Tag Archives: alternative

MLP Screening – Did The Market Overreact To Some 10%+ Yielding MLPs And Should We Value Them Differently?

Summary MLPs have held up relatively well against the commodity price decline until it recently plunged ~20% in the last 3 months. Alerian MLP ETF currently yields 8.5% with a select number of names trading well above 10% distribution yield. MLPs have largely been safe yield vehicles – will there be a shift in investor base and change in how investors value MLPs? Disclaimer: For avoidance of doubt, any reference to MLP excludes E&P MLPs for the purpose of this article. Alerian MLP Index (AMZ) Price Performance (click to enlarge) Alerian MLP Index Yield vs. Other Indices (click to enlarge) MLPs have been an efficient route for midstream asset owners to monetize their stake in assets that have largely contracted or recurring cash flow characteristics at valuations that far exceed private transaction multiples. For investors, it has been a very attractive/safe yield vehicle (and tax friendly) underpinned by a consistent and high growth profile as billions of new capital got deployed for new drilling and infrastructure developments. At a very high level, most MLPs service the upstream and/or downstream value chain in providing long-term recurring services. A recurring revenue stream ensures stable cash flow and given that 90% of distributable cash flows are required to be distributed in order to maintain MLP classification, investors enjoyed stable cash yield. Continued expansion of infrastructure and oil & gas exploration activities also led to high-single digit to double-digit growth in distribution. As a result, distribution yield (with growth embedded) kept falling and valuations kept going up. MLPs were also able to grow through acquisitions, using its extremely cheap cost of capital to acquire businesses at high multiples, which were still accretive from a distributable cash flow (“DCF”) point of view. While investors can view MLP businesses using more traditional valuation metrics such as EV/EBITDA and P/E, in real life, and in a grossly oversimplified form, valuations are quoted based on distribution yield. Again, in a very simplified manner, if you were to dissect distribution yield, the market essentially assigns a cost of equity (what level of levered cash flow the business should generate in perpetuity) and subtracts a growth rate on the DCF – and this dictates the distribution yield that the market bases its valuation/stock pricing for that particular MLP company. Let’s dig a little deeper in terms of this valuation concept. This was a perfectly feasible method of valuation for a number of reasons. 1) DCF for an MLP is actually very predictable and stable (EBITDA – maintenance CapEx – interest expense was very stable), 2) because it is very predictable and MLPs are required to distribute that DCF to investors, it made even more sense to value the business from a DCF/distribution perspective, 3) growth through backlog and continued capital spend in the broader oil & gas industry was also very visible and the implied valuation derived from a yield (or multiples if you invert the yield) standpoint was far in excess of general market valuation, and therefore, using EV/EBITDA or P/E where the general market trades at ~9-10x EBITDA and ~16-18x earnings obviates any sense of comparability. Said in a different way, DCF growth rate is what moved the needle from a valuation standpoint and was therefore the most important variable in determining how the stock price would move. To avoid any psychological biases, let’s remove the “MLP” classification for a second and just consider them as a normal c-corp business. Also, let’s work under the premise that there is no debate around the fact that the commodity price environment is challenging and there are lots of uncertainties and macro headwind pervading the market. For simplicity, let’s take out the near-term growth component and say there is no growth for the next year or two. Even without growth prospects, these are excellent businesses with contracted/recurring cash flows, minimal capital requirement to maintain earnings power, and minimal operational complications (often times there are pricing protection through contracts and even annual CPI escalators). How much would you pay for this type of business? Maybe there will be a slight dent in EBITDA this year or next year (not many names are really taking a hit on cash flow, they are just growing at a slower rate), but if the premise is that there is always cyclicality in the commodity market and things will turnaround to get back into a nice growth trajectory in a year or two from now, how much would you pay off next year or two-year forward FCF? To take a more draconian stance, even if there was no growth trajectory in a year or two from now, is it truly justifiable to say that many of these businesses should trade at 500-1000bps above debt instruments with equivalent credit ratings? When was the last time you were able to pick up a stock for 4-9x levered free cash flow even if there was a dim outlook for businesses that possess this quality? For the purpose of identifying “better” quality – off the top of my head, few high level components to look for in terms of evaluating the fundamentals of these businesses: 1) Contract structure (duration, minimum volume commitment, take-or-pay % vs. throughput %, fixed fee vs. commodity price dependent fee, inflation escalator); 2) Customer credit (liquidity, credit ratings, leverage), types of customers (E&P, refinery, other midstream, logistics, export demand, etc), customer diversity (having customer concentration through an excellent customer may sometimes be more favorable than having mediocre quality diversified customer base); 3) Liquidity (cash + RCF availability); 4) Geography (if volumes are growing at a certain geography or basin, it doesn’t matter if commodity prices are falling for the midstream provider); 5) Maintenance capital as % of EBITDA; 6) Growth capital need and payback period (some businesses like a pipeline are capital intensive in the beginning but it’s all about maintaining existing volume and increasing utilization whereas some businesses require continued capital spend to service both existing and additional customers; it’s a tough dynamic if you are in a spot today where you are asked to spend capital in hopes that you will utilize them in the future) While there was always some level of premium/discount for MLPs depending on sub-sector, commodity price exposure, contractual structure, maintenance/growth capital need to maintain cash flow profile, geographic footprint and size consideration, today’s market where many players are trading at yields that imply distribution cut and at a meaningfully compressed valuation relative to few months ago and versus the broader market, it definitely seems like an interesting environment where MLPs are interesting not just as a safe haven and perpetual dividend asset but an opportunity to generate alpha through capital appreciation. During this oil crash since summer of 2014, you have consistently seen sub-sectors get crushed, only to see a lagged pick up among “better quality” names (E&P, OFS, LNG, Petchems, etc). This sequence of overreaction immediately followed by a quick and steep rebound among quality names is common across all sectors during a market sell-off. While this article does not address a specific recommendation and may be repeating what is already well recognized among investors, I wanted to provide 1) a quick screening of MLP names that are under oversold categories and 2) perhaps a different perspective around decoupling from the prevalent methodology of looking at MLPs like a fixed income security to a more traditional equity security (especially in light of what the valuations imply at today’s price and for those who think investing in MLPs today is like catching a falling knife). Below is a quick screening based on MLPs trading above 10% 2015E distribution yield (I am sure I am missing a few names that have above 10% yields). Second table excludes names with net debt/’15E EBITDA above 5x. There is not much science for drawing the line at 5x but wanted to exclude names that may be trading at compressed valuations due to distress and/or were previously highly levered to rapid growth prospects. Again, I have no idea if the excluded names are truly in distress or sized debt prematurely with too much embedded growth – just wanted to make the bifurcation. MLP Universe (NYSEARCA: AMLP ) – Names trading above 10% distribution yield Source: Capital IQ – Crestwood Midstream (NYSE: CMLP ), Crestwood Equity (NYSE: CEQP ), Southcross Energy (NYSE: SXE ), Azure Midstream (NYSE: AZUR ), Hi-Crush (NYSE: HCLP ), Natural Resource Partners (NYSE: NRP ), CSI Compressco (NASDAQ: CCLP ), Cypress Energy (NYSE: CELP ), American Midstream (NYSE: AMID ), Teekay Offshore (NYSE: TOO ), Capital Product Partners (NASDAQ: CPLP ), Midcoast Energy (NYSE: MEP ), Martin Midstream (NASDAQ: MMLP ), Exterran Partners (NASDAQ: EXLP ), Targa Resources (NYSE: NGLS ), DCP Midstream (NYSE: DPM ), USA Compression (NYSE: USAC ), Teekay LNG (NYSE: TGP ), NGL Energy (NYSE: NGL ), Oneok Partners (NYSE: OKS ), Suburban Propane (NYSE: SPH ). MLP Universe – Names trading above 10% distribution yield and less than 5.0x net debt / ’15E EBITDA Source: Capital IQ – Crestwood Midstream, Crestwood Equity, Azure Midstream, Hi-Crush , CSI Compressco, Cypress Energy, Teekay Offshore, Capital Product Partners, Martin Midstream, Exterran Partners, Targa Resources, DCP Midstream, Oneok Partner , Suburban Propane. Disclosure: I am/we are long CELP. (More…) 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.

Buying The Fear And Hedging With TVIX

Summary Is there reason to fear? Global markets are tumultuous with good reason. The best way to hedge and profit. Buy the fear; sell the greed. A common piece of advice, this is easier to accomplish in theory than practice. It has been a long bull market, one extended unnaturally in the zero interest rate policy environment since the housing crash. The result is elevated PE levels and absurd valuations for momentum-building story stocks. The rounds of quantitative easing under the Fed’s loose monetary policy have left the bond markets historically bloated, a fact substantiated by such notable personae as Bill Gross and Robert Shiller. In spite of these things and because of these things, historical hedges such as gold have been sold-off at an alarming rate. Pessimist blogger extraordinaire Zerohedge reported that as of July 24, 2015 hedge funds were net short gold futures for the first time ever. Hedge funds were selling short the classic hedge. The stock markets shrugged off the alarming fall of crude starting last fall. They shrugged off the 20% rise in the USD and the implications that had on corporate earnings. Earnings “adjusted for currency” became a nice comforting euphemism to bolster revenues hugely supplemented not by improvements in underlying businesses but in widespread financial manipulation via buybacks. Corporations have clearly lacked emphasis on organically growing revenues, opting to organically grow stock prices, touting it as “returning value to shareholders.” The vast majority of shareholders aren’t the ones getting paid in stock options… Russia fell on crude prices, their ruble falling almost 50% in the past year. Then the Chinese stock market started plunging. The Chinese government though, ever resourceful, opted to ban short selling as well as freeze trading on a good many companies in order to halt the precipitous decline ($2 trillion in value lost precipitous). Then in the past month China decided to let their currency, the renminbi decline in value. We’ll just do it once, they said. It will show that our market is becoming more free, they said. The slowdown in manufacturing growth has stymied the engine of global growth, impacting commodities and the countries that relied on their exports of those commodities disastrously. During this tumultuous time the American stock exchanges have remained remarkably consistent. I’ve been seeing a lot of days I thought would end in the red, but luckily for us all someone has been buying the dips and turning the indices green just enough. Today the buying finally lost its luster. The greed palpably began to turn to fear, sending the volatility index (VIX) shooting up over 25% on the day for August 20 . The Dow and S&P 500 both dropped over 2% for the day, and the assuredly-not-irrationally exuberant Nasdaq plummeted over 2.8%. Meanwhile the SPDR Gold Trust ETF (NYSEARCA: GLD ) spiked just shy of 1.75% for the day. Must be pretty worried about rate hikes, huh? That has been the primary focus of investors, as reported by mainstream journalists. How the Fed raising interest rates .25% from effectively zero will cause us all to lose our heads and immediately sell off everything. While markets have certainly responded to FOMC minutes and economic data, these reactions have been little more than knee-jerk ripples for quite some time. I think it is quite apparent that the powers-that-be in the investment world are much more worried about other things: like if our economy isn’t heading for another recession, when Greece will be allowed to default and focus on fixing their economy instead of haggling for more loans, how much China is slowing down, and the absurd amounts of sovereign debt in some pretty important developed countries. Remember when the U.S. sovereign credit rating wasn’t lower than Australia’s? Since S&P downgraded the U.S. in 2011 to AA+ we have added $4 trillion in debt. What’s a trillion a year anyway. What to do The first thing that I had to tell myself: Stop trying to predict the oil bottom. We are awash in an oil supply glut and Iran is gleefully coming to hawk their crude wares to the world. Demand hasn’t caught up to supply, and stock prices in oil companies haven’t caught up to their protracted loss of revenue. Slowdown of Chinese demand made that knife accelerate its fall, and I’m getting far away. it’s simple: when demand starts comfortably outpacing supply it would be wise to evaluate opportunities in the integrated oil market. So what can we do now? If you believe that volatile times are ahead, as I do, you can capitalize on that risk with a hedge that trades in it, the VIX. There are a few ETNs, or exchange-traded notes, whose values track the futures contracts of the volatility index. When the market goes down and the buyers’ market becomes the sellers’, the VIX spikes, and ETNs that track it spike with it. For those who are supremely confident that the economic situation is deteriorating, and fear is coming, there is a VelocityShares Daily 2x VIX Short-Term ETN (NASDAQ: TVIX ), up over 20.5% in market and after-market hours on August 20. If you do not want to expose yourself to leverage (I respect that), you can look into the iPath S&P 500 VIX Short-Term Futures ETN ( VXX), the unleveraged counterpart that tracks the VIX. This simple way to hedge against the market moving against you can be a powerful part of your portfolio. Rather than the small movements of a fund that sells short the Dow or the S&P, you have a hedge that encapsulates fully a diversified buy-the-fear strategy. (click to enlarge) TVIX wasn’t traded on exchanges during the Great Recession, as you can see it only tracks to 2011. That spike in 2011, when the U.S. was bumped down from the highest credit rating and given a negative outlook, could easily be replicated in October. National debt is already over the debt ceiling, as the U.S. treasury website attests, and it is projected to rise through at least 2025. Buckle, up, it’s going to be a volatile fall. If you are more traditional in your tastes, I would suggest the thousands-of-years old gold hedge. China has been buying it en masse, and they seem to be the only ones really controlling the markets, so a follow-the-leader doesn’t seem like too bad of an idea (I jest…sort of). In all seriousness, the rapid devaluation of gold has presented a fantastic buying opportunity. This is a commodity that has held value far beyond the lifespans of empires. For those of us that for some reason can’t have physical gold, a fund that holds gold bars is a suitable substitute, barring a complete shutdown of our financial system. Stan Drunkenmiller, of betting against the pound fame, recently bought $300 million worth of SPDR’s gold ETF that I mentioned earlier . Betting with a billionaire is a good strategy; betting with a billionaire hedging against oncoming catastrophe with an undervalued asset is a fantastic strategy. For long-term peace of mind, buy gold. For short-term profit, buy fear itself. Disclosure: I am/we are long TVIX, GLD. (More…) 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.

Prime Minister Tsipras Resigned, The Greek Parody Is Set To Continue

Summary Prime minister Tsipras resigned, new elections are expected in September. A new anti-austerity Popular Unity party to be created. GREK investors should expect increased share price volatility and potentially new lows. The Greek parody seemed to come to an end finally. But the recent developments show that another act has only begun. Although opponents of the austerity measures were victorious in the referendum that took place in early July, the Greek government agreed to adopt reforms and austerity measures demanded by the creditors, in order to avoid the looming state bankruptcy. On July 15, the Greek parliament approved bailout measures with 229 out of the total of 300 votes. The measures included increase of value added tax, limits on public spending and reform of the pension system. As a result, €86 billion should be provided to Greece over the next three years. The reaction of the Global X FTSE Greece 20 ETF (NYSEARCA: GREK ) was positive at first, but the share price decline resumed very quickly due to the uncertainty as to whether the new financial package for Greece will be approved by the creditors. There are 19 countries in the eurozone and in 8 of them (Austria, Germany, Greece, Estonia, Finland, France, Latvia, Slovakia) the parliament had to decide whether the country will vote for or against the bailout package. Things started to look brighter in August, as it began to be clear that the bailout package will be approved. On August 18, Fitch upgraded the Greek credit rating to CCC, on August 19, the German parliament approved the bailout package. Germany was the last country to approve the package. It seemed like the Greek problem has been resolved (swept under the carpet) for now. But another of the countless surprises was prepared by the Greek government on August 20, when prime minister Tsipras resigned . According to Reuters, the new elections should take place on September 20. Tsipras wants to support his position and get rid of the opposition inside his own party. According to BBC , 25 members of Syriza plan to create a new Popular Unity party, led by the former energy minister Panagiotis Lafazanis. The situation may get really complicated, as the July referendum showed that a majority of Greeks opposes the austerity measures. If the new anti-austerity party gains too much power, all the bailout process may be endangered. After Tsipras won elections in January 2015, he said that his government doesn’t feel obliged to fulfill commitments of former Greek governments. If the new government behaves the same way, the Greek parody may start over again. Source: own calculations, using data of YahooFinance It is highly probable that the relatively calm couple of weeks have ended for GREK. Volatility measured by the 10-day moving coefficient of variation (chart above) was relatively low over the last couple of weeks, as it ranged from 1% to 4%. But GREK investors should prepare for another turbulent period ahead. GREK’s share price development will be driven mainly by the pre-election polls. The most vulnerable part of GREK’s portfolio continues to be shares of Greek banks, however their cumulative weight declined to approximately 12%. The banks are in a complicated situation, as the eurozone finance ministers declared that bail-in of depositors will be explicitly excluded. It means that the Cypriot scenario shouldn’t repeat in Greece. But the bondholders are endangered. This decision should prevent bank runs and increase the trust of depositors in Greek banks. On the other hand, Greek banks will have even bigger problems to raise money via bond markets. Conclusion The situation in Greece is getting more complicated once again. If the anti-austerity parties win the coming elections, it is hard to predict what may happen. GREK investors should be prepared for another weeks of increased share price volatility and it is quite possible that new lows will be created. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) 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.