Friday, July 3, 2020

US Pipeline Companies: Part #2

Williams Companies

Their business: Mostly Natural gas, they break down their segments by geographic region:
  • West: Gas gathering, processing and treating in several Western US shale oil fields.  27% of 2019 EBIDTA.
  • Northeast G&P: Gas gathering, processing and fractionalising in the Appalachians.  30% of 2019 EBIDTA.
  • Transmission and GOM: Transport along their Transco pipeline, with a little gas/oil gathering in GOM.  42% of 2019 EBIDTA.
Transco is irreplaceable - more than one fifth of US natural gas consumption flows through it.  for Northeast G&P, Morningstar estimates that Williams collects about a third of overall gas volumes across the Appalachian region.  Their other assets are more exposed to market forces, especially declining crude.

West could be badly affected by crude oil shut-ins, as 30-40% of US natural gas production is associated with crude oil (the gas is an unwanted by product).  Northeast G&P would not be affected  and may even benefit if gas prices rise due to a falls in associated gas.  Transco would likewise be unaffected or benefit.  I believe more than half of GOM's natural gas production is associated with oil wells, so they may be hit too.

Leverage: 2019 debt was 5.4 times EBIDTA.  Very high.  They aim to reduce it to 4.2 times.

For operating leverage, 2019 CFO was 40% of revenue (excluding product sales).  ie: Service revenue would have to fall by this much before they start losing cash.

Valuation: Trading at a 7% trailing yield, with CFO at 1.8 times their dividend.

Growth: Still growing.  Capex in 2018 was 4.2bn, 2019 was 2.4bn, 2020 is expected to be 1.5bn.  For comparison, 2019's CFO was 3.6bn.  They have not announced further cutbacks to 2020 capex.

Near term they have earmarked 3.2bn:


Longer term they have other opportunities:


Management recently said they expect to have "positive free cashflow" from now.  Specifically: without any asset sales, their operating cashflows should support both their capex and dividends.

Long term or political risks: Don't see any.  Natural gas is environmentally clean and has low carbon emissions.  Oh wait...all fossil fuels are bad - one of their proposed pipelines was just killed by NY.

Worst case scenario:  Again, lets say US crude production halves. I'm going to assume that all gas production in their 'West' segment is associated with oil (1) (2).  So if gas production halves, revenue halves, and the company's CFO drops by 900m or 25%, to 2.8bn.  After the projected capex, they would have to cut their 2020 dividends to ~ $1.05,



Kinder Morgan

Their business: Mostly Natural gas:
  • Natural Gas: interstate and intrastate natural gas pipeline and storage systems, gathering, NGL fractionation, and LNG liquefaction & storage.  57% of EBDA.
  • Refined Pipelines: pipelines that deliver refined product, and some crude.  Including some terminals and mixing facilities.  15% of EBDA.
  • Terminals: Terminals, and Jones-Act qualified tankers.  18% of EBDA.
  • CO2: produces, transports and sells CO2, used for crude oil production.  8% of EBDA
KMI owns the Tennessee gas pipeline, one of three large interstate pipelines supplying Eastern US natural gas.  The company says that 40% of US gas passes through its pipelines.  They would be considered irreplaceable,

CO2 would be badly affected by crude oil demand, while natural gas gathering would be affected by oil production.  Refined pipelines would be affected by covid.

Leverage: 2019 debt was 4.8 times EBIDTA.  Pretty high.

For operating leverage, 2019 CFO was 60% of revenue (excluding product sales).  ie: Service revenue would have to fall by that much before they start losing cash.

Valuation: Trading at a 7% trailing yield, with 2019 CFO at 2.2 times their 2019 dividend.  It would cover the newly raised dividend ($1.05/year) by 2 times.

Growth: Still growing.  They announced they were reducing 2020 capex from around ~3bn to 2.2bn.  For comparison, 2019's CFO was 5bn.

Their new projects before the announced reduction are here (slide 13).  The reduction was probably in CO2:


Long term or political risks: The usual ESG stuff.

Worst case scenario:  Again, lets pessimistically say US crude production halves.  And KMI gets corresponding reductions in revenue as customers go broke.

For Natural Gas, how much would be affected by the halving crude production?  They say that gathering and processing was only 10% of EBDA (slide 21):


I can't relate this to revenues, but assume it cashflows from this fall to zero, as revenue is halved.    Thats an 800m reduction in earnings/cashflows.

For CO2, its easier - halving 2019 revenue subtracts 600m from earnings/cashflows.

So total, we lose 1.4bn from cashflows, which is now 3.6bn.

This gives us enough to cover the 2.2bn capex, but not enough to cover the 2.4bn in dividends - the $1.05 dividend would have to be cut to 60c to be cashflow neutral in 2020.

Lets also say that their refined revenue halves over 2020, due to covid.  This is realistic - not pessimistic - but its only temporary.  KMI's refined revenue also halves, as refined fees are usually volume based.  That removes 900m from their Products revenue, they will still have 500m they could use for dividends, or around 20c per share.

Conclusion

I like Williams and KMI the best, as natural gas is not affected by covid, and is only partially affected by crude.

Although both have high leverage, I can't see any way either company fails.  The dividend is comfortably covered under normal conditions.  And both have growth potential.

KMI has slightly more short-term downside due to more refined exposure.

In general, these types of businesses are predictable and profitable.  Its the black swan risks to watch our for (like Deepwater Horizon).  Or the political ones (Green New Deal).

Wednesday, July 1, 2020

US Pipeline Companies: Part #1

US pipeline companies are trading at 8-10% yields.  When stocks trade at that valuation, usually it means theres something wrong with them.  But these are exceptional times.  Lets take a quick look.

All of these companies own pipelines, with most revenue from long term take-or-pay contracts that don't depend on volume.  Their revenues should hold up - unless their customers go bankrupt, which is what the market is concerned with.

I'm trying to see how badly their businesses may be affected by the plunge in crude prices.  The crude market looks terrible now, I expect US crude production to drop in a seesaw pattern for 1-2 years, then grow.

Magellan Midstream

Their business: 62% of 2019 profits are from Refined Products (pipelines from Texas/GOM, up to Wisconsin/North Dakota/Wyoming), 38% from crude (pipelines covering Permian and GOM).

Their Refined business is large enough to be irreplaceable: they provide more than 40% of refined product in 7 of the 15 states they serve, and can access nearly half of nationwide refining capacity.

Refined usage has taken a beating due to covid.  I expect it to get worse for the year - the previous outbreak hit New York, the next outbreaks will equally spread in rural/red states. Probably get a recovery in 12-18 months, as the US situation changes from lockdowns into a normal recession.  For now, refined product demand has bounced a little after falling off a cliff:

Source: Macrovoices #122 Art Brennan, slide deck

Leverage: 2019 debt was 3.1 times EBIDTA.  Pretty low.

For operating leverage, operating expenses (excluding D&A, including interest and G&A) were about half 2019 transport/terminals revenue.  ie: revenue would have to fall by half before they start bleeding cash.

Growth: Limited.  They are paying out most of their cashflows as dividends.

Valuation: Trading at a 9+ percent trailing yield, estimated payout ratio 90-100%.

Long term or political risks: Gradual decrease in fossil fuel usage, replaced with electric cars/trucks/planes.

Worst case scenario: Lets say US crude production halves, and Magellan's crude revenues (620m in 2019) halve with it (half their customers go bankrupt).  Rough guess, this removes 300m from their profits, reducing the CFO by the same amount, and dividends by 1/3rd (slide 10).   So even if you think US crude production is permanently and badly impaired - which I don't - the dividend is still 6%.

Long term, I don't see Refined dropping.  They are under long term take-or-pay contracts.  The problem is if their customers go bankrupt during the lockdown period.  I estimate lockdowns will be on/off in different states for another 18 months.

Conclusion: 
I can't see any risk to this company's long term prospects, and I think their cashflows/dividends may take a temporary hit before going back to 2019 levels.  Short term, if their dividends drop, so does the share price.  Long term, its a cyclical play where you're paid to wait.  The only downside is limited growth.


Enbridge

Their business: 2019 EBIDTA breakdown:
  • Liquids Pipelines.  A series of pipelines transferring crude through Canada to the US.  Also covers most US shale basins, handling 25% of all US crude.  Tolls on the Canadian Mainline are based on volume (pp14-15), tolls on the US interstate pipelines are long term take-or-pay.  56% of 2019 EBITDA.
  • Gas Transmission and Midstream.  Long continent-spanning pipelines transferring gas from Canada to the Vancouver/US, and from US producing fields (especially the Marcellus) to consuming states.  Take-or-pay.  25% of 2019 EBITDA.
  • Gas Distribution and Storage.  A regulated utility consisting of last mile distribution of gas to Canadian households.  Also an unregulated storage business.  13% of 2019 EBITDA.
  • Others.  7% of 2019 EBITDA.
They are heavily exposed to crude oil volume:
  • Its 56% of EBITDA.  
  • Canadian Mainline pricing is volume based, so lower volumes will be felt immediately. Morningstar estimates that Mainline accounts for 30% of EBITDA.
  • It will have new competitors: TCE's new Keystone Phase 4 is expected to be operating in 2023 (unless Trump loses) and will compete with them.  Same with the Trans Mountain pipeline.
  • Meanwhile, Canadian crude output has fallen due to low prices.  Canadian crude usually trades at a large discount to WTI, because it is landlocked, and must go to the US for refining.
  • Canada's crude production is also energy intensive (like using steam to melt bitumen), so have high fixed costs, despite unlimited reserves.
  • So I think Canadian crude producers are marginal producers.  They may do very badly during this crude crisis.
Enbridge's US interstate gas pipelines (TETCO) distributes gas from the Marcellus down to the Southern US, and is irreplaceable. It would also be unaffected by crude.

So we have 30% of EBIDTA serving marginal (ie: Canadian) producers on volume contracts, in a market crunch, with long term competition coming up.  And another 26% on the US side under take-or-pay (where we would only be worried about customer bankruptcies).  With the 38% of EBIDTA being stable.

Conclusion:
I don't see this as a dividend stock, but more cyclical, levered to WTI (actually to the WTI and WCS differential).  If I want to play an oil price recovery, its probably better to buy Enbridge's customers (CNQ & Suncor).  Right now I'm looking for steady dividend stocks.


Enterprise Products

Their business: Their business segments by 2019 Gross Operating Margin (similar to EBITDA - p83) is 49% NGLs, 25% crude, 13% Natural Gas, 13% petrochemical & refined.

What are NGLs?  Natural Gas Liquids extracted from natural gas at the wellhead.  Different NGLs have different uses, in industrial, heating and transportation:

Source: EIA

In general, the 'wetter' the gas, the more NGL's it has.  So dry gas (from the Marcellus) has less NGLs than associated gas (from shale oil):


Source: IHRDC training course: Gas Processing and Fractionation.

EPP's NLG pipeline covers most shale (oil and gas) in the west and south US:


Source: EPP System Map

EPP's NGL processing revenue is currently mostly fee based (top of p5)... ie: based on volume, with contracts lasting one to ten years.  Their NGL pipeline revenue is also volume based (p7).  Their NGL fractionation revenue is a mix of volume, and commodity prices (bottom p11).

Given these, their EPP's NGL earnings are dependent on crude prices.  First, as associated gas production falls, NGL production falls with it, affecting their volume based payments.  Second, associated gas has more NGLs than dry gas.  The effect on falling crude on NGL supply/demand is very complex.

Lets look at crude (13% of Gross Operating Margin).  Their crude pipelines cover the Permian, Eagle Ford, Haynessville and GOM, with pipes running to Cushing.


I'm guessing that most of their crude is from shale, and will decrease as prices drop.  Their crude pipeline profits are volume-based (bottom p15).  So dependent on crude oil prices.

Their Natural Gas assets (13% of Gross Operating Margin) seem to be around shale oil fields (except for GOM):

And profits are volume-based (bottom p20), so this is again dependent on crude prices.

For Petrochemical and Refined (13% of Gross Operating Margin), they do not say specifically, but I guess they are dependent on the economy.

Conclusion:
I like EPP's long term track record, but all their business segments could be exposed to falling crude production.  I can't estimate how much.  Too risky now.  I may look at them later as a cyclical play if they are hit by falling crude production.

Friday, June 26, 2020

Oil Prices

Two MacroVoices interviews with Dr Annas Alhajji and Art Berman give an optimistic long term view on the crude oil market.

 Dr Annas Alhajji (22 June 2020):

  • The surplus is now 180m barrels in inventories in OECD (excludes China), Saudi Arabia is trying to eliminate it.
  • Comparing now and 2017: in 2017, oil inventories decreased 152m bbl in 10 months,.  This was done by the Saudis cutting production, US oil production increased by 1.2m barrels per day in that period.
  • This time, the rest of the world is cutting production.  US production is down by 1.8m/day compared to 2017.  Libya is at 30-40,000 barrels/day, down from 1m in 2017.  Venezuela now 600k down from 1.9m.  Iraq exports are half of 2017.  Brazil, Norway, Ghana have increased, but small amounts.  Overall, we will get serious supply side issues in the future.
  • Estimates the rebalance of the oil market will take a year.  Picture is way brighter in the next few months than people believe.
  • Shale: only 25% of oil has being brought back, (due to price differentials between WTI and oil areas), once the differentials improve, will see major comeback.  Expects all major companies shale wells to come back online, but there is a problem due to lack of new drilling, needed to offset rapid shale declines.  Major decline may last for 2 years.  Thinks will bottom around 9.8-10m US production, then see a recovery.
Art Bernan (18th June 2020):

  • US Production is down from 13.2m bpd to 10m
  • Unlikely to see negative WTI again.  The govt has opened up strategic reserve space (to lease to store oil).  And the market should resolve any issues if it happens again.
  • Can oil production be switched on and off immediately?  For shale (45% of US production), yes - barring occasional repairs, you can switch on/off production with a few clicks on an ipad.  For conventional, no. 
  • The  current rally is just a relief rally, too many people were short oil.  There is still too much oil around (slide 11).
  • Decline rates have been increasing with newer wells. 
  • Time from rig to first oil production is around 10-12 months.  Estimates 16 months lag from when oil prices rise to make shale profitable, to the time the first shale can be drilled.
  • So he expects the oil price to recover, longer term: "And that next down is going to be a buying opportunity. Because it sounds to me like maybe there’s a few more waves up and down along the way, but eventually we get a moon shot when there is a full economic recovery from this crisis and the industry is just not able to respond quickly enough."   [My notes: And I guess the recovery could be around 16+ months....]
  • Slide 13 shows current recovery in oil consumption so far.  It has not recovered yet.  And the recovery has been mostly in gasoline.

Saturday, June 20, 2020

What I am doing

Similar to last time:
  • For my dividend stocks, added Frasers Centerpoint for full position.  Now ~43% invested (all in dividend stocks).  The dividends are not yet enough to live off.
  • For the remaining ~40% of my portfolio allocated to macro, half is in gold (AAAU) and TIPS (ETF).  I consider these to be like cash.  Small 2% position in COW.
My trades are recorded in my Investing Note account.  This blog is for in-depth analysis.  I am now working again after a short time off, so less time to post here.

I think we get a correction or crash soon.  I'll look to add:
  • BIP plus some Singapore REITs (MCT, FLIT).
  • I think we get stagflation.  If the market corrects, then stocks in gold miners, copper miners, oil producers and fertiliser/farming companies look interesting.  Longer therm, my REITs should do OK in stagflationary periods (low interest rates and increasing nominal property prices, offset by lower rental demand).

Quick thoughts about inflation.  There are 3 causes:
  • Too much money printing.  Like adding extra zeros to your currency.  Zimbabwe.
  • Too much demand.  Overheating economy when production at full capacity.  Not now.
  • Supply constraints.  Not enough investment (eg: finding new copper/oil reserves).  Production cost increases (de-globalisation).
I don't know exactly what form the inflation will take, or how it will be transmitted through the economy.  Too much detailed theory doesn't help you trade.  I look to play it broadly through holding real estate (REITs), commodities or commodity producers, and things that don't devalue with paper currency (gold, TIPS).  Residential housing may be another thing to consider.

Wednesday, May 27, 2020

Bought Gold (AAAU)

Have bought 10% gold in my portfolio, or around SGD 80k.  Average price is USD 17.058.

I am holding the Perth Mint Physical Gold ETF (AAAU).  It is backed by the West Australian State Government, and (theoretically) allows retail investors to redeem gold.  GLD only allows you to redeem 100,000 shares, and the gold is stored with HSBC.

Day to day AAAU moves in line with GLD.  It has a lower expense ratio (0.18% compared to 0.4%), so it degrades less:

AAAU is liquid enough to buy or sell occasionally, but if I was short term trading, I would use GLD.

Why buy gold?

  • Its in a long term uptrend, since late 2018
  • It will do well in a deflation environment (recession this year), and with stagflation later (inflation from money printing but no growth).
  • I am uneasy buying long term Treasuries with rates so close to zero.  We do not know if the Fed can allow negative nominal rates.
The time to sell will be when we get expectations of economic growth.  No sign of that now.  I may hold this for months, quarters, or even years.

Gold is money that can't be printed.  Before I become a die-hard gold bug and doomsday prepper, I remind myself of the risks:
  • Paper gold fell in the March panic.  Everything fell against USD and physical gold.
  • There is a constant counter-party risk: you never know if you can redeem until you do it.
  • When we start getting real economic growth again, gold once more becomes a 'barbaric relic'.


For the rest of my portfolio, I am still waiting for the current bear market rally to die before I begin to buy.  May be waiting a long time.

Thursday, May 7, 2020

What I am doing

I am using two strategies: 'dividend stocks' and 'market timing'.

Am now 40% invested, all in dividend stocks/REITs/trusts, mostly SGX listed. The big ones are Netlink Trust and Manulife US REIT, with smaller positions in Frasers Centerpoint Trust and Mapletree Commercial Trust.

I think the last month's rally is a bear market rally.  I am waiting for a correction to continue buying Frasers Centerpoint Trust and Mapletree Commercial, plus Brookfield Infrastructure Trust.  This will take me up to 60% invested.

I'm willing to catch falling knives when buying dividend stocks.  Even though they will be affected by the recession (except Netlink), all the SGX-listed stocks above should survive without raising capital, unless revenue drops by more than half.  Once the economy recovers in a few years, I should have a dividend stream that I can live off.  Then figure out what I want to do with the rest of my life.


For the remaining 40%, I follow Hedgeye for market timing. They have called the cycle well, moving to bearish in mid Feb, and warning of a likely 20% correction on 4th March.  I wait for them to call a turn in the cycle before buying.

I've been covering a lot of stocks here lately, so I have a list of things to buy when the market does turn.  The shopping list:

  • Inflation plays (growing inflation, slowing GDP): Oil (Equinor), TIPs, maybe Natural gas cos.
  • Growth plays (growing GDP, slowing inflation): Copper (SCCO),...maybe the travel companies (Groupo Aeroportuario, Booking, Safran, Rolls), maybe Delfi
  • Growth+Inflation plays (growing GDP, growing inflation): Interest rate plays (Banks, Computershare, Interactive brokers), maybe Oil above.
  • The travel companies may also be buys after some uncertainty from the virus clears up, then we are just dealing with a normal recession.
If you put a gun to my head and forced me to buy something today, it would probably be Delfi, Groupo Aeroportuario and Berkshire Hathaway.  I haven't found any high quality stocks that are cheap.

Sold Straco

Sold two days ago at a small loss of SGD 400.

1) Want to buy BIP instead.  Wait for a correction first.
2) Straco take longer to re-open that I thought.  Even when they reopen, will be at reduced capacity.  This is a company that has high fixed costs and relies on crowds.  China's domestic travel may be recovering, but I can't see international travel recovering.
3) There is an increasing political risk of anything connected with China.

Used the current rally to sell Straco.  Evenafter one month, I still think it is a bear market rally.  I wait for a correction to buy BIP.   Waiting is the hardest part.