Short Boardwalk Pipeline Partners (BWP) remains a Hedgeye Best Idea, and we are reducing our Fair Value price to ~$10/unit after BWP’s disappointing results, guidance, and outlook.
We added SHORT BWP to our Best Ideas list on 12/2/2013 and issued a full report on 12/5/2013 (Link: Hedgeye Best Idea Short BWP December 2013). There we argued that, “BWP needs to cut its distribution to a sustainable level, which we estimate would be more than 50% below the current $2.13 per LP unit per year.” This morning BWP cut its distribution ~80% to $0.40/unit/year, and issued disappointing 2014 EBITDA guidance. The units are down more than 40% at the time of writing.
- What’s BWP worth now? We say Fair Value = ~$10/unit……In our 12/5/13 note, we gave a fair value range for BWP of $16 -18/unit. After the 4Q13 results and 2014 guidance, we now believe that our prior range is too high, given:
- BWP’s 2014 EBITDA guidance was weaker than we previously expected, primarily due to incremental weakness in BWP’s natural gas storage and PAL (parking-and-lending) businesses.
- We are more concerned with BWP’s 2015, 2016+ free cash flow outlook, given management’s reluctance to discuss it, as well as the weaker outlook for storage and PAL.
- We are less positive on Bluegrass going forward after a disappointing open season and management’s cautious tone/outlook when discussing the project.
- BWP’s leverage looks to be stuck ~5.0x EBITDA absent a significant equity injection or de-leveraging acquisition (but who wants BWP stock?). BWP will not de-lever in 2014.
For 2014, we estimate BWP LP EPU of $0.86 and LP EBITDA of $648MM, putting BWP at the current price ($14.30/unit at the time of writing) at 16.7x 2014 earnings and 10.7x EV/2014 EBITDA.
When thinking through BWP’s valuation, consider that BWP’s cash flows are at the front-end of secular decline - 2014 could be peak EBITDA; the Company has understated maintenance CapEx such that it’s DCF overstates its run-rate FCF; its over-levered at ~5.0x EBITDA with $525MM of principle due in 1H15; it likely needs a substantial equity injection in order to de-lever; it still has IDRs up to the 50/50 split; it has no "yield support" with an annual distribution of only $0.40/unit, and there is no hope of a distribution increase in the foreseeable future. Given all of these factors, we believe that BWP should trade at below-average multiples: at 8x – 10x EV/EBITDA, we value BWP at $7.00 - $12.50/unit.
The bull case for BWP will likely now shift to value buyers viewing it as a take-out candidate. Okay, we have some recent M&A comp transactions for similar long-haul natural gas transportation and storage assets. KMP acquired TGP and EPNG from KMI at ~8x forward EBITDA in 2012 and 2013, and SEP acquired the SE drop-down assets at ~9x EBITDA in 2013. We have a hard time believing that a potential buyer would be interested in BWP at more than 8x EBITDA given the potential future cash flow declines. Still, if we assume that a buyer could squeeze $50MM of cost synergies out of BWP, a bid for BWP at 8x PF EBITDA would be at ~$9.00/unit. Perhaps there is a case for a takeout, but not the current price.
- 2014 EBITDA guidance worse than expected……BWP guided 2014 EBITDA to $650MM vs. Bloomberg Consensus ~$780MM and our expectation of ~$700MM. BWP’s clean EBITDA (ex. base gas sales and other items) was $712MM in 2013.
- 2014 EBITDA is likely the high-water mark going forward; base business in secular decline……On the conference call, analysts repeatedly inquired about BWP’s outlook beyond 2014, to which management would give no color. The Company’s refusal to discuss 2015+, despite the fact that they should have revenue visibility on long-term contracts, gives us a good idea of what we need to know. Even with a full-year of the SE Expansion in service in 2015, we think it’s unlikely that this incremental EBITDA (we estimate ~$50MM) offsets continued weakness in BWP’s base transportation, storage, and PAL businesses. By our estimates, 2015 and 2016 will have more firm transportation contracts rolling off than in 2014, and 2014 transportation revenues will be down $40MM YoY on $75MM of contracts rolling. Transportation revenues could be down at least that much again in 2015 and 2016. Beyond that, 2019 could be a cash flow bloodbath, with ~2.5 Bcf/d of contracted capacity rolling off on Gulf Crossing and Texas Gas (see our 12/5/2013 report for contracted capacity rolls). The key point here is that BWP’s issues are very long in the tail – it’s not just 2014 weakness. In our view, DCF (~$1.60/unit in 2014) is overstated relative to run-rate FCF because “expansion” projects are merely making up for cash flow declines on the base businesses; longer-term, we expect CFFO to be flat-to-down while debt and units out increase.
- BWP will NOT be de-levering in 2014 (or 2015? or 2016?)……Management's comments suggest that it will not increase the distribution until its debt/EBITDA ratio falls to 4.0x from the current 4.9x (current debt/TTM adj. EBITDA as BWP presents it). That is not going to happen anytime soon! BWP guided 2014 DCF to $400MM; distributions will be $100MM and "Expansion" CapEx $330MM. There is NO free cash available for de-leveraging absent equity issuance (which management insisted they would not do in 2014).
Assuming net debt stays about flat around $3.4B over the next year, BWP will be 5.2x levered at YE14, in breach of its 5.0x covenant ratio. If we give BWP an additional $50MM of full-year EBITDA from the SE Expansion that is expected to be put into service in late 4Q14, BWP will be 4.9x levered on a pro forma basis at YE14. If BWP pays down the $175MM revolver by issuing subordinated debt to Loews, the leverage ratio from the standpoint of the equity holder will not change, though it will help with the debt covenant. Still, BWP would be at 4.6x covenant debt/PF EBITDA at YE14. BWP has no long-term debt due in 2014, but has $525MM due in 1H15 and $250MM in 2016. How does that get paid down? Equity issuance? Management is telling us not to expect more equity, but we're having a difficult time seeing how that's possible.
Call with any questions,
Takeaway: Gold is one of the few absolute return outlets in Quad #3 of our proprietary GIP framework (i.e. growth slowing as inflation accelerates).
- We’ve been calling for investors to get longer of inflation-oriented assets in lieu of consumption-oriented assets, at the margins, as it becomes increasingly likely the Fed stops tapering (or incrementally eases) over the intermediate term.
- Specifically, we continue to anticipate the pace of domestic economic growth will slow, at the margins, as reported inflation accelerates, at the margins. If anything, a marginally dovish Fed only insulates our non-consensus #InflationAccelerating view.
- This directionally stagflationary setup is otherwise referred to as Quad #3 in our proprietary GIP framework. As the historical backtest data below highlights, Gold is among the best performing asset classes in Quad #3, along with US Treasuries, Energy stocks and Utility stocks.
- All told, never forget that gold is an absolute return vehicle that competes with real yields and real yields are headed south because slowing growth is dragging down nominal yields and accelerating inflation is dragging up inflation expectations (see chart below). Don’t fight the tide; fight the Fed instead.
WHERE WE’VE BEEN
Over the years, we’ve been accused of being inflationistas (2010-11), deflationistas (2012-13), perma-bulls (2009-10; 2013) and perma-bears (2010-11). Ironically enough, however, we’ve yet to be labeled as perma-anything with respect to Gold – though I’m sure being overtly bearish on Gold heading into 2013 and then turning fundamentally bullish within three weeks of the bottom probably has something to do with that:
- THINKING WAY OUTSIDE THE BOX ON GOLD (12/14/12): “All told, we think investors should consider reducing their allocation to this asset class. At a bare minimum, it would be prudent for gold bulls to confirm whether or not our TAIL support ($1,669) holds before increasing exposure to gold here. If $1,669 breaks, there’s no true support to the prior closing lows.”
- GOLD: IS IT TIME TO GET BACK IN ON THE LONG SIDE? (11/26/13): “Right now may be a bit early, but gold is shaping up to be a compelling long idea heading into 2014.”
Flash forward to today, Gold is up a healthy +6.1% YTD and gold miners are up an even healthier +16.9% YTD; this compares with a -2.9% decline for the S&P 500 Index and a larger -4.4% decline for the XLY (Consumer Discretionary sector SPDR).
While we are certain consensus has no idea how to interpret these price signals, the aforementioned performance divergences should come as no surprise to subscribers of Hedgeye Macro research. Specifically, we’ve been calling for investors to get longer of inflation-oriented assets in lieu of consumption-oriented assets, at the margins, as it becomes increasingly likely the Fed stops tapering (or incrementally eases) over the intermediate term. Refer to our 1Q14 Macro Themes (1/9/14) and our US Economy Update Call from last Wednesday for more details.
WHERE TO FROM HERE?
We continue to anticipate the pace of domestic economic growth will slow, at the margins, as reported inflation accelerates, at the margins.
The arithmetic is actually quite simple; if the GDP deflator increases, then you need a commensurate increase in GDP to maintain the same pace of inflation-adjusted growth. Unfortunately for both buy-side and sell-side consensus, which came into 2014 as bullish as it had been in well over a year, neither the reported economic data nor bottom-up operating trends at the company level bode well for “a commensurate increase in GDP”.
This directionally stagflationary setup is otherwise referred to as Quad #3 in our proprietary GIP framework. As the historical backtest data below highlights, Gold is among the best performing asset classes in Quad #3, along with US Treasuries, Energy stocks and Utility stocks. The recent quantitative breakout in Brent Crude Oil bodes well for the Energy sector and the confirmed breakdown in Treasury yields bodes well for Utes (+2.9% YTD) and other yield-chasing plays (the MSCI US REIT Index is up +5.1% YTD).
While it’s early (for EM assets and commodity currencies in particular), other price signals are starting to confirm our view that the Fed is most likely to back away from tapering over the intermediate term (3-6M); in fact incremental monetary easing is not out of the question.
The WoW deltas in commodity currencies and EM asset plays suggest investors might want to start digging around for tactical opportunities on the long side of these asset classes. With respect to our #EmergingOutflows thesis, we’re not quite there yet on the latter, but if I can front-run my own thought process in the context of incremental confirming evidence, we’ll likely be there in another month or so.
All told, never forget that gold is an absolute return vehicle that competes with real yields and real yields are headed south because slowing growth is dragging down nominal yields and accelerating inflation is dragging up inflation expectations (see chart below). Don’t fight the tide; fight the Fed instead.
Associate: Macro Team
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Last week Consumer Staples underperformed the broader market, with the XLP +0.4% versus S&P500 +0.8%, continuing a weak start for the sector in 2014, down -4.8% YTD.
The Hedgeye U.S. Consumption Model is flashing predominantly red, as only 4 of the 12 metrics are flashing green.
From a quantitative set-up the sector remains broken across the immediate term TRADE and intermediate term TREND durations, our language for a bearish medium term sector outlook. You’ll see a similar bearish setup for most of the largest names in Consumer Staples.
We continue to believe that the group is generally way over-owned and loaded with premium valuations, despite a healthy moderation in the P/E week-over-week, declining 120bps to 17.7x. Headwinds we see for the group include:
- U.S. consumption growth is slowing as inflation rises, in-line with the Macro team’s 1Q14 theme of #InflationAccelerating
- The economies and currencies of emerging markets – once the sector’s greatest growth engine – remain weak with the prospect of higher inflation in 2014 eroding real growth
- Less sector Yield Chasing as Fed continues its tapering program
- In the U.S., the most recent data on ISM Manufacturing and Prices Paid disappointed month-over-month
- The high frequency Bloomberg weekly U.S. Consumer Comfort Index has not seen any real improvement over the past 6 months and declined week-over-week
Top 5 Week-over-Week Divergent Performances:
Negative Divergence: NUS -15.6%; FLO -9.8%; HAIN -6.0%; DF -4.6%; HRL -3.7%
Positive Divergence: HLF +4.7%; BNNY +4.6%; CCE +2.6%; DPS +2.1%; BF/B +2.1%
The “Newsy” News Flow:
Coca-Cola and Green Mountain Partnership - last week KO announced it will purchase a 10% minority equity position in GMCR. Under the terms of the equity agreement, KO will acquire 16.7M of newly issued shares in GMCR for approximately $1.25B. KO also revealed a new Keurig cold machine to dispense liquid syrup with built-in carbonation, which it has been working on for 5 years!
- We note that Soda Steam (SODA) has struggled with sales of its non-branded syrups — can branded Coke change the consumer's tide towards syrups? Also, we suspect the need for KO and GMCR to combine their hot and cold systems into one as customers desire the innovation but lack the kitchen cabinet space for two units. Could PEP partner with SODA, or just buy the company outright?
CVS Cuts Tobacco - CVS Caremark announced last week that it will stop selling tobacco products at its more than 7,600 drugstores nationwide by October 1. The Company estimates that it will lose approximately $2 billion in revenues on an annual basis from the tobacco shopper.
- While Big Tobacco is beginning to forecast cigarette volumes down 2-3% in 2014, a moderation from 2013 of ~ -4%, CVS’ decision is a bold one that could be very impactful – namely will Walgreen’s, Duane Reade, and Rite Aid follow along? CVS does not sell electronic cigarettes and said it was waiting for guidance on the devices from the FDA.
Last Week’s Research Notes
Earnings Calls This Week (in EST):
Monday (2/10): BNNY 5pm
Tuesday (2/11): RAI 9am; DF 9am
Wednesday (2/12): LO 9am; DPS 11am; MDLZ 5pm
Thursday (2/13): PEP 8am; JAH 8:30am; AVP 9am; THS 9am; IFF 10am; BG 10am; TAP 11am; KRFT 5pm
Friday (2/14): SJM 8am; CPB 9:30am
In the charts below we look at the largest companies by market cap in the Consumer Staples space from both a quantitative perspective and fundamental aspect where we can offer one. As you will see over time, sometimes our fundamental view does not align with the quantitative setup (though not often).
BUD – no-volume (no conviction) beta bounce last week doesn’t do anything to change this bearish TREND ($100.89 resistance)
DEO – one of the new worst looking big cap charts listed in America; never mind the TREND remaining bearish, now the TAIL risk is on here w/ resistance of $123.97
KO – outdone by a hair in the downhill crash competition at #Sochi by DEO; bearish TREND resistance remains overhead at 39.74; TAIL risk = #on
PEP – is it the chips? Don’t know but it couldn’t look worse than KO and it doesn’t; bearish TREND remains but holding long-term TAIL risk line of 79.42, barely
GIS – Cheerios are cool, but the stock still isn’t; bearish TREND resistance as intact as a bowl without milk up at $49.98
MDLZ - the name of the company is turning out to be as unimpressive as the stock sans Peltz renaming it; TREND support now resistance at $33.67
KMB – don’t cry for me Argentina – your KLEENEX is the only signal on our screen that absorbs the bullish TREND support of $103.43
PG – good Mom commercials at the Olympics, bad stock; bearish TREND @Hedgeye firmly intact up at $79.99
MO – dogs bounce too, eh? Altria is earning its newfound bearish TREND with resistance up at 36.29
PM – dog breath.com remains – bouncing big last week on no-volume gets this puppy a biscuit too; TREND resistance firmly intact up at 85.16
Food, Beverage, Tobacco, and Alcohol
Below are key European banking risk monitors, which are included as part of Josh Steiner and the Financial team's "Monday Morning Risk Monitor". If you'd like to receive the work of the Financials team or request a trial please email .
European Financial CDS - Outside of Greece, most of Europe's banking system saw swaps tighten last week. Spanish, Italian and French banks led the charge lower, followed closely by Germany's banks. Greek banks were wider by ~30 bps on a w/w basis.
Sovereign CDS – Sovereign swaps were tighter across the globe last week with the exception of Germany, where they widened by one basis point.
Euribor-OIS Spread – The Euribor-OIS spread tightened by 3 bps to 13 bps. The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States. Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal. By contrast, the Euribor rate is the rate offered for unsecured interbank lending. Thus, the spread between the two isolates counterparty risk.
Takeaway: Waiting and watching for now while the EM situation shows greater signs of clarity.
Last week we flagged the rising Euribor-OIS and TED spread as areas of concern. Historically these have been solid indicators that the market is moving from a risk on to risk off mentality and it's our view that it's best to stand aside when these gauges of interbank systemic risk are rising. It would appear for now that that widening may have proved short-lived as both gauges have this week returned to generally benign levels. That said, we're not quite comfortable sounding the "all clear" signal just yet. For one thing, VIX levels remain elevated and for another, we think the EM scare that initially prompted the nervousness is unlikely to have blown over just as quickly as it emerged. With our Macro team’s quantitative setup in the XLF showing just 1.9% upside to TRADE resistance and 4.1% downside to TRADE support, we think it makes sense to wait and watch at this juncture.
* 2-10 Spread – Last week the 2-10 spread widened to 238 bps, 6 bps wider than a week ago. We track the 2-10 spread as an indicator of bank margin pressure.
* Euribor-OIS Spread – The Euribor-OIS spread tightened by 3 bps to 13 bps.
* CRB Commodity Price Index – The CRB index rose 1.9%, ending the week at 290 versus 284 the prior week. As compared with the prior month, commodity prices have increased 6.4% We generally regard changes in commodity prices on the margin as having meaningful consumption implications.
* TED Spread – The TED spread fell 6.4 basis points last week, ending the week at 15 bps this week versus last week’s print of 21.36 bps.
Financial Risk Monitor Summary
• Short-term(WoW): Positive / 7 of 13 improved / 2 out of 13 worsened / 4 of 13 unchanged
• Intermediate-term(WoW): Negative / 2 of 13 improved / 9 out of 13 worsened / 2 of 13 unchanged
• Long-term(WoW): Positive / 5 of 13 improved / 0 out of 13 worsened / 8 of 13 unchanged
1. U.S. Financial CDS - US Banks and non-bank Financials were almost universally tighter last week with the modest exceptions of Sallie Mae (+2 bps) and Travelers (+5 bps). The large cap US banks were all tighter, with MS, C and BAC tightening by 10-11 bps while GS and JPM tightened by 9 and 8 bps, respectively.
Tightened the most WoW: C, BAC, GNW
Widened the most WoW: TRV, SLM, MET
Tightened the most WoW: AGO, MBI, MTG
Widened the most MoM: TRV, MET, AIG
2. European Financial CDS - Outside of Greece, most of Europe's banking system saw swaps tighten last week. Spanish, Italian and French banks led the charge lower, followed closely by Germany's banks. Greek banks were wider by ~30 bps on a w/w basis.
3. Asian Financial CDS - Chinese and Indian banks posted modest w/w tightening in swaps, while Japanese Financials were essentially unchanged.
4. Sovereign CDS – Sovereign swaps were tighter across the globe last week with the exception of Germany, where they widened by one basis point.
5. High Yield (YTM) Monitor – High Yield rates were unchanged last week at 6.02%, but are up 7 bps vs the previous month.
6. Leveraged Loan Index Monitor – The Leveraged Loan Index rose 1.0 points last week, ending at 1848.
7. TED Spread – The TED spread fell 6.4 basis points last week, ending the week at 15 bps this week versus last week’s print of 21.36 bps.
8. CRB Commodity Price Index – The CRB index rose 1.9%, ending the week at 290 versus 284 the prior week. As compared with the prior month, commodity prices have increased 6.4% We generally regard changes in commodity prices on the margin as having meaningful consumption implications.
9. Euribor-OIS Spread – The Euribor-OIS spread tightened by 3 bps to 13 bps. The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States. Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal. By contrast, the Euribor rate is the rate offered for unsecured interbank lending. Thus, the spread between the two isolates counterparty risk.
10. Chinese Interbank Rate (Shifon Index) – The Shifon Index ended the week at 4.44%, up 164 bps month-over-month. The Shifon Index measures banks’ overnight lending rates to one another, a gauge of systemic stress in the Chinese banking system.
11. Markit MCDX Index Monitor – Last week spreads tightened -3 bps, ending the week at 87 bps versus 90 bps the prior week. The Markit MCDX is a measure of municipal credit default swaps. We believe this index is a useful indicator of pressure in state and local governments. Markit publishes index values daily on six 5-year tenor baskets including 50 reference entities each. Each basket includes a diversified pool of revenue and GO bonds from a broad array of states. We track the 16-V1.
12. Chinese Steel – Steel prices in China ended the week at 3,393 yuan/ton, which is down 57 yuan/ton on a month-over-month basis (-1.7%). We use Chinese steel rebar prices to gauge Chinese construction activity, and, by extension, the health of the Chinese economy.
13. 2-10 Spread – Last week the 2-10 spread widened to 238 bps, 6 bps wider than a week ago. We track the 2-10 spread as an indicator of bank margin pressure.
14. XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows 1.9% upside to TRADE resistance and 4.1% downside to TRADE support.
Joshua Steiner, CFA
Jonathan Casteleyn, CFA, CMT