNXM is clearly dwarfed in size by behemoth constituent midstreams Shell Midstream Partners, LP (NYSE:SHLX)and DCP Midstream, LP (NYSE: DCP) both of whose market capitalizations are ~ five times CNXM’s market capitalization, the company has potential as a bona fide player in the midstream oil and gas space. The company’s stock price has been under pressure since it became a sole sponsored MLP 1 ½ years ago due at least in part to issues related to CNX. However, despite the headwinds they face, recent positive developments as detailed herein have occurred which bode well for the company.

CNXM’s recent inclusion in the prestigious Alerian Midstream Energy Index will increase their visibility in the oil and gas subset of the MLP midstream industry. CNXM’s impressive ROIC hopefully will become more recognized by the investment community and may very improve as a result of the disruptive Evolution technology recently implemented by their sponsor. Financial metrics such as balance sheet, income statement and cash flow data are important quantitative criteria as well as qualitative issues such as management with deep industry experience which is also critical for successful execution of company objectives. CNXM CEO Nicholas J. (“Nick”) Deluliis has 15 years of employment with CONSOL Energy, CNX and affiliated companies. Under Mr. Deluliis’ leadership, the company has earned management effectiveness ratings in the top 10% of industry peers based on ROA, ROE and ROI ratios. CNXM has stated that 2019 will be a “transformational year” and in the author’s view may achieve “the little MLP that could” status in the foreseeable future, and he is presently considering initiating a starter position in this “under the radar” midstream stock at a price below $14.00.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.