Description

MPLX is AMZN, and incumbent long-haul pipeline MLPs are brick and mortar retail.

MPLX is an MLP, but "MLP" has become a bad word these days and does not appropriately characterize this investment opportunity.  We prefer to think of MPLX as a word-class infrastructure business that has recently completed a highly unappreciated transformation.  MPLX is now well-positioned to take share, disintermediate, and effectively disrupt the former midstream industry darlings (ETP, KMI, PAA, et. al. we are talking about you).  Our variant view on MPLX is not simply that it’s a cheap high quality MLP in a beaten up sector, but that the company will benefit from increasing network effects as it connects the dots within its vertically integrated asset footprint via highly accretive growth projects (in many cases, this growth comes at the expense of its midstream peers).  This scale advantage precipitates strong, visible growth that warrants a cost of equity capital premium. As MPLX’s cost of equity capital improves, the company will benefit from positive reflexivity and even more accretive M&A and growth project opportunities will present themselves on the horizon.

In February, parent MPC completed its final dropdown of $1 billion of EBITDA to MPLX.  This transaction strategically and financially aligns MPC with MPLX by eliminating MPLX’s IDR burden and effectively lowering its cost of capital.  

MPLX today primarily is a set of (1) natural gas gathering and processing (G&P) assets in the lowest cost natural gas basins in North America (Marcellus, Utica, SCOOP/STACK, and an emerging position in the Permian) and (2) logistics and storage (“L&S”) assets that largely service MPC’s 1,881 bpd refining system, which pro forma for the acquisition of ANDV later this year, will be 3,038 bpd, representing the largest refining system in North America.

The G&P Segment

MPLX’s G&P segment sits on coveted real estate, on top of dedicated acreage from the most prolific low cost E&Ps in the Marcellus (i.e. primarily RRC and AR), which offer strong volume growth for many years to come.

These G&P assets in the Marcellus/Utica have an unappreciated, capital-light growth opportunity from filling up unutilized capacity based upon producer customer drilling activity.  We calculate that $440MM of EBITDA upside can be achieved with no capex and assuming a conservative 90% incremental margin on Marcellus/Utica processing and fractionation assets (industry sources indicate incremental margin may be mid to high 90s).  

Further unmodeled capital-light upside exists from filling up gathering lines (especially with RRC in the Marcellus) and further West and East Texas G&P asset utilization, which is still in the low 60s % utilization rate given recent asset expansions.  

In addition to organic volume growth, MPLX’s G&P segment benefits from an extensive organic growth project pipeline, the majority of which is in the Marcellus.  While MPLX only provides one year capex guidance, we believe the growth project runway extends many years. While MPLX has not publicly commented on it, AR management recently told us that they have already acquired real estate in partnership with MPLX for the next large processing complex once the Sherwood site, MPLX’s largest facility, is full.

For more information on the secular growth in natural gas and NGLs, see third-party research from RSEG and Wood Mackenzie.  Speaking with RRC and AR (among other Marcellus producers) and reviewing their investor materials is also a helpful resource to assess this long-term growth opportunity.  To understand NGL demand, EPD also provides good investor materials.

The L&S Segment

MPLX’s logistic and storage assets benefit from contractual inflation and FERC-based escalators servicing MPC’s refining complex volumes (think of the L&S business as a large-scale annuity contract with an investment-grade counterparty).  Absent growth projects, this business segment is a steady low to mid-single digit organic EBITDA grower.

Pro forma for the final dropdown in February, MPC owns 64% of MPLX.  As such, MPC’s MPLX stake represents a very significant amount of its total equity value, and MPC is highly incentivized to ensure that MPLX has as low of a cost of capital as possible.  The hiring of Mike Hennigan, former CEO of SXL and an extremely well regarded executive in the industry, as an outsider to run MPLX indicates MPC’s seriousness in building a standalone midstream business:

https://marcellusdrilling.com/2017/05/sunoco-lp-ceo-mike-hennigan-defects-to-mplxmarkwest-energy/

While MPLX’s contracts with MPC are up to 10 years in duration, we foresee essentially no risk to contract renewal given MPC’s strong alignment.  MPC’s refineries are near the bottom of the cost curve, and regardless of the pace of Elon’s Model 3 ramp, it will be many, many years before EV penetration rises to the point where MPC’s refinery utilization rates would be threatened.  Gasoline itself represents only ~45-47% of MPC’s refining slate, with other end products (primarily distillate) serving as irreplaceable industrial fuels.

MPLX’s Long-haul Connect-the-Dots Opportunity: How MPLX Will Disrupt the Midstream Industry

In February 2017, MPLX embarked on its long-haul investment strategy with the acquisition of the Ozark pipeline and an investment in DAPL:

http://ir.mplx.com/mobile.view?c=251401&v=203&d=1&id=2245401

http://ir.mplx.com/mobile.view?c=251401&v=203&d=1&id=2246470

With MPLX’s strategic transition now complete, we expect many more opportunities for MPLX to connect its low cost gathering assets (at the wellhead) to demand centers (primarily MPC’s refining system, as well as new export opportunities).  Hennigan has spoken recently regarding the potential to JV with ETP’s Mariner East 2 asset, as well as connecting Permian gathering assets via long-haul pipe to MPC’s Gulf Coast 600k bpd refinery at Garyville.

Notably, on ETE/ETP’s earning call this week, Kelcy Warren discussed a willingness to find a strategic partner for both ME2 and ETP’s new 30-inch crude pipeline from Midland (the Permian) to Nederland (Gulf Coast).

“We're developing an agreement with a strategic partner. The project is expected to initially transport up to 600,000 barrels per day of capacity, easily expandable to 1 million barrels per day.”

– Kelcy Warren, 05/10/18

Given his absolute control of ETE, when capital gets tight, Kelcy has historically been happy to dilute his limited partners (rather than shrink his empire by selling non-core assets to finance future growth):

https://marketrealist.com/2017/08/how-market-reacted-to-energy-transfer-partners-secondary-offering

https://www.streetinsider.com/Corporate+News/Energy+Transfer+Equity+%28ETE%29+Completes+Private+Offering+of+Series+A+Convertible+Preferred+Units/11407780.html

So why did Kelcy sell a stake in DAPL, and why is he looking to sell further stakes in ME2 and also his new Permian long-haul project?  Why would Kelcy want to sell a stake in attractive projects to benefit a midstream competitor?

While in the midstream go-go days of 2013-2015, midstream incumbents could fund projects on their own and get customers to participate in open seasons, we believe that now and going forward the large powerful customers dictate terms.  With the full-backing of MPC and pro forma for the acquisition of ANDV, MPLX effectively speaks for the largest consumer of crude oil in North America. If midstream incumbents don’t offer equity participation in their projects to MPLX at attractive terms, then MPLX has the ability to plop its own pipelines right beside the incumbents and run the incumbents’ pipelines dry (Gary Heminger has told us himself he could do this).  Absent an attractive equity participation in a long-haul Permian pipe, we believe MPC/MPLX would do exactly that with Garyville, which currently consumes 600k bpd of crude exclusively on third party pipelines.

Under the guidance of Mike Hennigan and having just completed its strategic transformation, MPLX is just getting started.  Over the next decade, MPLX has the ability to re-direct volumes off third party pipes into a growing vertically integrated system.  At the same time, MPLX will benefit from natural gas and NGL volume growth in the Marcellus/Utica through its control of the low cost volume at the wellhead to vertically integrate downstream (hence the potential ME2 JV, potential reversal of Centennial pipeline, Laurel pipeline participation, etc.).

Given MPLX’s dominant industry position, one would think the units would trade at a premium to the sector.  However, we can purchase this self-funding AMZN of midstream for a mere 11x free cash flow at a 7.1% dividend yield that is growing double digit!

Maintenance capex requirements at MPLX are minimal. For instance, MPLX’s G&P assets are essentially brand new and won’t require much maintenance for many years.  Also, $650MM of the most recent MPC dropdown EBITDA is a wholesale contract with zero capex.

But for the haters out there who don’t believe in the concept of maintenance capex, we are happy to report that MPLX trades at reasonable multiple of net income, even though FCF is ~35% ahead of net income.  

If we look forward less than two years, MPLX is trading at less than 9x FCF, 12x EPS, and an 8%+ dividend yield.  Again, this is a self-funding flywheel with no equity issuance required to fund a $2.2bn annual organic growth capex budget.

Where do high quality infrastructure assets trade on a P/E basis?  Industrial gas trades at 21-26x (PX, APD, AI FP, LINU GY), railroads trade at 17-20x (UNP, CP CN, KSU, NSC, CNR CN), potato processors (LW) trade at 26x, garbage trades at 21-30x (WM, RSG, WCN).  Midstream energy used to trade at huge multiples before the blow up in 2015… MPLX itself traded at 30-40x+ (albeit in a different format).

We think that today much of the midstream sector is undervalued relative to its growth and the stable profile of its earnings, and especially relative to the broader industrials space.  We further believe that MPLX is the highest quality business in midstream today. However, simply valuing MPLX relative to EPD and MMP presents a significant discount on a relative basis (and MPLX is growing both cash flow and its dividend faster than EPD/MMP).

In the above analysis, we continue to grow the distribution at a moderating pace.  An annual ~$2.2bn growth capex budget is funded with a combination of retained cash flow and incremental leverage (we hold debt at ~4x EBITDA) with no new equity issued.

At 18-22x EPS, which implies a modest 6-7% unlevered free cash flow yield, we believe you will make 62-95% on a 1.64 year time horizon (December 31st 2019 price target valuing on NTM earnings at that date).   Longer term, we believe MPLX has the potential to be a powerful compounder given the plethora of organic opportunities adjacent to its infrastructure and its unmatched market power given its tethered relationship to MPC.  We see multi-bagger potential over several years.

Catalyst

• Earnings beats
• Announcements of M&A/JVs and incremental growth projects
• Management is continually evaluating the best structure for MPLX, including the potential for a C-Corp conversion (with accelerated depreciation, MPLX could essentially pay no taxes as a C-Corp for many years. A C-Corp structure would expand the universe of investors that could invest in MPLX).
• Roll up of ANDX after the close of MPC's ANDV acquisition later this year.  It's too early to play with the spreadsheet math here, but Management indicates that any sort of roll up would be accretive to MPLX's standalone plan (otherwise they wouldn't do it... PF for the ADNV acquisition, MPC will have much more economics in MPLX than ANDX).  Roll up accretion would account for both MPLX's higher asset quality and higher growth profile relative to ANDX.