| 2008 | 2009 | ||||||
| Price: | 9.78 | EPS | |||||
| Shares Out. (in M): | 0 | P/E | |||||
| Market Cap (in $M): | 580 | P/FCF | |||||
| Net Debt (in $M): | 0 | EBIT | 0 | 0 | |||
| TEV (in $M): | 0 | TEV/EBIT | |||||
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Intro and Brief Thesis
CPNO is a growth-oriented midstream energy company structured as a Limited Liability Company. CPNO provides services to natural gas producers, including natural gas gathering, compression, dehydration, treating, transportation, processing and conditioning. As an LLC, there is no double corporate taxation and no separate general partner (GP) that receives half the profits above a certain threshold, This creates a lower cost of capital for its investors versus MLPs and corporations. Further, unlike an MLP, the board is elected by unit-holders – so there is some sense of control by shareholders. Further, a simple corporate structure enables the company to buy or be bought more easily in an industry ripe for consolidation.
In an effort to keep this easier to parse through, the rest will be in outline structure.
- >55% is fee based
- 16% is keep-whole (KW) – where CPNO guarantees the producer a certain fee for its production based on its BTU (heat) content. CPNO then sells the production volumes for its own account taking all risk. The company uses simple hedging (through puts) and extra fees to cover their risk. The 10Q gives detailed information on the hedges – information that you can actually understand)
- 7% is percent of proceeds (POP) – the most exposed sector to pricing. To hedge out risk, the company buys puts as well
- 20% percent of liquids (POL) – also exposed to pricing and again hedged
- 40% Ethane which is turned into ethylene for plastic bags and the like
- 30% Propane: 60% for heating, powering forklifts, etc. and 40% is for chemical feedstock
- 20% Butane – mostly used as octane enhancer for motor gasoline.
- 10% is natural Gasoline
- Volume declines: The key risk is that in a declining economy, volume demand will fall off forcing producers to cut back production (from current wells and new drilling projects). Prices for natural gas must also stay above the incremental lifting costs for production to remain economical. In Copano’s case, nat gas would need to fall another 40% to have a material impact on a large portion of their customers’ production rates.
- The location and type of production sources (geography and geology). In CPNO’s case, both are favorable – particularly on a relative basis
- NGL Pricing - NGL’s compete directly with crude oil derived feedstocks – particularly for ethylene. Thus in a declining oil price environment, NGL prices have and will continue to come down. Again, CPNO hedges against this
- Natural Gas Pricing: Evidently, this too impacts revenues and profits for CPNO and its peers when not dealing in fixed fee contracts. Again, the company has hedged out much of this risk through puts on a significant portion of its forward production volumes out into 2010 as well as over half of the volume through 2011
- They are currently hedged with product specific puts and swaps through 2011.
- Copano has no dirty hedges – where one hedges NGL risk through crude oil derivatives
- Although it varies a bit product by product, for 2009 and 2010, CPNO is fully hedged against NGLs, 80% hedged against natural gas, and 80% hedged for non-ethane products.
- These hedges, for the most part, were locked in earlier this year when prices were inflated.
- For 2011, they are 50-60% hedged for 80% of production.
- Counterparty risk is limited due to diverse group of counterparties. Hedges they have all privately arranged with Goldman, Barclays, Deutsche Bank, and some with Morgan Stanley although very small portion.
- Over 85% of operations are in non-shale. So they have very little exposure to the plays that are most susceptible to depressed pricing environment.
- $550MM revolver with a rate of Libor +175 due October 1st 2012. Revolver is with BofA, JP Morgan and Wells Fargo, but they have 31 banks in total.
- They have two senior notes totaling roughly $650 from May 2008 with avg. life of 8.5 yrs. Earliest is due in 2016
- In good shape in terms of covenants, comfortably within their covenant range.
- They have $174mm in cash and $345mm remaining on their revolver for a total of $519mm liquidity.
- 4Q08 capex is expected to be $30mm.
- For 2009 the maximum capex they would spend is $180mm
- 2009E expansion capital is $70mm with an additional $110mm for McMullen Lateral Acquisition (the 150 mile Texas pipe). So total capex for 4Q08 and 2009 is $210mm and they have over $500mm in liquidity.
- The McMullen acquisition requires FERC approval so 2009 capex spending could be significantly lower than this if FERC doesn’t approve the acquisition until the back-half of 2009. In that case, some of the capex for the acquisition would spill over into 2010
- Have over $3.00 a share in cash, about that in the hedge book.
- The primary valuation metric for the MLP space is yield and the primary yardstick for this measurement is the difference between 10-Year Treasuries and the company yield.
- A common valuation technique in the industry is to divide a projected distribution, generally one year forward, by a distribution yield assumption and then apply a yield spread to 10-year Treasury to represent a risk premium. This way, the target unit price is equal to the projected distribution divided by the yield assumption. The yield assumption reflects the risks associated with achieving the distribution level, as well as the overall visibility of the partnerships ability to generate and grow cash flow. A partnership that has strong potential to grow the numerator (distribution), should trade at a lower yield than a partnership with less growth visibility.
- For the past 18 years there was a strong correlation between the 10 year treasury yield and yields on MLPs (CPNO trades with MLPs) but recently the relationship has deteriorated. The spread between MLP yields (exGP) versus 10-Year Treasury securities averaged 258bps over an 18 year period and today the spread is 650bps, the highest it has ever been. CPNO’s spread is over 2000bps and many smaller MLPs have a yield similar to CPNO’s.
- One way to value Copano would be to assume a reversion to the mean spread between G&Ps and the 10-Year Treasury. But in this credit environment, particularly for smaller players like CPNO, that is non-sensical. So, let’s assume the spread between the 10-Year Treasury and Copano’s yield comes in to 1300 basis points (13%) within the next two years, which is more than double the current and unprecedented 650bp mean spread between G&P yields and 10-Year Treasury securities, an investor would still realize a very attractive return.
- For example, if we conservatively assume by 2010 the spread between the 10-Year Treasury and Copano’s distribution yield comes in to 13% (650bp + 650bps) and we also conservatively assume Copano doesn’t grow distributions for the next two years, (current distribution is $2.28 and guidance is $3.00 for 2010), then Copano would trade at $14.39 ($2.28/15.1% = $15.10). Based on the current price of under $10, this is unit appreciation of roughly 54%. If you include the annual unit distributions from 2009 and 2010 of $2.28 each year, you have an additional $4.56 which brings your total (undiscounted) return to 111%.
- Furthermore, Copano trades below P/B and well below net asset value.
o Historically, Copano has traded well above book value and even remained well above 3x book value from 2004 – 2007. Currently Copano trades at nearly half of book value
o Book value is $19.07 and if Copano traded at 1x BV by 2010 and maintained distributions, an investors total return would be roughly 142% ({[$19.07 + $4.56] - $9.78} / $9.78)
- Copano also trades well below a conservative estimate of NAV.
- Copano’s NAV (which for the sake of the example I calculate as Total Assets, excluding Risk Mgmt. Assets and Intangibles, less Total Liabilities) is $660mm or $13.66 a share.
o This is a 38% premium to the current valuation of $9.78.
o If we assume Copano trades at $13.66 by 2010 and maintains distributions for the next two years, we have a total return of 85.3% ([$13.66 + $4.46] - $9.78} / $9.78)
- While Copano appears undervalued based on the previously discussed measures, it is also at a fairly low valuation based on EV/EBITDA.
o Copano currently trades at an EV/EBITDA multiple of 7.25x. This is a trough valuation based on historical company comps, but its still above the average trough valuations for the G&P names in past downturns. In the 2003, average G&P transaction multiples fell to EV/EBITDA multiples of around 6.25x and in 1992 they fell as low as 4.5x. It is highly unlikely Copano units would decline much lower than 6.3x EV/EBITDA due to the premium multiple they deserve for reasons presented earlier; however, at 6.3x EV/EBITDA, Copano would trade at $7.00. This is a 28% downside.
- So, if we assume a 28% downside and roughly 100% upside (an average of all three valuation methods) we have a fairly attractive reward:risk ratio of roughly 3.5:1. Recall this is all based on the assumption that Copano maintains a distribution of $2.28, despite guiding toward a $3.00 distribution in 2010.
- Built-in-growth in North Texas (cryogenic plant coming online in 2Q’09), Oklahoma and Cantera acquisition in Rockies (backlog of completed wells now being connected)
- McMullen acquisition should boost to earnings. This is a 150 mile pipe with gas already on it. The pipe will take gas to Houston Central without relying on Kinder Morgan
- CPNO has THREE different processing modes, one of which is conditioning mode:
o Full Recovery: (Texas and Oklahoma) – If the value of recovered NGLs exceeds the fuel and gas shrinkage costs of recovering NGLs (this is most profitable mode, but they need a positive spread between the cost basis (nat gas) and the product (NGLs)
o Ethane Rejection: (Texas and Oklahoma) – If the value of ethane is less than the fuel and shrinkage costs to recover ethane (in Oklahoma, ethane rejection at Paden plant is limited by nitrogen rejection facilities)
o Conditioning Mode: (Texas) – Copano has the ability to go into conditioning mode at their Houston Central Plant (this will also be available at the St. Joe plant in North Texas when completed), which enables them to limit losses on their G&P business
- Volumes more resilient than most G&Ps because many of their producers can’t take volumes and shut them in due to the nature of their fields – else they risk permanent shutdown
- The current price is implying the company cannot grow as demonstrated above
- The current price also implies a distribution cut despite recent management confirmation of distribution increases
- With its hedges and ability to move between full recovery, ethane rejection and conditioning mode, the company is not a typical G&P company yet is priced that way
- CEO and founder owns 10% of company
- Highly incentivized
- Board elected by unit-holders.
- Board is also completely independent. The board was chosen through rigorous interview process. They interviewed people with no ties to the company or management.
- Volume growth in North Texas, Oklahoma and Rockies (Cantera Acquisition) is significantly less than the company has projected.
- Cut 2010 unit distribution guidance of $3.00 – apparently well-built-in..
- Rising interest rates
- All operations in shale (although limited to less than 15% of business) cease due to depressed commodity price environment.
- FERC doesn’t approve acquisition of 150 mile pipe to Houston Central.
- Volumes decline due to unforeseeable events such as weather.
- The company continues to do more acquisitions – accretive or not – that stretch the balance sheet going into what could be a prolonged economic downturn.
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