Description

Long NGL Energy Partners – Downside to $18, Upside to $30

NGL is a midstream logistics-oriented MLP.  They own a variety of pipeline, storage, and transportation assets to handle crude, wastewater, NGLs and gasoline/diesel fuels.  The company 2 years ago was 50% fee-based, and carried too much leverage.  During the energy meltdown, NGL traded from a high of $45, collapsing to a low of $6 per share.  At the lows, the company cut their distribution (from $2.56 to $1.56 per unit) and issued expensive preferreds in May 2016.

Since then, the stock has rebounded as they sold $450mm of assets they owned (publicly traded TLP LP and private GP units), and used capital from that and their preferred deal to reduce leverage.  

They also:

1)      Completed the Grand Mesa pipeline (under budget) which will add $120mm of EBITDA in year one (starting November 1, 2016), and $150mm in year two.  Total EBITDA at the company should grow from $490mm in FY 2017 (ending March) to roughly $600mm in FY 2017.

2)      Bought back $100mm of their 2019 and 2021 bonds at around 60c on the dollar.  Those now trade at par.

3)      Acquired a few small businesses at 5-7x EBITDA in conjunction with Oaktree, who now has one voting board seat (and another non-voting board seat) and importantly a say on capital allocation.

4)      Will be 70% fee based proforma for the Grand Mesa pipeline.

5)      Plan ultimately to get an investment grade credit rating, from BB- today.

6)      Improved liquidity to $1.1BB, and removed any maturities that might have caused concern among investors.

Throw in improving cold weather this year, higher oil prices, and NGL should throw off $2.27 per share in DCF in 2017 (March FYE), and $3.06 in 2018 (March FYE).

Comps with similar leverage and fee based midstream assets (KMI, OKS, PAA) trade at 12.4x, 12.4x, and 12.2x EBITDA, respectively.  The yields on OKS and PAA are 6.8% and 7.1%.

At 12.2x EBITDA, NGL would trade to $32.50.

At a 7.5% yield on a $2 distribution, NGL would trade to $27.

At a 10% FCF yield on calendar 2017 figures, NGL would trade to $30.

Note that Plainview wrote up NGL on VIC 2 years ago as a short when it was $29.  There is a lot of good background info and a good comparison to how different the business and industry are today.

Summary

Business

NGL started as a propane retailer and wholesaler in 2010.  They IPO’d in May 2011, and subsequently acquired 13 various businesses, diversifying into other logistics assets.  The theme of their asset base today is the gathering, storage and moving of crude, wastewater, propane/butane, and refined gasoline & diesel.  While some of their logistics assets are of the “low value added” variety (trucks and tankers and barges for moving crude for example), these now are mostly idle as shale production has dropped and pipeline capacity added.  There is a diverse mix of assets, some contracted, some weather-driven, some volume driven.  Overall, it should reduce earnings volatility.

Here is a spreadsheet of each segment below:

The refined products business is the company’s largest segment at 29% of EBITDA.  Generally this business purchases gasoline from refiners on the Gulf Coast, and ships it to retail customers (like Costco and Sunoco) in the Northeast.  It’s a volume driven business, and has performed well as miles driven (and hence gasoline volumes) are the primary drivers.  Low crude helps this segment.  A recent purchase of capacity on the Colonial pipeline was a nice little coup for the company.

Retail propane, the company’s legacy business, is the second biggest at 20% of EBITDA.  Given that propane is a heating fuel, demand hinges on the weather.  2015 was a particularly warm winter, and propane volumes fell 16%, with EBITDA falling 19%.  Assuming a “normalized” winter, EBITDA should rebound from 79mm to 105mm.  They did acquire $10 of EBITDA at a 7x multiple this year, so EBITDA looks to be inline with 2015 excluding that.  Propane margins generally appear stable year to year, with volume the biggest variable.

Crude oil logistics also looks to be an improving business, and represents 18% of EBITDA.  While 2015 EBITDA fell 16%, the company has recently complete the Grand Mesa pipeline, which will add $150mm to annual EBITDA once ramped up in 2017-2018.  Overall, Grand Mesa was a huge project, costing $800mm, and will alone represent 25% of EBITDA at the company proforma.  The company has 9 year take or pay contracts with a variety of producers (the Grand Mesa runs from the DJ Basin to Cushing OK).  The good news with Grand Mesa is that most of their customers have already renegotiated terms.  Year one EBITDA originally was contracted at around $160mm, but now looks to be around $120mm, ramping up to $150mm.  There has been a lot of skepticism in the market regarding the Grand Mesa, with concerns around the cost to complete, available financing, and customer contracting. These are mostly behind them, and rig counts last week were up 14% versus a year ago.  The biggest customer is XOG, who has a clean balance sheet (raising equity last month) and intends to double production in 2017.

Liquids is a solid business for NGL, around 17% of EBITDA.  Mostly this segment purchases NGLs (propane and butane) from fractionators.  They store them, and transport them to refiners (who blend butane with gasoline) and wholesalers.  There is commodity exposure, and 1c of movement in propane/butane margins per gallon can move EBITDA by $20mm.  But generally propane prices have been on a tear, up to 72c/gallon today (Jan 2017 contract) from 35c a year ago, which should help margins.  NGL also utilizes storage to capture seasonal propane spreads (buy in summer, sell forward in winter).  Expansion at their Utah Sawtooth storage facility is not baked into my numbers but should add growth in 2017.

Water Solutions is the company’s smallest segment, at 15% of EBITDA.  Generally this business owns gathering lines and water pipelines to carry wastewater (by product of shale drilling) to treatment facilities to restore water to drinkable standards.  Injection wells are ultimately used to store the treated water.  Management is de-emphasazing this segment, as rig counts collapsed in 2015 when oil dropped.  On the plus side, NGL owns significant excess capacity, and Q3 2016 was the first quarter showing an improvement in rig counts.  They operate roughly 1/3 of their assets in the Permian Basin too, which in aggregate has added over 60 rigs in the past few months as oil prices have recovered (from 140 to over 200 rigs now operating).  A $1 change in oil should equate to $1mm in incremental EBITDA (the company can resell oil “skimmed” from the wastewater, hence the commodity exposure here).

Oaktree Preferreds

Oaktree purchased $240mm of 10.75% preferreds last May.  The financing included 3.65mm penny warrants (included in share count).  The preferreds are redeemable at 140% in year one, 115% in year two, and 110% in years 3-7.  They can be called at 101% thereafter, and the company can pay in stock or units (or some combination).  While horribly expensive financing, it did provide NGL with smart asset allocators, who can assist in finding and evaluating acquisitions, etc.  Its clear listening to management that they respect Oaktree (who doesnt?).  

I like the new CFO and Treasurer (brought in back in Q1 2016), who seem to have a conservative mindset and intend to reduce leverage and raise the company’s credit rating to investment grade.  Given seasonality, by March 31, 2017, leverage should be 5.0x, and 5.4x through the preferreds, very manageable levels.  The company has $1.1BB of liquidity, and no bond maturities until a $380mm bond comes due in 2019.  These leverage figures do use 2018FY EBITDA numbers – which seems fair given that Grand Mesa pipeline just began operating.

Projections

The company has guided to a range of EBITDA from $485mm to $500mm for FY 2017 ($50mm from Grand Mesa).  As Grand Mesa ramps up, management has stated that they should do over $600mm in EBITDA in FY 2018.

2017 figures assume normal winter weather, as well as $42.50 per barrel in oil prices.  Should oil average $55 per BOE in 2018FY, EBITDA should improve by around $23mm.  The Grand Mesa pipeline adds $80mm (fully contracted) in EBITDA in FY 2018, and should water volumes improve 10% then EBITDA would increase by another $11mm.  These seem likely.  From $492, that would take EBITDA up by $114mm, to $606mm in FY 2018.  The company also recently completed the expansion of the Sawtooth Cavern in Utah (NGL storage in the Liquids segment), not included in my numbers.

Management has indicated that growth spending will be confined to smaller tuck in type deals, and organic projects only.  Targets are 5-7x EBITDA, and 20% type IRRs.  There is an At The Money (ATM) program to issue stock, which appears to be used in small quantities.  Capex should be much lower going forward as most of the 2016-2017 capital spending was from constructing Grand Mesa (800mm).  Again, I think Oaktree adds a lot of value to the company here.

Free Cash Flow

Given the cut to the distribution last year, the company pays virtually no IDRs.  There is little to no risk to a sale of the GP to the LP this year (at least not until the distribution gets back to $2.50 or higher).  These are usually done at high multiples and typically dilutive.  (See WPZ and MPLX this month).

At $21.50, NGL trades at 9.5x current year (FY 2017) DCF, and 7x forward DCF.  Most comps in the industry trade between 10-14x DCF, with yields typically in the 5-7% range.  Given the huge distribution coverage 1.7-2.0x, the yield arguably should be lower.

Risks

While 70% of the business is fee based, volume of oil and gasoline as well as propane and butane impact EBITDA.  

The remaining 30% is mostly driven by crude oil prices, which have bounced back.  Should OPEC/Russia not deliver on production cuts, oil could have downside back to the low 40s.

The downside case at $42.50 oil, with a warm winter looks like 2015 results, combined with Grand Mesa (which has take or pay contracts, but also spare capacity), would mean $2.16 in DCF/share in FY 2018 (from $3.06).

One contractor on the Grand Mesa pipeline is Bonanza Creek (ticker BCEI), who filed for Chapter 11 last month.  They recut their deal with NGL (detailed in a Dec 23, 2016 8K).  The new rate is $4.25/barrel shipped, capped at 20,000 per day.  NGL gets 10% of prices over $55/barrel (to a $7.25/barrel limit).  The math works out to 20-30mm of revenue.  A minimum volume commitment kicks in in 2018. The new terms are already reflected in management’s guidance for the Grand Mesa (which cut year one EBITDA from $160mm to $120mm).

The biggest contractor on the Grand Mesa is Extraction Oil (XOG), which has a good balance sheet (under 2x leverage), and anticipates volume growth of roughly 100% in 2017.  Volumes ramp up from 40k/day in year one, to 58k/day in year three on the Grand Mesa.  XOG has 14 years of drilling inventory in the DJ Basin.  Customer risk appears low here, although it is a recent IPO.

Stock based comp is high, and (different from the company), I treated it as a cash expense in figuring out DCF/share.  A more aggressive view would be to ignore SBC, and assume that DCF is in the mid $3 range in FY 2018 (assuming some more shares, but adding back the expense).

IDR’s at $2/share in distributions would equate to $12mm per year, but these figure also ramp up quickly.  At $2.56/unit in distributions, IDRs would cost nearly $65mm.  I view that as a high class problem however, as the stock probably is over $30 with that kind of distribution level.  In fact, it was over $40 at that level before.

Catalyst

The distribution should be raised with the start of FY 2018 (in mid April 2017).  I sense that the distribution will be raised from $1.56 now to $2 over the next 12 months.