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NGL Energy Partners: Smart Management

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About: NGL Energy Partners LP (NGL), Includes: NGL.PB, NGL.PC
by: Long Player
Long Player
Oil & Gas Value Research
Get analysis on under followed Oil & Gas companies with an edge.
Summary

Water transportation and disposal are growing very rapidly.

New Mexico is one of the most water-stressed states in the United States.

This company has the technology to materially reduce the water stress of New Mexico caused by the unconventional oil and gas industry.

Diversification into three main business units and several basins provides more than adequate protection.

The water business grows during downturns because existing wells tend to produce more water as they age and less saleable product.  This offsets the lack of demand from lower fracking.

NGL Energy Partners' (NGL) management made some sizable purchases before the oil price war and the coronavirus challenges. Mr. Market did not realize the recession-resistant nature of some of those businesses.

Current produced water transportation and disposal volumes on its systems have increased in March to a record 1.9 million barrels per day, including approximately 1.5 million barrels per day in the Delaware Basin"

Source: NGL Energy Partners March 19, 2020, Earnings Press Release

The water business was part of the purchases made before the latest market downturn. That business will probably continue to grow throughout the downturn. Many oil and gas wells produce a lot of water during the time they produce commercial amounts of oil and gas. In fact, the amount of water often increases as the well ages and produces less oil and gas. Therefore, this part of the midstream business will probably continue to set records throughout the duration of the latest industry downturn.

Much of the market focus is on the oil and gas produced. But a midstream company with water handling capabilities often handles far more water produced by the well than actual commercial production. Some of these companies have wells that flow 20 times as much water as saleable product. That implies a whole lot more water over the life of the well than just about anything else. Far more importantly, the midstream partnership now has a counter-cyclical business to offset the declines elsewhere when industry drilling activity slacks off.

Source: NGL Energy Partners J.P. Morgan Global HY & Leveraged Finance Conference Presentation in February 2020.

More importantly, much of the area that has the most oil and gas in Texas and New Mexico do not receive that much rain. Therefore, water reuse is becoming extremely important. Plus, when anyone is done with water, the ability for people to drink that water and use it personally is rising in importance. Therefore, water purification is also a rising need in the area.

There have been droughts in the past that caused operators to drill wells but delay completions until water was available. Idle capital dollars can be very costly to an exploration and production company. This company has water rights that will only increase in value over time.

Source: NGL Energy Partners J.P. Morgan Global HY & Leveraged Finance Conference Presentation in February 2020.

New Mexico was previously shown to be one of the most water-stressed states in the United States. The growing unconventional business will only increase that stress in the future. Therefore, the technology possessed by this partnership far exceeds the value of the stock. The plant shown above can be built in New Mexico. Further revenue can then be derived by selling the treated water to either farmers or towns for appropriate use. The water can also be used for fracking when there is a drought.

Admittedly, once this midstream operation (or division) has some operating history as configured, future industry downturn will cause a "hiccup" in water use when less wells are fracked. However, the continually rising water amounts from producing wells should materially offset such a decline. This particular downturn will be different because company volumes will benefit from the recent purchase. Therefore, this partnership may show growth through the current industry downturn.

Guidance

So far management is maintaining guidance:

"Fiscal Year 2020 (ending March 31, 2020) Adjusted EBITDA from continuing operations guidance range remains unchanged at $565 million to $595 million"

Source: NGL Energy Partners March 19, 2020, Earnings Press Release

Investors should expect updates as the fiscal year continues due to the unusual nature of the challenges occurring in this fiscal year. However, the diversification of this company to include water handline should minimize some of the potential earnings volatility.

Even if the company does manage to maintain its guidance all year, the partnership will remain relatively leveraged and it has preferred stock outstanding as well. Therefore, this issue may not be suitable for conservative or income minded investors. The lack of operating history as the partnership is currently configured may be another risk factor. Large acquisitions take time to optimize and this partnership made two decent-sized acquisitions in the last 12 months.

Diversification

The company has several businesses where no customer really dominates. Most of its businesses have competition. Therefore, rates are negotiated. However, should any midstream try to gouge customers, there are regulators in every state and the federal government to appeal to depending upon the situation.

Source: NGL Energy Partners J.P. Morgan Global HY & Leveraged Finance Conference Presentation in February 2020.

This company operates in some of the lowest cost basins in the country. Time will tell how the latest purchases perform. But the company appears to be well located to extract maximum profits. The unconventional business is a relatively young business. Therefore, there could be a lot of cyclical growth ahead for this partnership.

On February 18, the company announced another 20,000 dedicated acres were added to the water handling system. The Permian business has grown so fast that midstream companies probably need a couple of years to catch up with demand. But that means growth for the water business will be much easier to come by than it is for much of the oil and gas industry at the current time. Because this pipeline system offers huge savings when compared to trucking, this part of the business should continue to grow some time before exhibiting any evidence of a business cycle.

The water strategy is one of growing in a highly fractured business with a lot of small competitors and high cost trucking as the other main competition. This particular strategy is a "hands down-winner" and probably will be for a long time.

Third Quarter

The third quarter EBITDA took a big jump as more capacity was used. The fourth quarter should benefit from the following acquisition:

Source: NGL Energy Partners Third Quarter 2020 Earnings Press Release

For those who may not remember, XTO Energy is an Exxon Mobil (XOM) subsidiary. This highly desirable customer instantly became a significant part of the NGL future planning. More importantly, once the main structure is in place, then future add-on projects can be very profitable as are "debottlenecking" projects (also known as ways to get more volume through the same assets).

Income may have dropped for the third quarter. But there is nothing unusual about that when a major acquisition is part of the achievements in the current quarter. Far more important is the EBITDA growth because the cash flow growth should follow once the assimilation activities and operational optimization activities related to the acquisition cease.

Source: NGL Energy Partners Third Quarter 2020 Earnings Press Release

The effect of purchasing the water companies and then selling some are shown above as a large decrease in the operating income of water solutions. In fact, that activity is the single largest contributor to the decrease in income.

On the other hand, water handled volumes increased to more than 1.4 million gallons of water per day during the third quarter. The original announcement at the beginning of the article showed water volume was now up to 1.9 million gallons per day for a huge quarterly increase from the previous quarter. The latest acreage dedication could well cause 100% increases or more when compared to the previous quarter. Should this partnership decide to add a water treatment plant to the Permian structure, then this partnership would have some very material advantages over the competition to add to a long list of cost savings advantages for potential customers.

Management will be exiting some of the refined products business and using any cash received to pay down debt. A small sale was recently announced with the $50 million in proceeds going to debt reduction. The core businesses will be the Crude Oil Logistics, Liquids, and Water Solutions. That is a very attractive mix in some very attractive basins.

The Future

Debt outstanding was $3 billion at the end of the third quarter. That amount is nearly 4 times the annualized amount of third quarter EBITDA. That is not a really great ratio. But it also does not signal trouble.

The real key will be how much more revenue can be extracted from the newly combined water systems. There will probably be several high return projects to "hook up" key parts of the system and "debottleneck" other parts that will materially increase long-term profitability.

In the meantime, EBITDA is likely to continue its relatively fast growth. The Permian and Eagle Ford locations are excellent. The Permian location (in particular) has a lot of potential customers looking for lower cost solutions than trucking. This company now has many of those solutions in place with the ability and technical knowledge to provide still more solutions (at the right price) in the future.

The current oil price war and the coronavirus challenges will have to be closely followed. Most likely the oil and gas industry will have a horrific second quarter followed by recovery beginning sometime by the end of the second quarter. This company will easily "weather the storm." In fact, as far as this company is concerned, there may not be a storm at all.

Sometimes partnerships grow fast enough that the numbers do not display the results of the current downturn. That appears to be the results here. The onus is still on management to prove the results of the latest purchases and sales. But management appears to be off to a good start. Should operations continue as currently planned, then these partnership units could soar to much higher levels from overblown fear levels.

Value

The market value of the preferred and the common units (this company issues a K-1) adds another turn (to the calculated debt ratio) so that the enterprise value is roughly 5 times EBITDA. That is a very low value for a company this well-located with decent growth prospects. The latest distributable cash flow of more than $125 million well covers the distribution to the limited partners. The distribution obligations are $.39 per unit each quarter. That is a small fraction of the distributable cash flow.

As this article was being written, the preferred stock and bond prices were reaching absurdly low levels. On a risk-adjusted return, the bonds may temporarily provide a better return than the common stock. A similar situation may well exist for some investors to consider the preferred stock.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in NGL over 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.

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.