When we last covered the Center Coast Brookfield MLP & Energy Infrastructure Fund (NYSE:CEN), we changed our "short position" to a neutral stance. Our rationale was that the discount to NAV adequately reflected the problems with this closed end fund. We also had a modestly constructive stance towards the sector and that helped shape our views. That was quite some time back and since then oil has rallied and decisively cleared the $60 mark. We took a look at this closed end fund to see whether it could be played from either side.
According to its website "CEN seeks to provide a high level of total return, with an emphasis on distributions to shareholders." This is done by investing in a portfolio of MLPs and energy infrastructure companies. To examine where this fund is today, we have to look at where this fund has been. We all know how that story went in March 2020 as funds like CEN got crushed with the energy blowback. While what happened then can hardly be blamed on CEN management, the fact remains that CEN had quite a few issues that made the impact far worse.
This can be easily seen when we rebase performance to February 1, 2020 for ALPS Alerian MLP ETF (AMLP), First Trust MLP & Energy Income Fund (FEI), Kayne Anderson MLP/Midstream Investment Company (KYN) alongside CEN.
CEN's total return looks devastatingly bad and there are key reasons for that. There are also specific reasons we chose those comparatives to illustrate our point and we shall go through that below.
AMLP beat CEN by a country mile and the reason here is simply a lack of leverage. AMLP is a passive unleveraged ETF and while it got blown up in the "March Madness", it bounced back quite well. On a total return basis, AMLP is now down just 7.87% while CEN is down almost 10 fold as much. The moral of the story is that leverage works, until it does not.
Ok, so leverage is bad when things go south. But why did two leveraged funds, FEI and KYN do so exceptionally well vs. CEN? Both FEI and KYN were leveraged, but there were three areas that FEI and KYN surpassed CEN. The first is that CEN traded at a premium to stated NAV while the others traded at a discount.
A good part of the additional fallout on CEN came from that reversing. While the discounts on FEI and KYN have widened, CEN's trip from premium to a 23% discount was extra painful.
The second reason is that CEN was substantially overpaying distributions that it actually did not cover with cash flow. The other two funds did it a bit as well, but in CEN's case, the amounts were monstrous.
Finally, CEN held and still holds a large illiquid private asset.
Source: CEN Fact Sheet
This asset could not be reduced in stages during the COVID-19 crash. As closed end funds are generally leveraged, they are forced to sell stocks on the way down to maintain their covenants. In most cases, there is some buffer on the way down. But the COVID-19 crash was extreme and most funds had to liquidate stocks, right at the bottom. In case of CEN, its primary asset was completely non-marketable at that point. Hence CEN sold far more at the bottom than anyone else. One side effect of that was the private investment ballooned to 41% of assets from 14.7% in 2019.
Source: 2019 Annual Report
CEN currently appears to be cheap, thanks to a wide discount to NAV. Unfortunately, that is not all there is to examine. The private asset in question was valued on September 30, 2020.
Source: 2020 Annual Report
This is a marked drop from the previous year.
Source: 2019 Annual Report
In our opinion though, the 11.0X exit EBITDA multiple is incredibly high for a tiny midstream company. According to Goldman Sachs (GS), the sector trades at close to 8.5X EV to EBITDA multiples.
Source: GS Asset Management
This is the public sector where firms are valued in the billions. They are also running debt to EBITDA at around 4.0-5.0X. The KKR partnership is tiny in comparison. The partnership is an investment in VMLP. That company, as described below was using high leverage before the pandemic.
VMLP is a Calgary, Alberta-based private midstream company, 46% owned by Pembina Pipeline Corporation (Pembina unrated) and 54% by Kohlberg Kravis Roberts & Co. L.P.(KKR unrated), a private equity firm. VMLP is engaged in natural gas gathering, field compression and processing in the central Montney in British Columbia.
VMLP's Ba3 CFR benefits from (1) the continuing development of economic resources in the liquids-rich Montney by the Cutbank Ridge Partnership (CRP, a joint venture partnership between Encana Corporation (Encana: Ba1 positive) and Mitsubishi Corporation (Mitsubishi: A2 stable)) processed by VMLP; (2) the company's solid contractual agreements mitigating all price and some volume risks on the CRP agreement; (3) and the absence of volume or price risk on the Hythe/Steeprock contract with Encana, and Hythe contract with NuVisa Energy (unrated). VMLP's CFR is constrained by; (1) its natural gas throughput volume risk on the CRP facility contract; (2) very high leverage of around 6.6x in 2019; (3) and the complexity of its contracts.Source: Moody's March 2019
This downgrade was in March 2019. Moody's stopped reviewing the debt in 2020. At present it is highly probable that debt to EBITDA is ahead of 7.0X, though we have no direct visibility into this.
The structure as it stands also produces no discernable cash flow for CEN and that puts the onus of funding the distribution from its other publicly traded holdings. CEN also now suffers from very high costs in relation to the fund size. It has close to $70 million net assets (if you accept the valuation of the private investment). Last year, this was the expense structure.
Source: 2020 Annual Report
Some of these expenses will scale down with asset size but many will not. if we subtract out the numbers from the semi-annual report (March 30, 2020), we can get a rough estimate.
Source: 2020 Semi-Annual Report
By comparing the two, we can note that Legal, Audit and Trustees' Fees do not scale down with asset size.
CEN offers too much uncertainty with 41% of its assets in a single private investment. There is of course subjectivity in valuing such an asset, but in our opinion, the 11.0X exit EBITDA valuation multiple is not justified. CEN could of course prove us wrong by selling it at a premium to what they have marked it at, and we would be happy to issue a "mea culpa" if that happened. We would not hold our breath though for that.
Investors also have to deal with a small asset base and what is likely to be an extremely high management expense ratio. There are definitely better choices out there in the MLP space and we would not be interested in going long this one, even if we had a positive opinion of this sector.
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