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TEP/TEGP: In a $5 Billion Hole; 3Q16 Recap

In a $5 Billion Hole……TEP’s assets are worth around $3B.  Combined, TEP and TEGP have  just over $8B of enterprise value with $2.2B of net debt (including 25% of REX).  This means that the combined TEP and TEGP equity is only worth ~$1B, but it trades at a market cap of ~$6B.  This is Tallgrass’ $5 billion hole, the crux of our short thesis, and what will likely lead to the collapse of TEP and TEGP, down 80% - 90% to fair value (see tables below).  Should our fundamental call on Pony Express be wrong, and that pipeline has no cash flow issues whatsoever in the future, then TEP/TEGP equity is worth ~$3B and has ~50% downside from its current market cap.  Either way, current Tallgrass longs – mesmerized by financial engineering, near-term distributions, and the bizarre notion that Tallgrass is some kind of “platform company” – will be left holding an empty bag.  We’ve seen this movie before (LINN, KMI, ETE, VRX, etc.), the move down is typically sudden and violent, as everyone attempts to exit at the same time through a narrow doorway.  It will be worth the wait.    

 

On the 3Q16 Results……TEP’s 3Q16 results were as expected.  Pony Express’ volumes were 276 Mb/d, down from 286 Mb/d in 2Q, but management guided to an uptick in October and November, which was a surprise to us.  We don’t expect the volume story for Pony Express to get interesting until (if?!) Dakota Access is in-service, the timing of which remains uncertain.  REX’s 3Q16 adjusted EBITDA was down $(46)MM ((27)%) YoY on account of the UPL bankruptcy and the ECA contract restructuring.  REX’s Zone 3 Capacity Enhancement project is now completely sold out and is expected to be in-service circa Jan 1, 2017, consistent with our expectations and model. 

 

Aggressive Non-GAAP Accounting……It’s not central to our short thesis, but worth calling out: TEP’s non-GAAP accounting is very aggressive, even relative to its MLP peers.  TEP’s maintenance CapEx on its consolidated assets is only 13% of deprecation.  And maintenance CapEx for REX was $1.6MM in 3Q16, a mere 3% of depreciation.  This is a massive, regulated asset, and TEP wants us to believe that it has an economic useful life of more than 1,000 years!  Further, REX reported $84MM of "DCF" yet distributed $87MM to its partners, and TEP includes its share of REX’s distributions, not the DCF, in its own DCF calculation.  It wasn’t overly material in the quarter, but this is worth keeping an eye on, particularly when TEP owns a larger percentage of REX in 2017+.

 

Short TEP is Better Risk/Reward than Short TEGP……TEP equity is massively overvalued and the management team is heavily-invested in TEGP – this is the perfect recipe for (a lot of) TEP equity issuance.  As you would expect, this management team is acquisition hungry.  For this reason, we strongly prefer the TEP short over the TEGP short.  TEP is in the 50/50 IDR split and as a result, any large acquisition or investment will likely destroy value for TEP unitholders, but could be very beneficial to TEGP.  Short TEP / long TEGP is too cute for us, but we do agree with that relative positioning.

 

TEP/TEGP: In a $5 Billion Hole; 3Q16 Recap - tep2

 

 

Let us know if you have any questions or comments.

 

Kevin Kaiser

Managing Director


OPEC Cuts = MIRAGE | CALL TODAY 1:30PM EST

Takeaway: Please join us for a flash call at 1:30PM ET today to discuss yesterday's developments and understand the thinking in Saudi Arabia and OPEC.

Please join us for a flash call at 1:30PM ET today with former US Secretary of Energy Spencer Abraham and former Vice Chairman of the Paris-based International Energy Agency Joe McMonigle to discuss yesterday's developments and understand the thinking in Saudi Arabia and OPEC.

 

OPEC Cuts = MIRAGE | CALL TODAY 1:30PM EST - HE M opec fc

 

KEY DISCUSSION POINTS:

  • A Tweet from the Wall Street Journal's OPEC reporter that "OPEC is ready to cooperate on a cut" sent oil futures higher and moved the entire market for two hours going into the close.
  • The WSJ tweet quoted a television interview given by the UAE energy minister but turned out to be false alarm as his comments resembled previous statements about cooperation if everyone cuts.
  • With oil heading lower, you should expect similar comments and headlines but it's nothing more than a mirage.
  • Investors should ignore the noise because it's too early for a cut. The Saudi's think their market share policy is winning.
  • A cut now would be counter-productive - like sending a lifeline to US producers.

 

Participating Dialing Instructions

  • Toll Free:
  • Toll:
  • UK: 0-
  • Confirmation Number: 13630766
  • Materials: CLICK HERE

 

BIOS:

 

Spencer Abraham

Secretary Spencer Abraham serves as Senior Energy Analyst and is Chairman and CEO of The Abraham Group, an international strategic consulting firm focused on the energy sector and based in Washington, DC.

Secretary Abraham is a member of the Board of Directors of Occidental Petroleum, NRG Energy and PBF Energy. Secretary Abraham served as the tenth Secretary of Energy in United States history from 2001-2005 under President Bush. 

 

Prior to being named a Cabinet Member, Spencer served as an effective and highly productive U.S. Senator from Michigan for six years.

 

In addition, he is a frequent commentator on FOX News, CNN and Bloomberg TV as well as a periodic contributor of op-ed articles to the Financial Times, The Wall Street Journal, The Washington Post, The Weekly Standard and other publications.

Secretary Abraham holds a law degree from Harvard University, where he co-founded the Federalist Society, and is a native of East Lansing, Michigan.

 

 

Joseph McMonigle

Joseph McMonigle serves as a Senior Energy Analyst and is president and co-founder of The Abraham Group LLC.


Mr. McMonigle is the former Vice Chairman of the Paris-based International Energy Agency. He also served concurrently as U.S. Representative to the IEA (2003-2005).

 

In addition, Mr. McMonigle served as Chief of Staff at the U.S. Department of Energy and also as the American co-chair of the U.S.-China Energy Cooperation Working Group. He is also an attorney and member of the Energy Bar Association as well as the Pennsylvania and District of Columbia bars.

 


KMI | Poor Results and a Massively Overvalued Stock

KMI is Worth $10 – $13/sh……With every quarter’s results we are more convinced that KMI is massively overvalued.  We see no reason why fair value for this Company isn’t in the range of 9x – 10x current EV/EBITDA, or $10 - $13/sh (on $7.2B of annualized EBITDA and $42.5B of net debt).  KMI is a capital intensive, cyclical conglomerate with low-to-no growth and an over-levered balance sheet.  In our opinion the MLP go-go days of valuing this company based upon its dividend/distribution are behind us – this market is smartening up and KMI longs have a hard lesson to learn yet.

 

3Q15 Results A Little Soft……KMI posted 3Q15 results shy of consensus expectations: adjusted EPS of $0.16/sh vs. consensus $0.18; EBIT of $1.10B vs. consensus $1.17B; and EBITDA of $1.80B vs. consensus $1.83B.  FCF in the quarter was $144MM or $0.07/sh.  The dividend declared was as expected at $0.51/sh.  For the YTD 2015, KMI has declared dividends equal to ~4x its FCF and ~3x its adjusted EPS.  In the quarter EBIT was (9)% YoY and EBITDA was (1)% YoY.  Over the last year KMI has negative EBITDA growth despite spending around $1B of CapEx per quarter and making $3.5B of acquisitions.

 

KMI Reduces 2016 Dividend Growth Guidance; Unclear on Long-Term Dividend Growth Guidance……Just over a year after consolidating its MLPs, KMI announced that it is reducing its 2016 dividend growth guidance to a range of +6% – 10%, from the prior +10% annual CAGR through 2020.  On the call KMI’s management team was rambling and reeling in response to several questions regarding long-term dividend growth – at this stage it seems uncertain and highly dependent on where the stock price is.  One of the more amusing aspects of the conference call (there were many) was KMI management bemoaning, on the one hand, the high dividend yield causing financing problems, and on the other, the stock being undervalued.  If the stock were truly cheap then the logical move would be to eliminate the dividend and use that cash to repurchase shares…  Why not?

 

Mysterious New Financing Vehicle Coming Soon and That’s Not Good……Someone must be telling KMI management that the stock has traded poorly this year because of an equity overhang...  Yesterday KMI announced that it has found a new source of equity capital that will eliminate the need for new common KMI shares between now and mid 2016.  We speculate that it could be some equity investment from Rich Kinder himself (with other insiders and/or big holders?) with a special dividend feature (thinking something like a special class of shares that has a dividend below the common dividend for X years before converting to common).  Investors should be wary of such a last-ditch effort to save a broken model.

 

Other Items of Note……

  • Every segment will miss the 2015 budget even after including the acquired EBITDA from Hiland and the Vopak terminals that were not contemplated in the budget.
  • Numerous pockets of fundamental weakness in steel and coal terminals, G&P volumes, liquids pipelines volumes, CO2 volumes, and oil E&P volumes (oil production in 3Q15 was (2)% YoY and below plan in every field).
  • KMI took a $387MM impairment charge on the Goldsmith oil field; KMI bought the field in 2013 for $280MM.
  • KMI issued $1.3B of common equity in 3Q15, taking YTD 2015 equity issuance up to $3.9B.  KMI shareholders have been diluted by more than they’ve received in dividends so far this year.

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I’m on the road in London this week so am keeping this recap short and to the key points.  Stay tuned for more after we get the 10-Q in the next couple weeks…  And it may be coming time to do another deep dive presentation on KMI – it’s been too long!

 

 

Kevin Kaiser

Managing Director



New Best Idea: Short Genesis Energy LP (GEL)

We are adding Genesis Energy, L.P. (GEL) to our Best Ideas list as a short.  We see more than 50% downside to fair value.

 

GEL is $4.8B market cap MLP with a variety of midstream businesses: Gulf of Mexico (GoM) offshore pipelines, marine transportation, crude-by-rail terminals, refinery sulfur removal services, onshore crude oil and CO2 pipelines, trucking and other marketing assets.  The asset base has been put together largely via acquisition over the last 10 years – the Company has an impressive history of growing its distribution with “accretive” deals, its largest being the July 2015 purchase of Enterprise Products’ (EPD) offshore GoM pipelines and services business for $1.5B.  The market lauded this acquisition, and it is a big reason why GEL is one of the best performing MLPs in 2015, +4% vs. the AMZI Index (25)%.

 

But we are far less optimistic on the prospects of that acquisition … one of the many topics we’ll cover in our conference call presentation on GEL on Thursday, October 15th at 11am ESTAll Hedgeye Energy subscribers will receive the dial-in information and slide deck early Thursday morning.

 

Key Topics 

  • Cyclical and Structural Headwinds Emerging: Near-term and long-term outlook for GEL’s key operating segments: offshore oil pipelines, marine transportation, and crude-by-rail
  • A Gift Horse from EPD?  What did GEL acquire?  And was it really a great deal?   
  • What’s in a Distribution?  A critical look at GEL’s non-GAAP financial metrics and distribution policy
  • Valuation - What’s GEL Worth?  We go far beyond the run-of-the-mill MLP valuation methods to show that GEL has more than 50% downside to fair value
  • Catalysts and Risks:  When and how might our thesis play out?  And what are the risks to this idea?

 

Kevin Kaiser

Managing Director

 


KMI | 2Q15 10-Q Review (Hiland, G&P, S&T, Coal)

Kinder Morgan, Inc. (KMI) published its 2Q15 10-Q on 7/24.  We didn't find anything earth-shattering in the filing, and a boring 10-Q is a good 10-Q...  That said, there were some interesting segment / asset-level data points that deserve mention.

 

Detail on Shell Acquisition......“On July 15, 2015, we purchased from Shell US Gas & Power LLC (Shell) for $200 million its 49% interest in a joint venture, ELC, that was formed to develop liquefaction facilities at Elba Island, Georgia. The purchase gives us full ownership and control of ELC. Shell continues to subscribe to 100% of the liquefaction capacity.” 

 

Hiland EBDA Contribution Disclosed......KMI disclosed that the Hiland G&P assets contributed $36MM of EBDA to Natural Gas Pipelines and the Hiland Double-H crude pipeline contributed $12MM of EBDA to Products Pipelines in 2Q.  Assuming $20MM of annual G&A, that puts the acquisition multiple at 18x current EBITDA.

 

G&P Weakness Hits Natural Gas Pipelines......Natural Gas Pipelines EBDA was down YoY on an organic basis (ex. Hiland), with the commodity-sensitive G&P assets weighing on the segment:

 

KMI | 2Q15 10-Q Review (Hiland, G&P, S&T, Coal) - kmi natgas

 

CO2 S&T EBDA Down 32% YoY......In our view, the market under-appreciates KMI's oil price exposure in its CO2 S&T business.  In 2Q15, S&T EBDA was down 32% to an implied $79MM (~$320MM annualized):

 

KMI | 2Q15 10-Q Review (Hiland, G&P, S&T, Coal) - kmi S T

 

Weak Bulk Terminals Volumes Bodes Poorly for Future EBDA......Bulk transload volumes were down 22% YoY, while Gulf Bulk EBDA was actually up $6MM (+32%) due to "increased shortfall revenue from take-or-pay coal contracts.”  MVCs for KMI's major coal export customers, BTU and ACI, likely expire around 2020 - 2021 (see KMI's 2012 10-K), though with those coal companies' unsecured bonds currently trading ~10 - 30 cents on the dollar, those contracts could be at risk of default / renegotiation.  See this presentation for more on KMI's coal exposure

 

Commodity Hedges......KMI's commodity derivatives disclosure is poor, though it looks as though the significant QoQ change was a ~30MMbbls increase in NGL fixed price swaps.  KMI also added some natural gas basis swaps.  As of 6/30/15, KMI's commodity derivatives were marked on the balance sheet at $317MM, net.

 

KMI | 2Q15 10-Q Review (Hiland, G&P, S&T, Coal) - KMI hedge

 

YTD Equity Issuance......"During the six months ended June 30, 2015, we issued and sold 62,079,878 shares of our Class P common stock pursuant to the equity distribution agreement, and issued an additional 968,900 shares after June 30, 2015 to settle sales made on or before June 30, 2015, resulting in net proceeds of $2,599 million."

 

2015 CapEx Guidance Revised Slightly Lower......"Sustaining" CapEx: $603MM, down from $614MM prior; "discretionary" CapEx: $4,098MM, down from $4,179MM prior.

 

Link to 7/16 Note: KMI 2Q15 Recap & Valuation Update

Link to Updated Valuation Sheet: KMI Valuation Tear Sheet (Excel)  

 

Kevin Kaiser

Managing Director


Short CHK | New Best Idea | Thesis and Call Invite

Thesis Overview

 

In this new era of low hydrocarbon prices, North American E&Ps can no longer pursue reserve and production growth at any cost.  We believe that equity investors have, and will continue to, shift their primary preference away from growth, and to profitability: full-cycle economics, returns on invested capital, and free cash flow.

 

We are adding Short Chesapeake Energy Corp. (CHK) to our Best Ideas list with a fair value range of $3 - $7/share based on an Investor Recycle Ratio of 1.5x at above-current-strip commodity prices.  It is possible that CHK could become severely distressed over a 2 – 4 year time frame, calling into question any equity value at all, should commodity prices remain low for long.  At the current price of $13.50/share, we believe that CHK is pricing in ~$90 WTI and ~$4.00 Henry Hub.  CHK equity investors are paying $1.90 per proved Mcfe for a company that only generates $1.60 of undiscounted EBITDA per Mcfe produced (at $65 WTI and $3.25 Henry Hub).

 

In our view, the market is mispricing CHK’s move to one of the highest-cost, large-cap E&Ps in North America, largely due to its massive and growing midstream expenses, a situation that worsens in the years ahead.  These iron-clad, multi-decade commitments make CHK a highly-unlikely takeout candidate, and may also make asset sales difficult.  We also believe that the market is underappreciating CHK’s leverage due to its $2.9B cash balance and $1B realized hedge gain in 2015; by our model CHK will burn ~$1.5B of cash each year for the foreseeable future, and net debt / EBITDA will be ~5.0x at YE16.

 

CHK is no longer growing production and its economic earnings / free cash flow are sharply negative; in 2016 we expect CHK to lose ~$1.2B ($1.85/share) at current strip prices, before minimum volume commitment payments.  We estimate that CHK needs ~$70 WTI and ~$4.00 Henry Hub just to sustain production and be cash flow neutral.  In short, unless commodity prices increase meaningfully from current levels, the long-term outlook for CHK is dire

 

---

 

We will publish our analysis supporting our short CHK thesis in a comprehensive slide deck on Thursday, June 11th.  We will host a conference call that day at 1pm EST to walk through the key slides and field questions.  The slide deck and dial-in information will be sent to all current subscribers next Thursday morning.  The slides and call will explore:

 

  • CHK’s full-cycle cost structure with an emphasis on its midstream expenses and price differentials;
  • A deep-dive into the CHK / ACMP gas gathering agreements (it’s not the minimum volume commitments that really hurt!);
  • Comparative analysis of CHK’s full-cycle economics relative to peers (E&P investing is often a relative game);
  • Valuation analysis and commodity price sensitivities.
  • Catalysts, risks, sentiment
  • Sidebar: Should Williams Companies (WMB) be worried?

 

Kevin Kaiser

Managing Director


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