Review of Williams Companies (WMB)

Williams Companies (WMB) has doubled since I bought it in mid-2020.  Should I sell it?

Business Segments

What do they do again?  And how are they affected by energy prices and inflation?

Based on 1Q24 EBIDTA (slide 8):

• 39%: Interstate Gas Pipelines.  Mostly Transco (30%) running through the east coast, bringing gas from the Appalachians and GoM to consumers and LNG export terminals.  Smaller pipelines in the Northwest.

Regulated long-term contracts: "The rates are established primarily through the FERC’s ratemaking process, but we also may negotiate rates with our customers pursuant to the terms of our tariffs and FERC policy."   In general, FERC gas-transmission rates are often adjusted for cost-of-service (bottom p1), so its like a "delayed" inflation adjustment.

• 38% Gathering and Processing from gas fields.  Collecting and treating gas (eg: removing NGLs) from producing fields so it can be transported in pipelines.  Mostly volume based.  So indirectly affected by price (eg: revenue drops during warm winters).  Management mentioned these contracts are often inflation protected (bottom p19).  A few of them have exposure to gas prices (bottom p18).

• 13% Gathering and Processing from oil fields: onshore (7%) and GoM (5%)

• 4% Marketing.  Deliver gas to customers, bear the risk of price movements in-between the time of order and delivery.  Very volatile.  Was 10% of EBIDTA in 2023, -ve in 2022, and negligible in 2021.

A 2022 Fitch Report estimated that 50% of revenue was from regulated or take-or-pay contracts.  so rough guess: maybe a quarter of their G&P revenue is covered by take-or-pay. 

Cashflows

CFO covers dividends.  But not always CFI and dividends together.  ie: They are investing for expansion:

They rarely sell assets, last made substantial disposals in 2018: 

Maintenance capex was 820m in 2023, and is guided at 800m and 1.2b for 2024 and 2025 (p11).

Growth

Growth capex was 1.9bn in 2023, and is expected to be 1.6bn in 2024 and 1.8bn in 2025 (p11).

The above "growth capex" excludes acquisitions of new businesses.  Following this, I'll take the words "capex" or "growth capex" in this post to exclude acquisitions, which is pretty strange.

Lets put it in a table.  AFFO below is CFO (excluding some working capital changes and minus a few things) - think of it as "Smoothed CFO" ¹:

AFFO easily covers maintenance capex plus growth capex, and almost covers dividends after that too.  It doesn't cover acquisitions in 2024, so debt will go up.

They say they've gotten 19.5% ROIC on their 2019-2022 investments (p12).  Seems ridiculously high, but these are usually small "bolt on" projects.  e.g.: small pipelines adding off their main lines, adding new takeaway or feeds to new customers.  Or adding incremental G&P capacity to their existing network.

And thats probably only for growth capex, as recent acquisitions were bought at 7-10X EBITDA (1), (2).

Overall they aim to grow EBIDTA and dividends by 5-7% in the next 2 years.

The background is growth opportunities from the expected US LNG export boom (slide 16):

Management comments on the urgency of this (p17): "Our issue is that our customers, which are some of our best and biggest customers on Transco are –their demands are very urgent. And for us to sit around and wait to finalize any more of the demand that was pending out there, really, it doesn't serve those customers very well." 

To summarise, they are still growing, and taking on debt to afford to both pay dividends and make acquisitions.  At some stage of the cycle - years later - that may become a bad thing, but its good today.

Valuation

Taking FCF to be "AFFO minus maintenance capex" ², it is projected to average 4.2bn over 2023 to 2025. At a share price of $42.5, thats a price to FCF of 12.x.  Fairly priced for a long term growth rate of 5-7%.

The yield is 4.5% before tax (or 3.1% after tax for me).   AFFO payout ratio is just under half.

Conclusion

Its not cheap anymore - growth is priced in.  I wouldn't buy now, but its not clearly overvalued so I'll hold.  We're probably still at the beginning of the US natural gas export boom.

1 AFFO is defined by them as "cash flow from operations excluding the effect of changes in working capital and certain other changes in noncurrent assets and liabilities, reduced by preferred dividends and net distributions to noncontrolling interests. AFFO may be adjusted to exclude certain items that we characterize as unrepresentative of our ongoing operations".^↩

2 Their definition is different - slide 34^↩

Notes on TC Energy (TRP:TSX)

I love gas pipelines, like Buffet's toll roads.  This company owns pipeline throughout North America.  The stock has fallen due to crappy management, and is below its 2020 price.  Its got world class assets, and I don't think bad management can destroy it no matter how hard they try.  Lets take a look.

Segmental Breakdown and Pipeline Details

From their 2022 AR.  "EBIDTA" below means "2022 Comparable EBIDTA".

The business is transporting gas over a continent, so we gotta look at a map to understand it:

Source: 2022 AR (p40)

US Gas Pipelines (41% EBIDTA):

• Columbia Gas (6): Transports gas from the Marcellus to markets and pipeline interconnects throughout the U.S. Northeast, Midwest and Atlantic regions.
• ANR (7): Transports natural gas from various supply basins to markets throughout the U.S. Midwest and U.S. Gulf Coast.

Canadian Gas Pipelines (28% EBIDTA):

• NGTL (1): gathering and processing from producers in the WSCB to the Canadian Mainline.
• MainLine (2): Transports gas produced in East Canada to West Canada.  
• Costal GasLink (26): Pipeline under construction to ship gas from WCSB to the west coast for LNG export.  Its construction has had bad cost overruns, but is now 91% complete.  Expects to be operational 4Q23.

Mexico Gas Pipelines (8% EBIDTA).

Liquids Pipelinse (14% EBIDTA):

• Keystone (not shown above, see p62).  Transports crude oil from Canada to and through the US for refining, down through Oklahoma to the GOM.  Canada cannot refine most of its crude, which is exported by pipeline to the US (87% of total crude in 2020), and Keystone transports around 14% of that.  There were (costly) expansion plans (Keystone XL) approved by Trump which were cancelled by Biden.

Nature of Revenue and Pricing

Nearly 80% of their EBIDTA is regulated (p28):

• Meaning that rates negotiated with customers have to be approved by government agencies (FERC - US, CER - Canada) to prevent price gouging. 
• The Canadian Mainline (7% of EBIDTA) was built before US shale gas was discovered, and has since struggled to compete with cheap US gas coming from the Appalachian Basin (Marcellus).  It has no pricing power.  In this case prices drop - regulation doesn't matter.

So regulation does limit upside a bit, while not protecting downside.

I think the 2020's will be the decade of inflation.  Are TRP's revenues protected against this?

Some FERC rates are automatically-inflation adjusted.  Depending on the pipeline classification, rates are automatically adjusted every year, or inflation adjustments are written into the contract with the customer:

Source: Invesco. Why Inflation cam be a tailwind for midstream

I could not google any information on wether the Canada Energy Regulator adjusts rates for inflation.  The company says NGTL "operates under the terms of the 2020-2024 Revenue Requirement Settlement which includes an ROE of 10.1 per cent on 40 per cent deemed common equity." (p178)  To me, this does not sound like it adjusts for inflation.

Here are some hints that it does take inflation into account:

Source: finchat.io

I could not get any details.  Not sure if they will adjust the entire tariff by the inflation rate, or only the part reflecting increasing maintenance costs (while excluding build costs from the past).  This would be a small adjustment as maintainence costs are low for gas pipelines.

So for inflation protection:

• US pipelines adjust for inflation.  Yearly if its a "non-compeditive" pipeline.  For "compeditive" pipelines, its based on the contract, so will depend on if you have pricing power.
  
• Not sure if/how Canadian pipeline tariffs adjust for inflation (?)
• If an area has too many pipelines and not enough demand, prices will go down, regulation and inflation adjustments don't matter.

Cashflows

Dividends are lower than CFO, but CFI is very high due to capex on new projects.  CFI plus dividends has exceeded CFO in many years:

Projected capex is below.  Maintenance capex (part of CFI) is approximately ~2bn per year.  I've annotated for their later Costal GasLink blowout:

So its not until 2026 that they'll start paying down debt.

Debt

At end 2022, debt was 51bn: 41bn in loans or notes, plus 10bn in  Junior Subordinated Debt.  Thats unsustainable, at 8X 2022 CFO, or 12X 2022 FCF.  CFO should grow (probably another 3bn in the next 5 years) as the new projects come online, so that makes it a bit better.

Debt maturity (I have not broken it down into USD/CAD debt):

What is the effect of rising rates on their debt?  I went through years of annual reports - they did not make it easy - to consolidate their debt issuance.  They have:

• 30bn fixed rate debt
• 8bn floating rate
• 3bn unknown
• 10bn Junior Subordinated debt. (p195).  These are fixed rate for the first ten years,before converting to floating rate.

If all debt due by end-2027 is refinanced at 9% (The 20 year risk free Canadian rate is ~3.7%, the US one is 4.5%.  I'm using a high rate for high debt and shitty management)...then their 2022 results would have ben lower by 900m, a 20% reduction in FCF.  The same stress test for WMB and KMI give 10% and 7% reductions respectively.

The key thing for this company is no more cost blowouts till 2025, then being able to pay down debt after that.

Risks

• Canada's carbon tax is $20/ton today, but due to increase to $170 by 2030.
• The company has a history of operational problems: Milepost 14, Keystone pipeline leaks, Columbia gas line pressure drop. Concerned it may be a cultural issue.
• To much debt, especially when the Junior Subordinated debt converts.
• They may move into ESG and renewables, which have lower returns.

Valuation

At CAD 48, its trading at a 7.75% yield.  Thats paying out 75% of their 2022 FCF.

New projects coming online should increase CFO by half in 3-5 years, but they need to pay down debt.

Misc

I don't know the withholding tax rate.  Interactive Brokers usually charges me 15% for Canadian stocks, but TRP has significant operations in the US, so it may be higher.

Edit: Nov 2023: Confirmed my witholding tax is 15%

The stock plunged three weeks ago on news of the Keystone spinoff, then recovered.  It looks like capitulation, so that may be the turning point.

I have bought a 2.5% position, and would go up to 5%.  My max size for this is half that of WMB or KMI, who have less operational and financial risk.

References

A good intro: TC Energy shares have fallen too far (HFIR Energy Income on SeekingAlpha)

Quick notes on Woodside Energy (ASX:WPL)

Largest Australian LNG producer, with long-life conventional projects.

Its a well-covered blue chip, so no point over analysing it.  I just want to get a feel for their risks and numbers.

GeoPolitical Risk

Very low.  All 2021 production and 94% of their 2P reserves were from offshore Australia.  So its is safe from any wars/revolutions in Russia, Asia or the Middle East.  About half their 2C gas reserves are in Canada, and they have some development in Senegal.

Some China risk.  30-40% of Australia's LNG exports go to China.  Probably the same proportion for Woodside's.  If China attacked Taiwan, these would need to find a new market.  That event would probably tank the LNG market.

Some ESG risk: In 2021 19% of Woodside shareholders vote to "manage down" oil and gas production.  Australia is pretty woke.

Reserves

After dropping for the past 7 years, 1P and 2P reserves doubled in 2021, the increase being transferred from their 2C reserves (p56), almost all of it to due to first time reserves classification of the Scarborough development (West Australia) (p145) (p26).

Taken at face value, they have 12 years of 1P gas reserves remaining.

Balance Sheet

Net debt is low at 3.7bn.  Less than 1X 2021 EBIDTA (a good year).  Or 2X 2020 EBIDTA (a bad year).

Historical Cashflows

They paid high dividends, even in 2020's downturn.  I'm a bit uncomfortable with this.  I did the numbers below to get a feel for their last past 10 years' cashflow generation, capex and dividends.

CashFlows from Ops are usually greater than Cash(out)flows For Investment.  The yellow line is usually positive:

Dividends are high, based on 50-80% of NPAT.  No relationship between cashflows generated and dividends paid out:

Over the period, the average annual cashflow generated (CFO-CFI) was 1.2bn  The average dividend paid out was 1.1bn.  So they paid almost all cash generated as dividends!

These dividends are a little high and could be better used for growth.  But they are probably sustainable - its not a ponzi.  I just dislike cyclical companies that pretend to be something they aren't.

The latest 2021 dividend of USD 1.35 is 80% of NPAT.

BHP Merger

The proposed merger with BHP Petroleum, if done in Dec 2021 (pro forma), would have:

• Almost doubled the number of issued shares (up 95%)
• Not increased debt, but added a 4.1 billion provisions (restoration, I think)
• Increase 1P reserves by 62% (in MMboe - however BHP's reserves are 'oiler', at around 30% oil) (p235)
• Changed production profile to be 'oilier': up to 30% oil.  Also change production profile from 100% Australian to 15% GOM and 5% Trinidad and Tobago (near Venezuela) (p238)

• Increased CFO from 3792m to 6314m (up 86%).
• Increased CFI from 2941 to 4042 (up 37%)

2/3rds of BHP's assets are in GOM.  These have a 20-30 year expected life.  Their Australian assets have a 10 year lifespan (p151):

They expect 400m pre-tax savings annually (p226) in 'synergies' which are not part of the pro-forma numbers above.

From the numbers, I'm guessing the merger maaaaayyy be OK for Woodside shareholders.  If they get their 'synergies'.  They are both Australian companies, so no culture shock.  BHP is a motivated (maybe irrational) seller.

Capex and Production Growth

For Woodside, the term capex means "Cashflow from Investment".

I couldn't find much.  Best I found was 2019 (pre-covid) slides expecting a 2021 peak in capex of 4-5bn (slide 39):

With ramp ups in production volume till 2024-2026 (slide 9):

Actual 2021 CFI was 2.9bn.  Looks like a lot of investment has been pushed back and is still to come.

Presentations and transcripts in 2020 and 2021 don't give long term capex targets, they only give them for the following year.  2022's capex is expected to balloon to 4bn (excluding BHP's assets) (p24).

Conclusion

Blue chip company paying almost all its cashflows as dividends.  I think it will diversify my energy stocks, adding production from a low risk part of the world.

I'll add this to my watchlist.  Not buying it now cause I think the market's going off a cliff in the next 3 months.  And there's a chance that woke BHP shareholders dump their unholy fossil fuel shares once the merger goes through on June 1st.

Misc

Australian WHT on dividends to Singapore residents is 15%.

The main business problem the company has is a rising AUD and costs, if the commodities boom continues.

Sold Gazprom

In 2020, Gazprom sold 78% of its gas to Western Europe.  The story was that it would keep growing through Nordstream 2 and increasing exports to China.

Now Nordstream 2 is finished.  And Europe is likely to wean itself off Russian gas in the next few years.  Its a matter of survival.  So Gazprom is no longer a long term dividend story.  

Would I buy at at its current price?  No.  Too unpredictable.  So out it goes.  Sold on the bounce tonight.  Loss of USD 2K, or around 14% (includes dividends received).

I need to think about my other Russian stocks.  Oil, fertiliser and metals are harder than piped gas to place sanctions on. But oil production probably falls long term as the Russians need western technical expertise to keep their equipment running and drill new wells.

Bought back 1% more gold after it corrected yesterday.  Now back at a 6% position, and want to buy more.  With 6 rate hikes priced in (after the start of the war), thats still 5 too many.

Natural Gas

Harris Kupperman's natural gas trade looks interesting.  WTI going negative sends a clear signal that oil is not profitable, therefore shale oil shut ins should decrease the supply of natural gas.

What are the chances of it happening?

Around 30m Bcf/day of natural gas production is associated with oil (p19), out of 92 Bcf/day total.  So around 1/3rd of it is associated.

For demand, the EIA predicts a drop in demand due to covid-90, due to less commercial usage (especially restaurants), less industrial and exports.  Slightly offset by an increase in home demand.

There are many moving parts to the thesis.  What are the risks?

1. Shale oil producers may not begin to cut back until next year, due to hedging.
2. Even if the supply of natural gas drops, demand may drop further.
3. Trump may put tariffs on imported oil, or simply force the Saudis from targeting US shale production.  There are good reasons why the US needs its own oil industry.

How would I play it?

Initially I wanted to follow the textbook and but the lowest cost producers.  Cabot, here.  But there are too many things about this industry that I can't understand.  I do not understand industry decline curves, or how much companies have to reinvest to maintain reserves.   Nor well level data.  Or takeaway capacity from the different producing regions.  This industry is difficult to understand, and full of liars.

Better to spread my bets and just trade the FCG ETF.  That removes company specific issues, though it concentrates on the Marcellus.  Most of the companies there are generating cashflows from operations, though many are loss making - but they look like they won't go to zero.  I do not know enough to cherry pick companies or create my own ETF.

This is far from a certain thing, so if I took the trade, I would trade around the position to manage risk.  Take my signals from the market and play a rising natural gas price as it happens.  Don't throw all my bets down on the table and say 'this is definitely going to happen'.

I do not know if or when I'll make this trade.

Bought CSE Global, Gazprom and a European Bank

Made three trades in the past month.

Bought CSE Global at 46c.  They are a technology company, primarily servicing the oil and gas sector and secondarily, government infrastructure.  Most of their work is project based - they talk about recurring income, but I'm not sure how 'recurring' it really is.  I bought because it was fairly cheap and it 5% yield is probably sustainable.  I can collect it while I wait for oil sentiment to improve.  Key numbers to watch are its order book, and receivables (they had a big problem with them in mid-2017).  Its 2% of my portfolio, due to its lumpy (project based) earnings.

Bought Gazprom at USD 6.91, a Russian gas giant supplying Europe and China.  It was cheap, paying a 7 percent yield (before 10% Russian withholding tax, plus ADR fees).  It should grow dividends to a 50% payout ratio, as their capex winds down and sales increase.  This idea is from Sven Carlin, here.   I'm not analysing it, as its a big company, not transparent, and theres no advantage to me doing so.  Its also 2% of my portfolio, with 2 big risks.  One, geopolitical risk (eg: wars) means gas to Europe may be disrupted, even if its cheap. And two: Putin decides this company should belong to the Russian people, once again.

Bought call options on a European bank.  This bank has gone through several rounds of capital raising and NPL disposal.  Its cheap, trading at half tangible book value, where similar banks from the same country are trading at 70+ percent.  It will probably pay a 5% yield (@ 50% payout ratio).  If it reaches 70% of tangible book by June 2022, my money gets multiplied 2 and a half times.  If not, then zero.  Its a 1% position.

[Edit 8-Nov: Bought more options, expiring in Dec 2021.  Another 1% of my portfolio].

Last month I finished buying Manulife US REIT, its now around 10% of my portfolio.

Gazprom

I entered a small position in Gazprom, the Russian gas company, last year.

Gazprom is an indispensable supplier of piped gas to Europe, trading at a single digit PE.  It (and its underlying currency) trade in accordance with crude oil prices.  It was a 1% speculative position, due to the risk of forced privatisation.

This was based on a previous recommendation from Capitalist Exploits.  They turned negative on it due to increasing geopolitical risk: US shareholders have been given a deadline to dispose of their Rusal stock/bonds, and Gazprom could be next.

Sold it last week.  Profit around USD 600.

US Natural Gas

US Natural gas prices have been low since 2008, and are now below the cost of production.  When this happens to a commodity, eventually either its price must go up, or the the cost of production must drop.  The usual value-investment strategy is to buy a lost cost producer which can outlast the competition and will benefit when the commodity price rises later.

In short: I think US Natural Gas prices will rise soon due to falls in production.  But I could not find a stock reasonably priced enough to bet on this.

Natural gas pricing

Since natural gas is difficult to transport and impossible to store, it price is set regionally, not nationally or globally.  US Nat Gas prices reference the Henry Hub (Nymex) price, and gas sold by companies in gas producing areas is sold at a regional discount, reflecting transport costs and the area's supply/demand (gas produced vs outgoing pipeline capacity).   The discount changes over time, for example, in the Marcellus, Cabot had a discount of 10c to 30c in 2013, and 89c in 2Q14.  The Marcellus differential for the last year seems to be around 80c to $1.40 - see the 2 NGI charts here.

One note for calculations: the Nymex price is in btu, but most companies provide their average realised price in mcf.  There's no way to convert between the two.

Production Costs

What is the cost of production, and how do we find the lowest cost producer?

Commodity companies always provide their own version of production costs (e.g.: C1 costs, cash costs, extraction costs, half-cycle costs) in presentations.  These exclude Depreciation, Deletion and Amortisation (DD&A),  General Administrative (SG&A), interest, and sometimes royalties.   Ignore all this rubbish and just use the expenses from the income statements instead.  Use the latest quarter, because the gas industry costs change so fast. Strip out hedging (derivitives), one off costs (e.g.: litigation) or irrelevant costs (transport of 3rd party gas).  Subtract Oil and liquids revenue from the gas production expenses based on whatever price they realised that quarter.  After this, we can get a breakeven cost of gas per mcf.

I checked the 2015Q1 income statements of 7 US/Canadian companies.  Only three were were making money unhedged:

This was period included the Q1 seasonal price spike - so I'm sure that overall production costs are higher than the market price.

Demand vs Supply

US production is around 70-75 bcf/day.

Only one area, the Marcellus has rising - almost exponential - production.  All other areas are flat or declining - See this nice 2013 map and graphs.  Although the Marcellus has the lowest cost of production, it also has the widest differential to Nymex pricing.  There are some indications that national production will peak or decline this year:

• 2 articles (1) (2) by Bill Powers: the states' Department of Natural Resources and Texas Railroad commission data currently shows flat or falling output.  EIA projections of output increases are wrong.

• Several companies have indicated flat or lower production in their 1Q 2015 earnings calls. Cabot stated they will reduce their Q2 production by ~10% sequentially, and "continue to monitor the price environment before we make any decisions on selling more gas into the local market".  Chesapeake stated that they shut in some production from December onwards, Q1 Marcellus production growth was "pretty well flat", and they intend to maintain this (albeit with the ability to quickly grow if prices rise).

Couldn't find a cost curve for natural gas.  There's too many players, and the production costs keep changing due to technological advances.

Shale gas wells have a high initial decline rate (See first graph in the first result here), like shale oil.  So we can't ignore DD&A - it represents money that needs to be ploughed back into drilling new wells as current ones decline.

On the demand side, natural gas is in a secular uptrend, due to the fact that its been cheap for so long, and as a lower-carbon replacement for coal.  Everyone knows it will will always be cheap.

Company valuations

The cheapest producers are Advantage, Cabot and Chesapeake.   Southwestern is also profitable, as it gets a higher realised price as most production is outside the Marcellus.

To value a company: I pick a what I think the long term average commodity price should be, project their earnings for that price, then apply a PE ratio to that.  I'm picking a NYMEX price of $4 (roughly $4/mcf on average) - just a guess since I have no cost curve.  I also pick a PE of 12.  Theres nothing magical about that number, but thats where I'd be comfortable buying and holding long-term through hell or high water.

Cabot

Targets "close to 3 Bcf per day by end of '17".  At a realised price of $3.80/mc ($4 NYMEX and an optimistic 20c discount), I get an annual EPS of $1.80, giving a target price of $21.6.  The stock is now too expensive.

Advantage

Targets 245 million mcf/day by end 2017.  At a realised price of CAD 4.50 (approximately USD 3.60), I get an annual EPS of CAD 0.75, giving a target price of CAD 9.00 (or USD 7.18).  May be worth investigating further.

Chesapeake

Although they have a low cost of production, they also had a terribly low realised price ($1.61 vs Cabot's $2.23).  They gave no reason why: "This was primarily the result of weaker Marcellus Shale basis differentials in the Current Quarter compared to the Prior Quarter and increased gathering and transportation costs. "  Cabot also operates in the Marcellus.  The difference does not seem to be permanent: in 1Q 2014, their realised price was  $3.86, better than Cabot's $3.74.  In between then, they sold off a lot of gas producing assets.  Lets see if their realised prices improve first.