Natural Gas Provides A Place To Ride Out The Storm: Williams And MPLX

Summary

• Natural gas demand is unlikely to decline significantly even in a worst reasonable case COVID-19 scenario.
• Its North American transmission, therefore, provides a place to hide regardless of whether the COVID-19 crisis gets worse or not.
• Natural gas infrastructure firms such as MPLX and Williams will thus do fine and continue to produce solid cash flows.
• Looking for a portfolio of ideas like this one? Members of Cash Flow Kingdom get exclusive access to our model portfolio. Get started today »

As COVID-19-induced fear and greed cause thousand point up and down days on the Dow to start to seem common, one has to consider, where can I hide that is still likely to make me some money? Well, other than going to cash, which I think is a really bad idea when this is going on, I'm sorry but I don't have a decent answer for you.

That is, if your main focus is stock price.

However, if you can look beyond short-term equity price gyrations and focus instead on good dividend payouts supported by strong balance sheets and solid underlying fundamental cash flows, I might be able to help.

You see, this might be the worst year ever for North American natural gas. The US Energy Information Administration 'EIA' even thinks, when all is said and done, that overall volume demand could decline as much as 4%.

Gasp! The horror of it all! Can the firms which deal with this stuff even hope to survive?!

Well, below, we point out one which we think just might. But, first, let's review current natural gas demand expectations.

Natural Gas Demand

What continues to remain apparent is that overall natural gas demand is remarkably resilient relative to other forms of energy and indeed relative to most commodities in general. You may have seen this chart before, it shows natural gas demand didn't decline during the Great Recession, and even increased slightly during the 2015 oil price shock.

Source: Energy Information Administration 'EIA'

Likewise, a potential 4% decline natural gas volume due to COVID-19-induced shutdowns just isn't that significant. The reason behind natural gas's resilience is its main uses - heating, cooking, and electricity production - do not decline even as everyone stays at home and practices social distancing. Some uses, such as domestic and foreign industrial uses to make plastic do decline, but the continued ramp of natural gas for worldwide electricity production is mostly making up for it.

"EIA expects that total U.S. consumption of natural gas will average 81.9 billion cubic feet per day (Bcf/d) in 2020, down 3.6% from 2019."

As far as I can tell, this is the worst decline North American natural gas has experienced since EIA started keeping records. It primarily reflects less consumption in the industrial sector, down 8.7% due to reduced manufacturing activity, and a decline in LNG exports to 5.6 Bcf/d in Q2 2020 and 3.7 Bcf/d in Q3 2020, likely also due to less manufacturing activity worldwide.

Meanwhile, it is interesting that traders seem to understand lower oil prices (-9% today) can be a positive for natural gas prices (+2% today) due to less associated gas being produced in oil-centric regions like the Bakken. However, they completely miss that natural gas midstream firms that don't have much exposure to the Bakken should be just fine.

For example, MPLX LP (NYSE:MPLX) and Williams (NYSE:WMB) are both down about 12% over the last few days. Traders obviously recognize natural gas demand will still be there, else the price of natural gas wouldn't be up relative to the price of oil. So, one is left to wonder, why are MPLX and WMB trading down. Where exactly do these traders expect the natural gas to come from, and more importantly, how do they think it gets to market?

A Couple Equities that can Weather the Storm: MPLX and WMB

Source: StockRover.com (The Yacktman Forward Rate of Return is a measurement of expected future return based on cash flows. It uses the normalized free cash flow of the past seven years and adds in the 5-year growth rate.)

MPLX has some Bakken and Permian associated gas exposure, but its main business is clearly processing and moving natural gas out of the Marcellus primary gas region.

Source: MPLX presentation

If anything, its business is expected to increase as less gas gets produced in associated regions like the Permian and, especially, the Bakken, while more gets produced in primary gas regions like the Bakken.

Similarly, WMB's Transco pipeline serves the power companies of the North East. It doesn't care much where the gas gets produced, as long as the North East continues to consume it. Thus, I'll worry about demand for the Transco pipeline when the North East stops heating its buildings, cooking its food, and turns off all the lights (electricity production).

Source: WMB presentation

My point is, does anyone really think the cash flow prospects for either of these firms changed notably over the last week? We are expected to use about 96% of the volume of gas that we used last year. That gas has to be processed and brought to market. A partial switch from associated with primary gas regions is more likely to increase the demand for these firms' assets than decrease it.

The Distribution Stream

Meanwhile, as of today's close, MPLX offers a 15.6% distribution that was covered 1.4x last quarter. It is possible this distribution will be cut due to growth funding, debt paydown, and other cash flow needs, but unlikely. Debt to EBITDA at 4.1x is reasonable, just slightly above goal, and well within their 5x covenant limit. Whereas we expect MPLX to be able to internally fund growth, the distribution, and all operations by 2021. Really, any question here is more about how best to bridge from 2020 cash flows needs to 2021, rather than a long-term cash produced.

As of today's close, WMB offers an 8.8% dividend that was covered 1.8x last quarter. It is unlikely to be cut. Debt to EBITDA at 4.4x is a little higher than MPLX, but still reasonably under their 5x covenant limit, especially considering the revenue from their Transco pipeline is one of the most prized and stable sources in the industry. So stable in fact that they were recently able to finance 10-year debt tied to it at 3.25% as well as $1 billion of additional 10-year corporate notes at 3.5%. In other words, bondholders don't show the slightest concern that they may not be paid. Dividend seekers shouldn't worry either. Williams is already internally funding growth, the dividend, and all operations from its sizable and steady cash flow stream.

Analyst’s Disclosure: I am/we are long MPLX, WMB. 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.

This article is not meant to be an introduction, not comprehensive coverage of these investments. I do not know your goals, risk tolerance, or particular situation; therefore, I cannot recommend any specific investment to you. Please do your own additional due diligence.

Comments

[Darren McCammon]

With Henry Hub natural gas prices likely to close >$5 today, I'll take the opportunity to remind any readers still following this thread that our single largest allocation remains in the natural gas sector (>33% of our entire portfolio remains in natural gas related investments despite having already taken significant profits along the way). There's plenty of excess cash flow after capex need being generated in this sector. Once leverage targets are met, this usually translates to correspondingly large shareholder rewards via dividends and buybacks.

[Darren McCammon]

$WMB $MPLX

How A Federal Drilling Permit Ban Could Impact The Williams Companies And MPLX LP

seekingalpha.com/...

[Paul_S]

@Darren McCammon - I'm continuing to think through the implications of this news that came out a month and a half ago:

"FINDLAY, Ohio, Aug. 11, 2020 /PRNewswire/ -- MPLX LP (NYSE: MPLX) announced today that it has priced $3,000,000,000 in aggregate principal amount of unsecured senior notes in an underwritten public offering consisting of $1,500,000,000 aggregate principal amount of 1.75% senior notes due in 2026 (the "2026 senior notes") and $1,500,000,000 aggregate principal amount of 2.65% senior notes due in 2030 (the "2030 senior notes").

"The 2026 senior notes and 2030 senior notes were offered at a price to the public of 99.785% of par and 99.913% of par, respectively."

Meanwhile, the equity units are yielding 17.4%. Isn't this the bond market screaming that MPLX management should issue more debt and buy back equity units? Many MLPs with high yields have been de-leveraging. Managements seems to believe that their high equity yields imply they have too much leverage for the current environment. But, if the bond market wants to finance these operations, why not let it? I know you can't do that without limit. MPLX has a stated goal of remaining an "investment grade" credit. But, if they issued another $5 bn of bonds right now they could buy back 30% of their equity units at the current price. Do you think management really believes that doing that would make their equity unit price fall for fear of having too much financial leverage? A quick calculation indicates that their net debt/ebitda multiple would go up from 4.4x to 5.4x. Is that really too high? Their equity unit distribution coverage would go way up because the debt is so massively less expensive than their equity yield.

What am I missing? What aren't MPLX, EPD, MMP, and others taking this approach instead of deleveraging? Do you think that if they tried this it would make their equity prices rise dramatically and get their equity yields back down to normal 5-6% levels?

[Darren McCammon]

Congratulations Paul, you have indirectly discovered what we at Cash Flow Kingdom call the Investor Disparity ratio. It shows cases where their is sharp disagreement in risk between bond and equity investors, thereby helping to identify places where one might capture alpha.

As for selling debt and buying shares, that makes total sense from a shareholder capital allocation perspective. However, you need to consider how management alignment and goals can differ from shareholders. In particular most management teams have an aversion to shrinking the firm (remuneration tends to grow with size). Additionally they realize they are less likely to lose those lucrative positions from somewhat suboptimal investor returns than they are from excessive debt blowing up on them. And last management is more likely to listen to a Wall Street analyst whose firm has a lucrative investment banking arm than they are to a no name buy side analyst such as myself.

[Dollarsandcents]

@Paul_S

"Isn't this the bond market screaming that MPLX management should issue more debt and buy back equity units? "

While you make valid points and you could certainly be right, ultimately, I think this is the equity market screaming to MPLX management that the dividend is unsubtainable. Yes, debt holders are considered the smart money and equity holders the dumb money but it is easier to be considered "smart" when you have a promise to be paid a revenue stream that is secured with assets.

[Darren McCammon]

If you are going to claim the dividend is unsustainable, you might want to provide some numbers to back that assertion up (if you are going to say the market is pricing it that way then you need to also contend why the market is correct). For instance does DCF more than cover the dividend? Will the firm go one step further and be FCF positive next year? (e.g. operating cash flow covers both the dividends and capex?)

[Darren McCammon]

"Recently Berkshire Hathaway (ticker: BRK.A) announced the acquisition of Dominion Energy’s (D) midstream natural-gas assets. The deal nets [Berkshire CEO] Warren Buffett close to 8,000 miles of natural-gas transmission pipelines and 900 billion cubic feet of natural-gas storage capacity.....Investors should look for energy assets where the cash-flow runway is longer than being priced for, plus [there is] the stability to survive the coronavirus. Well-established natural-gas transmission pipelines fit this description." - Ned Davis Institutional Research

[Darren McCammon]

Pretty good analysis and first article from this new author:

"10% Preferred Yield And 50% Appreciation From Ramco-Gershenson"
seekingalpha.com/...

[Darren McCammon]

$BRK.B $D
Berkshire Hathaway just purchased $10B worth of Dominion Energy natural gas assets. Given this endorsement for the natural gas midstream sector, heres some other FREE public coverage Cash Flow Kingdom has provided on other publicly traded natural gas midstream firms:

$AROC
"Natural Gas Provides A Place To Ride Out The Storm: Archrock"
seekingalpha.com/...

$DCP
"Fear Creates Opportunity: DCP Midstream Partners"
seekingalpha.com/...

$ET
"Fear Creates Opportunity: Energy Transfer Partners"
seekingalpha.com/...

[Grange Gorman]

Yes, after Dominion and Duke abandoned the Atlantic Coast Pipeline, as essentially being politically unfeasible, or so I took their chat. Note that Dominion's former gas assets were for the most part divorced from oil shale basins.

[Darren McCammon]

The real winner here is of course BRK. Not only are those natural gas assets that much more valuable, BNSF continues to benefit from shipping Powder River Basin coal to NorthEast coal fired plants for that many more years.

[CapVandal]

Interesting deal. FWIW BHE is doing the deal. It will involve $4 Billion in cash and assumption of 5.7 debt by BHE. BHE has generally kept its profits and spent them acquisitions with occasional cash assistance for acquisitions. But mostly, BRK doesn't put money in or take money out of BHE. BHE has $2 Billion in cash as of 1Q20. BHE already owns Kern River Pipeline and some other Pipeline assets. www.sec.gov/...
But the main takeaway is that this deal appears to be a typical BHE acquisition. And will likely result in a very small cash investment from BRK's core cash pile. But if the rumored large EBITDA is realized, a windfall for the energy unit.

[Patient Tech Investor]

Happy Father’s Day

[CapVandal]

MPC owns 2/3 (64%) of MPLX, as well as being the general partner.

What exactly does this mean? I'm not sure, but I don't consider it necessarily bad for MPLX. For example, 2/3 of the distribution is effectively an inter company charge.

However neither business can really be considered independent. This takes on added significance with the re-announced sale (or spinoff) of Speedway. A sale would essentially eliminate debt considerations.

Speedway is a major asset. The largest CStore operator in the US is Seven Eleven, with about 10,000. #2 is Alimentation Couche-Tard, with 6,000, and Speedway has 4,000. The end state would be an acquiring Seven Eleven would have 14,000 and a huge lead. Or Alimentation Couche-Tard would pull even (or leapfrog) Seven Eleven. Or the spinoff of #3 Speedway could be worth maybe 20 Billion to MPC shareholders - 2/3 of the current market cap of MPC. Couche-Tard has a market cap north of 30 Billion, with 2/3 in the US (using brand Circle K).

But overall, I see MPC as a buy and the combined entity (MPC + MPLX + Speedway) as formidable.

[CapVandal]

Just to clarify, the sale of Speedway is nothing more than a lite version of the Singer/Elliot proposal. seekingalpha.com/...

And also to emphasize that MPLX is a captive. The two companies are joined at the hip, and I doubt that MPLX will outperform MPC over the long term. To that end, I would suggest owning owning MPC or owning both.

The complete Elliot deal was a headache, but a sale of Speedway at 10x EBITDA is attractive, and could be thought of as erasing the Andeaver deal.

[CapVandal]

A spinoff has already been announced. csnews.com/...
Reintroducing the possibility of a sale is new.

[Darren McCammon]

$ET
Be Greedy When Others Are Fearful: Buy 15%-Yielding Energy Transfer
seekingalpha.com/...

[just-an-opinion]

At one time, and likely still today, much of MPLX's revenue were derived from crude and finished products shipments to and from Marathon Petroleum-owned refineries and tank farms. That's not uncommon with refiners that own and operate connecting pipelines. I just believe it is important to consider that point in analysis of revenue sources of such pipeline companies. That is, there is often a direct connection between the revenues of the pipeline division to the thruputs of its refining division. Pipeline companies that are pure common carriers operate from a very different market revenue source basis.

[papaone]

just, good comment

[roadranger]

Don't forget they got Mark west.
If you add that you get a lot of NG and NGL to add to the equation.

[Portwine67]

Thank you Darren, I am long MPLX (I actually like the K1, and tax treatment).
Question: How do you see the MPC / MPLX / Elliot situation playing out in the future?
It was a very strange set of events over the last year or so... and that MPC March 11th report: "Marathon Petroleum explores $15 billion MPLX asset sale" was just plain weird.

[Darren McCammon]

I mostly stayed away during the considering strategic alternatives episode, while following it with interest to see what they decided. It's only after the decision to essentially stay the course under self funding MLP model was made, and the midstream market crashed and burned in mid-March, that I took a position. Going forward I think the board made a rational decision after careful consideration and thus will tend to stick with it ("Marathon Petroleum Corp. Board Concludes Review of Midstream Business": ir.mplx.com/... ).

[BarnOwl]

I feel good about MPLX and have a large position. How many 14.x dividends can one find that are covered at 1.4x? Am hoping that management will indeed cut back their proclivity to invest in the business and improve their self funding position.

[Darren McCammon]

I know your question was facetious, but there's actually a number of midstream firms you can buy with 1.4x or greater coverage right now. Some good, some not so good. In the midstream space these include:
AROC
BKEP
CCLP
CEQP
CNXM
DCP
ENB
ENBL
ENLC
EPD
ET
ETRN
GEL
GPP
HEP
HESM
KMI
NGL
NS
PAA
PBFX
RTLR
TCP
TRGP
TRP
USDP
WMB

The midstream space has changed quite a lot from what it was a even a couple years ago. A lot of firms, whether MLPs or C-corps, have gone the self-funding route. They have had to because investors were no longer willing to support a premium price that allowed them to issue shares accretively. Fundamentally, financial risk has gone down significantly since 2014. Ironically, Mr. Market now considers $15 per share self-funding firms risky, that it considered safe back in 2014 when they traded at $60 and weren't self funding. Mr. Market is a strange bloke. He rejoices in paying full price, even bragging at paying a premium to full price, while thinking the same thing worthless trash when he can buy it on sale.

[Grange Gorman]

Historical coverage, we have no idea what their coverage will look like going into 2021, even with reduced payouts. I don't even think management does, for the most part, at least they don't agree. PAA and ET management are 180 on Permian oil volumes.

[elliot_mllr]

Mr. McCammon:
That analysis of Mr. Market is extremely astute. You might do an article around that theme.
Elliot Miller

[Darren McCammon]

Sorry readers, but I'm not going to answer any more, what about (insert name of another midstream firm) questions. It hasn't even been 24hrs since this was published and I've already been asked about: KMI, ENBL, TRGP, DCP, ENB, and CCLP. Instead let's discuss WMB and MPLX. Tell me why you think they are good or bad investments with as much specific detail and data as possible. Add to the conversation. Your insight is welcome, all of us working together can analyze an investment better than any one of us can separately (including me).

If you want information about other midstreams you need to buy a subscription to Cash Flow Kingdom ( seekingalpha.com/... ) or if you want a service that focuses on midstream firms I recommend @Michael Boyd 's Energy Income Authority (seekingalpha.com/...).

[Donggle]

@Darren McCammon you are not the Shell Answer Man? Those asking for free info have no idea who he was. Most wont even take the free trial.

[Darren McCammon]

Proof that old people don't have to have bad memories. The Shell answer man, that's like mid 70's isn't it?
:)

[Darren McCammon]

Even I barely remember that one.

[User 47988483]

Is there an alternative ETF that covers this space without a K1, Its just not worth the hassle (been there done that)

[Donggle]

Easy costs you in more tax money.

[Darren McCammon]

The people behind the American Energy Independence ETF (USAI), SL Advisors, know the sector well.

I would recommend you DO NOT buy a leveraged midstream sector ETF. The leverage increases your risk considerably due to the possibility of the underlying fund getting margin calls, yet it is arguable whether that leverage increases your long term return much at all.

[Allocation Alpha]

TPYP is a decent alternative to individual stocks

[svetlanakhachaturyan1]

How you would compare MPLX and ENBL?

[Buddha1010]

@Darren McCammon ,

Any thoughts on KMI?

[vitullijoe]

Interesting that you felt MPLX would not cut distribution-----seems market is pricing in dividend cut or the stock should move higher in price based on current yield. Ideas?

[Deadeye]

I would very much like to see your thoughts on TRGP.
Thanks for your informative articles.
Long WMB & TRGP

[Darren McCammon]

I have a position in their preferred NGLS.pA. Members of Cash Flow Kingdom have information on why I chose the preferred instead of the common.

[elliot_mllr]

One can also add DCP to the list of natural gas oriented MLPs.
Elliot Miller

[Darren McCammon]

DCP also has a lot of NGL processing and transport assets that should benefit now that the NGL crack spread has recovered. (I've been long the preferred since mid-late March.)

[sixthspeed]

I've been long wmb for years and recently mplx. Obviously bought years too early. The market seems to despise fossil energy. Any comments around chk bankruptcy impact to wmb?

[Darren McCammon]

First, CHK bankruptcy may have a >80% chance, but it's not a given. Second whether CHK old, CHK new, or some other firm recovers the energy, it will get recovered and move down WMB pipes to market.

CHK going bankrupt could affect WMB's price, but it would very likely be a short term effect. One strategy would be to step into the WMB investment, buying some now but leaving room to buy more later if CHK going bankrupt causes WMB price to decline.