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EVEP 2Q13 Review: Bumping Up Against Debt Covenant

Summary Bullets:

  • Short EVEP remains a Hedgeye Best Idea (added 4/26/13 at $47.00/unit);
  • 2Q13 results were in-line, no change to 2H13 guidance, an uninteresting quarter operationally;
  • 1st Utica acreage monetization was NOT a positive surprise;
  • EVEP is pushing up against its total leverage covenant and likely needs to issue equity in the next six months;
  • EVEP is now capitalizing a material amount of interest, and maintenance capex is likely understated; both items are "artificially" boosting DCF.


2Q13 results in-line……Adjusted EIBTDA came in at $52.6MM vs. $55.6MM consensus, and DCF of $0.61/unit (0.80x coverage) was in-line.  For the quarter, we have clean EPU of $0.13, FCF of -$0.96/unit, CF of $0.93/unit, and open EBITDAX of $42.4MM.  EVEP maintained 2H13 guidance.  Operationally, it was an uninteresting quarter.   


Utica acreage sale #1 was NOT a positive surprise……EVEP popped 9% on Friday morning as, in our view, investors mistakenly extrapolated EVEP’s sale of 4,345 net acres in Guernsey, Noble, and Belmont counties for $56MM, or $12,900/acre, over its entire package for sale.  This is by far EVEP’s best Utica acreage, and the price tag is neither surprising nor indicative of potential prices for its other acreage packages.  We were modeling $20k/acre for the Guernsey acreage.  In late June 2013, Eclipse Resources acquired ~49k net acres in the core of the Utica (Guernsey/Belmont/Noble/Monroe counties) from The Oxford Oil Company at a price between $10k - $15k/acre (exact terms not disclosed).  Prospectivity of the play varies across EVEP’s acreage, and the acreage sold was largely in the “core of the core.”   We assume that EVEP monetizes 45,000 net acres in the wet gas window of the Utica for $205MM (~$4,500/acre), including the package already sold, between now and the end of 1Q14.  The big piece is the 11,000 net acres in Carroll County (mostly in the NW corner of Carroll County).  We model $5k/acre, though with CHK dominating Carroll County Utica leasehold, it’s more difficult to handicap.   


Total leverage covenant is a problem……EVEP ended 2Q13 just inside its total debt to adjusted EBITDAX covenant of 4.25x.  We estimate that EVEP has to come up with ~$150MM of cash before the end of 3Q13 to stay compliant with that covenant.  The first Utica acreage sale for $56MM has them in need of another ~$100MM cash before quarter-end.  It will likely come in the form of either additional Utica acreage sales and/or an equity raise.  The situation does not improve from there, as EVEP will again be bumping up against the total leverage covenant in 4Q13.  Bottom line – unless EVEP can manage a large asset-for-equity deal, we believe that a ~$200 - $250MM secondary needs to happen within the next 6 months.  Either way, equity is needed to remedy a stretched capital structure and liquidity position ($520MM drawn on the $710MM borrowing base).


EVEP capitalized 17% of interest expense in 2Q13……EVEP started capitalizing interest in 4Q12 when it began investing heavily in its unconsolidated midstream affiliates (UEO and Cardinal).  In 2Q13, EVEP capitalized $2.4MM of interest, which was 17% of total interest paid and 9% of DCF.  EVEP is certainly permitted (under FASB Statement No. 34) to capitalize the interest associated with the midstream build-out, but we consider it somewhat aggressive as capitalizing interest increases DCF, which is the key metric for an MLP like EVEP, and the metric most use to value the equity.  It doesn’t sit right with us to see a serial capital raiser capitalizing a material amount of interest paid.  If EVEP expensed this interest paid, and deducted all GAAP interest expense from DCF, then DCF would have been $23.1MM, for 0.71 coverage, vs. reported $26.1MM and 0.80 covereage.


EVEP 2Q13 Review: Bumping Up Against Debt Covenant  - evep1      


Maintenance capex remains below 2012 trend……Maintenance capex in 2Q13 came in at $14.7MM, or $0.94/Mcfe produced.  This was 48% of total capex, $30.7MM, and is roughly half of the DD&A rate, $1.76/Mcfe.  The maintenance capex rate of $0.94/Mcfe suggests that EVEP is one of the most efficient E&Ps with the drill bit in North America, though its annual reserve replacement statistics paint a different picture, such as its $4.49/Mcfe Drill Bit F&D Cost (excluding revisions) in 2012.  EVEP’s maintenance capex took a curious step change lower in 1Q13, coming in at $13.6MM, falling 29% QoQ, and coinciding with the Company’s drop in DCF and distribution coverage.  Maintenance capex remains below 2012 trend by $4 – 5MM, which is ~17% of DCF.  We believe that EVEP’s maintenance capex is understated, and as a result its DCF overstated.     


Don’t worry, be happy……EVEP’s Executive Chairman John Walker said this on the 2Q13 conference call: “I want to thank those analysts who took the time to really understand EVEP and the Utica play, as well as our investors who hung in there as our unit price fell into the low 30’s. I wish that we or myself personally, at EnerVest and EVEP could have bought units as the price declined, but we've had restrictions on buying or selling EVEP units since last year because of our ongoing negotiations. Again thank you very much.”  No comment necessary. 



Kevin Kaiser

Senior Analyst

Morning Reads on Our Radar Screen

Takeaway: A quick look at stories on Hedgeye's radar screen.

Jay Van Sciver – Industrials

AMR-US Airways Deal Blocked by U.S. in Antitrust Suit (via Bloomberg)


Morning Reads on Our Radar Screen - 4488


Brian McGough – Retail

Ackman quits J.C. Penney board three years into turnaround push (via Reuters)


Josh Steiner – Financials

The many legal millstones weighing down JPMorgan (via AZCentral.com)

A.G. Schneiderman Sues Western Sky Financial And Cashcall For Illegal Loans Over Internet (via New York Attorney General Office)


Keith McCullough – CEO

Yet another US #GrowthAccelerating data pt for July > U.S. July Small-Business Optimism Index Rises to 94.1 (via Dow Jones)

Xinjiang violence: Two sentenced to death in China (via BBC)


Daryl Jones – Macro

LINN Energy not worth more than $18.00, Barron's says (via the fly on the wall)


Jonathan Casteleyn – Financials

Public Pensions Up 12% Get Most in 2 Years as Stocks Soar (via Bloomberg)


Matt Hedrick – Macro

Irish Banks Chasing Defaulters Who Sleep Well at Night (via Bloomberg)

Gentlemen Prefer Bonds?

Client Talking Points


Get this: 10-year yields had their largest percentage increase quarter-over-quarter in more than a decade.  And while 10-year yields have broken out, they remain well below the mean yield since 1989 of 5.21%. Meanwhile, the Barclay’s Aggregate Bond Index is set for its first loss in 14-years and only third loss since 1990.  We are already starting to see generational losses in bonds. So while gentleman may prefer bonds, they don’t prefer losses. Our immediate-term Risk Ranges for UST 10YR is 2.57-2.74%.


Stick with the game plan that's working. Long growth, short fear. Look, we're bearish on plenty of things that are actually going down - but U.S. stock bears have been mauled and have missed this epic move in equities for the better part of the year. As money continues to flow from the bond market to avoid losses, equities will be awaiting the capital exodus with open arms. Our immediate-term Risk Range for the S&P 500 is 1680-1714. 

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

WWW is one of the best managed and most consistent companies in retail. We’re rarely fans of acquisitions, but the recent addition of Sperry, Saucony, Keds and Stride Rite (known as PLG) gives WWW a multi-year platform from which to grow. We think that the prevailing bearish view is very backward looking and leaves out a big piece of the WWW story, which is that integration of these brands into the WWW portfolio will allow the former PLG group to achieve what it could not under its former owner (most notably – international growth, and leverage a more diverse selling infrastructure in the US). Furthermore it will grow without needing to add the capital we’d otherwise expect as a stand-alone company – especially given WWW’s consolidation from four divisions into three -- which improves asset turns and financial returns.


Gaming, Leisure & Lodging sector head Todd Jordan says Melco International Entertainment stands to benefit from a major new European casino rollout.  An MPEL controlling entity, Melco International Development, is eyeing participation in a US$1 billion gaming project in Barcelona.  The new project, to be called “BCN World,” will start with a single resort with 1,100 hotel beds, a casino, and a theater.  Longer term, the objective is for BCN World to have six resorts.  The first property is scheduled to open for business in 2016. 


Health Care sector head Tom Tobin has identified a number of tailwinds in the near and longer term that act as tailwinds to the hospital industry, and HCA in particular. This includes: Utilization, Maternity Trends as well as Pent-Up Demand and Acuity. The demographic shift towards more health care – driven by a gradually improving economy, improving employment trends, and accelerating new household formation and births – is a meaningful Macro factor and likely to lead to improving revenue and volume trends moving forward.  Near-term market mayhem should not hamper this  trend, even if it means slightly higher borrowing costs for hospitals down the road. 

Three for the Road


Cumulative construction shortfall since start of 2011 is ~3 million. Imbalance is supportive of both rising home prices and financials $XLF. @HedgeyeFIG


“An economist is an expert who will know tomorrow why the things he predicted yesterday didn't happen today.” - Laurence J. Peter


Is Best Buy the best comeback stock story of 2013? BBY up +158% in 2013 after falling -49% in 2012.

investing ideas

Risk Managed Long Term Investing for Pros

Hedgeye CEO Keith McCullough handpicks the “best of the best” long and short ideas delivered to him by our team of over 30 research analysts across myriad sectors.

Staying Imbalanced

“To achieve an extraordinary result you must choose what matters most and give it all the time it demands.  This requires getting extremely out of balance in relation to all other work issues, with only infrequent counterbalancing to address them.”

-Gary Keller, “The One Thing”


Yesterday, I presented to the global finance team of a Fortune 100 company.  Don’t worry, they weren’t paying us and we don’t do research on the company.  In fact, the presentation came at the request of a friend who is the number two person in their finance department.  He wanted to provide his direct reports some insights into how Wall Street research works.


The presenter that went before me was a former bulge bracket analyst covering their company.  He was a thoughtful guy and talked about the importance of setting guidance that could consistently be beat.  His view was that that investors don’t like to be surprised, and in part of course he is right.  The perception of predictable returns gives comfort to investors that don’t really do the work (think LINN energy).


He went on to talk about the fact that sell side analysts compete for commissions to get paid and try to make a lot of noise so as to garner “II votes”.   This description of traditional sell side analysts obviously gave me the opening to discuss how our model is different.  As I explained to the group, we get paid for two reasons: a) two have investment ideas that work and b) to make our clients think.


If we are not succeeding at those two objectives, then our business likely would not be sustainable as we have no asset management, trading, investment banking, or prop desk to cover the overhead.   In his recent book, Gary Keller calls this pursuing the One Thing and explains that the pursuit of this One Thing will ultimately determine your personal or professional success.  Hedgeye’s One Thing is research, what is yours?


Back to the global macro grind . . .


Every quarter we try to boil down the global macro markets to three key themes.   But in the spirit of this note, I’m going to distill this down to One key theme: #RatesRising.  Especially in light of the Wall Street Journal headline that emerging market growth is trailing the developed world, and thus indicative of our view of slowing emerging market growth being reflected in consensus, it seems likely that the direction of interest rates are likely to be the One Thing (as always subject to change as the facts change).  But consider the following:


1.  The Queen Mary of macro trends has inflected– We often use the analogy of the Queen Mary turning to describe the long term trend in interest rates.   The Queen Mary, of course, is the massive ocean super liner that dominated transatlantic voyage before the jet age.  Like any vehicle that is more than 300 meters in length, turning the Queen Mary was no easy task and not without its implications.


This analogy is appropriate for interest rates as they have literally been in decline for the last 30 years since peaking in the early 1980s.  This long term decline has enabled any business that depends on borrowing money to fund its business to have a steadily declining cost of capital.  In addition, this has made bonds a compelling asset class with a long term underlying bid to price.


In our models in Q2, yields inflected notably and broke out above our TRADE, TREND and TAIL levels.  In fact, as shown in the Chart of the Day, 10-year yields had their largest percentage increase quarter-over-quarter in more than a decade.  Even though 10-year yields have broken out, they remain well below the mean yield since 1989 of 5.21%.


2. The market is chalk full of debt – Given the generational trend in interest rates going lower and thus providing a tail wind for bonds, it should be no surprise that investors’ portfolios are chalk full of fixed income.  According to the most recent data, there is $38 trillion of bonds outstanding across all subsectors of the bond market.  Further, bonds outstanding have increased every single year since 1990.


The more critical data point from an asset flow perspective is that the notional value of bonds outstanding is currently at 68/32 versus the market capitalization of equities.  This, too, is an extreme ratio based on history and is literally the highest we’ve seen.   For comparative purposes, this ratio was at 50/50 as recently as 1999.


3. Volatility and duration across the bond market are in a set up that could lead to meaningful losses – As volatility in an asset class increases, so too does the expected loss and/or return.   According to Merrill Lynch’s MOVE index, bond volatility has almost doubled in the last quarter and is at two year highs.  Meanwhile duration is at close to all-time highs.  My colleague Jonathan Casteleyn of our financials team highlighted this in his recent presentation on asset managers (ping if you haven’t seen it yet), but based on current duration a roughly 100 basis point move in yields equates to a 8.9% loss on the 10-year treasury.


In part we are already starting to see the sort of generational losses in bonds that we should expect from the dynamics outlined above.  Specifically, the Barclay’s Aggregate Bond Index is set for its first loss in 14-years and only third loss since 1990.  While gentleman may prefer bonds, they don’t prefer losses.


The reality in markets is that there is rarely One Thing that dominates, but the seismic shift in interest rates will certainly be one of the most critical factors over the coming quarters and years.  As money flows from the bond market to avoid losses, equities will be awaiting with open arms.


Our immediate-term Risk Ranges are now as follows:


UST 10yr 2.57-2.74%


Nikkei 133

USD 80.82-82.11

Yen 96.69-98.44

Gold 1


Keep your head up and stick on the ice,


Daryl G. Jones

Director of Research


Staying Imbalanced - Chart of the Day


Staying Imbalanced - Virtual Portfolio

Damned Lies

This note was originally published at 8am on July 30, 2013 for Hedgeye subscribers.

“There are lies, damned lies and statistics."

-Mark Twain


I’ve been spending the last few weeks reading up on advanced statistical analysis of hockey.  Based on my initial research, hockey is very much behind the other major sports in the use of statistics to analyze and value players.  Much of professional hockey is still ruled by the old boys club who make player acquisitions based on “gut feel”.


To be fair, hockey is a difficult sport to analyze, unlike baseball which has repeatable interactions, such as at bats, that can be counted, hockey is more of a chaotic game.  I asked my good friend Theo Epstein from the Chicago Cubs, an early and successful user of Sabermetrics in baseball, about his thoughts related to the analysis of hockey.  He directed me towards what he called a plus / minus on steroids – Corsi.


This statistic was developed by former Buffalo Sabres goaltending coach and measures, or counts, the number of shot attempts on the opposition’s net (including blocked and missed shots) for which the player receives a plus and subtracts it versus the number of shots on his own net.  The theory is that shots are a proxy for possession and over the long run possession leads to goals and a positive goal differential to wins.


This stat can then be adjusted according to the relative quality of competition via a statistic called Corsi Rel QoC, which attempts to normalize Corsi for the quality of opponent.  There are also addendums to this stat that look at where a player typically starts on the ice.  For instance, if a player, due to his defensive proficiency is more often started by the coach in face-offs in his own zone, he is likely to have a lower Corsi rating. So, this too needs to be normalized over time and relative to other players.


But enough about hockey statistics and back to the global macro grind . . .


Yesterday the newest member of our Financials Team, Jonathan Casteleyn, launched on asset management coverage in a very thoughtful 90+ page presentation titled, “Fixing Your Income: The Danger of the Bond Market.”  Akin to all of Hedgeye’s research, this launch presentation was replete with statistics (and hopefully very few damned lies!)  From the macro perspective, Casteleyn raised a number of key points that I wanted to re-emphasize.


First, the U.S. bond market has $38 trillion outstanding across munis, treasuries, mortgages, corporate debt, agency debt, money markets and asset backed.  This is up more than 15% over the last five years and has been dually driven by the increase in corporate bonds, up 50% in that period, and treasuries, which are up roughly 100% in five years.  The ratio of stocks to bonds is now at 68/32%, which is one of the highest ratios we’ve ever seen.  Reversion to the mean anyone?


Second, 10-year treasury duration is literally at an all-time high of 8.9.  The implication of this is that a 100 basis point move in the 10-year equates to an 8.9% loss in value.  In other words, interest rate risk is literally as high as it has ever been, so any further normalization of rates (remember we remain well below historical levels) has the potential to lead to substantial losses in the bond market.   Given this, broker dealers are reducing trading exposure to interest rate products, which has the potential of exacerbating moves in the fixed income market.  As we highlight in the Chart of the Day, this is already leading to accelerating bond volatility (or as Taleb would say, more fragility).


Finally, Casteleyn corroborated our macro team’s bullish view of U.S. equities on likelihood of reversion to the mean on asset flows, as alluded to above.  He also pointed out that current all in yield of the SP500 is 6% (2.0% dividend yield plus 4.1% earnings yield), which compares favorably to the 2.5% yield-to-maturity on 10-year treasuries.   So not only do you get a better yield on equities, but equities typically outperform when the first hike in rates occurs.


That was a Cliff’s Notes version, at best, of the presentation yesterday, but if you have institutional research access please email sales@hedgeye.com to receive a copy.  This idea of continued and sustained outflows from fixed income is in the early innings and may have profound implications for asset returns in the coming quarters and years.


Speaking of interest rate volatility, the FOMC’s 2-day meeting begins today with a rate decision, or lack thereof, scheduled for Wednesday.  This is to be followed by the ECB on Thursday.  We actually would be lying, or at least have inside information, if we attempted to make a call on what either the ECB or Fed will say, but we can say this with some certainty, the potential for them to create market volatility is a real risk, so keep these events front and center on your risk management monitor this week.


Our immediate-term Risk Ranges are now as follows:


UST 10yr Yield 2.47-2.66%

SPX 1679-1699

Nikkei 13478-14501

USD 81.46-82.39 
Brent 106.48-108.12

Gold 1257-1354



I’ll sign off with one of my very favorite statistics quotes from George Bernard Shaw:


“Statistics show that of those that contract the habit of eating, very few survive.”


Stats don’t lie, my friends.


Keep your head up and stick on the ice,


Daryl G. Jones



Damned Lies  - Chartoftheday

Damned Lies  - Virtual Portfolio




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