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MLPs: A Trio of Takeover Targets
02/20/2015 10:00 am EST
With widespread selling across the energy space, Elliott Gue sees select opportunities where investors have "thrown the baby out with the bath water," including in the midstream MLP market. Here, the editor of Energy & Income Advisor highlights a trio of outfits where lowered valuations now make them potential takeover targets.
Steven Halpern: Our guest today is Elliott Gue, the newsletter industry’s leading expert on energy stocks and editor of Energy & Income Advisor. How are you doing today, Elliott?
Elliott Gue: I’m doing well, thanks for having me on.
Steven Halpern: Well, thank you for joining us. Today we’re going to discuss takeover ideas among master limited partnerships (or MLPs), specifically in the energy sector. Now, importantly, you emphasize that when picking takeover targets, investors should focus on those that would still have value as standalone entities. Could you explain the reasoning?
Elliott Gue: Sure. Well, as with any other company that you’re looking to buy that might be a takeover target, sure, a takeover can increase the value of a stock pretty much overnight, because usually they’re taken over at a premium to the value that they were trading on before to tempt shareholders to agree to the takeover, but it can often take a lot longer than you expect.
It is difficult to understand the timing of when those takeover offers are going to come around.
Some of these names that have been widely speculated to be takeover targets over the years in the energy space, you know, they’ll sit there for two or three years as takeover targets and no one actually bites and then you really want to own a stock that you’re happy owning as a standalone entity, because it may take a lot longer than you expect for that takeover to actually materialize, for that offer to actually come through.
Steven Halpern: Now, some of the MLPs you point to have lost some 30% of their value from recent highs, which has attracted you to them and you point out that they still have solid yields and have grown their distributions. Could you expand on that?
Elliott Gue: Sure, well, most MLPs—master limited partnerships—have come down sharply since the summer of 2014, because that’s when oil prices peaked out and started coming down.
Even though most MLPs are in the midstream energy business—meaning that they own assets like pipelines, natural gas storage caverns, natural gas processing plants—and these assets don't have a whole lot of commodity price sensitivity.
So, in most cases, a pipeline company doesn't care whether the oil moving through their pipeline is at $150 a barrel or $50 a barrel, the reality is that they’re still in the energy space and they still do tend to get hit whenever oil and gas prices are weak, which, of course, they have been since the middle of 2014. We’ve seen a lot of MLPs come down.
Now some of those MLPs, especially names in the upstream MLP space, probably deserve to come down and I think may even have some more downside to come, but a lot of the names in the midstream space that own unique, difficult to replicate assets, they’re being, sort of, babies being thrown out with the bathwater.
They’re names that don't have a lot of sensitivity to what’s going on in the energy markets right now, but are still getting sold off with the rest of the group on the theory that they’re still in the energy sector, so I think that does open up a lot of opportunities, but, you know, again, you have to be careful. You don't want to buy an MLP simply because it’s down a lot.
You don't want to buy an MLP simply because you think that the assets are undervalued. You have to be very careful, sort through and look at names that you don't mind holding even if they don't get that takeover offer. Now, as valuations start to come down, you’re going to see more of these MLPs get acquired, but you still have to be careful, I think, in my view.
Steven Halpern: You’re also focusing on MLPs that also have solid current yields. I guess that helps while you’re waiting.
Elliott Gue: It sure does and most of the cases we’re looking at MLPs that we believe can sustain those yields, even if oil and natural gas prices remain weak for another year or two, and in fact, we’re actually projecting oil and natural gas prices to remain—to take a lot longer to recover—than many investors think is likely.
We’re looking for more of a U-shaped recovery in commodity prices, where prices remain relatively low for a prolonged period of time. We want to own names that offer a nice yield, but not just a nice yield.
We want to own names that have long-term contracts in place with solid companies, solid counterparties, and have potential for new projects that can actually increase their distributable cash flow, because we want names that cannot only have a nice yield now, but can sustain or even grow that yield through this prolonged period of more moderate commodity prices.
Steven Halpern: One idea that you like in this environment is Targa Resources Partners LP with the symbol (NGLS). What’s the attraction there?
Elliott Gue: Sure, Targa is an interesting name that’s actually in the midst of a merger. They’re merging with Atlas Pipeline Partners that’s another MLP out there. They’re involved in a number of different areas of midstream energy business. Gathering and processing are two of their biggest areas.
Gathering is small diameter pipelines that connect individual wells to the larger pipeline network into gas processing plants. Gas processing plants separate natural gas liquids from raw natural gas, so natural gas liquids would be things like propane, ethane, and butane. Now, both of these midstream energy assets have some commodity price sensitivity.
On the gathering side, when commodity prices are weak, drilling activity tends to tail off, and therefore, the demand for new gathering systems, in other words, hooking up new wells to an existing system goes down, and on the processing side, when natural gas liquids prices are weak, demand for gas processing tends to go down.
Targa does have some sensitivity to commodity prices, but we actually think that they have a lot of very unique assets that would be very, very difficult and very expensive to replicate or replace, and therefore, may be attractive as a takeover target.
One example of that is that they have a huge gathering system partly that they’re acquiring with this merger with Atlas Pipeline in the Eagle Ford Shale of southern Texas.
Now, the Eagle Ford, with oil prices down and gas prices pretty low, it will probably see a moderation in drilling activity, but it is one of America’s lowest cost oil, natural gas and natural gas liquids plays, so we think long-term that’s an area where there’s going to be a lot of demand for new gathering and processing capacity and Targa has it.
Another thing that they have is one of America’s only export terminals for natural gas liquids, for propane on the Gulf Coast. We think this is an area you’re going to see a lot of growth as well.
Even with the recent downturn in oil and gas prices around the world, US propane and ethane prices are much lower than in other parts of the world, and therefore we think that there is going to be a lot of demand in the future for increased exports of these natural gas liquids outside the US, mainly to petro chemicals producers in other countries.
Steven Halpern: Now, you also highlight MarkWest Energy Partners LP (MWE). What makes this a potential takeover?
Elliott Gue: Sure, MarkWest—the crown jewel of the MarkWest portfolio—is really their gathering and processing system in the Marcellus Shale, which is in Appalachia, which is the lowest cost natural gas play in the US, and also, it produces a lot of wet gas, which means gas that is natural gas combined with natural gas liquids like propane and ethane.
Again, right now with gas prices really weak and with oil prices and natural gas liquids prices down, demand for gathering and processing in that region is probably going to be relatively weak, we do think they can continue to maintain their distribution, and at the end of the day, the value of the asset that they have, they have this huge network, this huge system in the Marcellus, which would be very expensive, time consuming and difficult to replicate, so we think that asset alone would make them very attractive to an acquirer.
The thing to remember is that even though Marcellus might see a little bit of a slowdown in the near-term, in terms of drilling activity, longer-term Marcellus is one of the first places that companies are going to go back to, because, again, it’s the lowest cost gas field in the United States.
And I would add probably one of the lowest cost natural gas plays anywhere in the world. It’s the kind of place that you’re going to see drilling activity return to first, even though commodity prices right now are low enough that they may slow down drilling activity in that region.
Steven Halpern: Now, finally, among your takeover candidates is NuStar GP Holdings, LLC, with the symbol (NSH). Can you briefly share your thoughts on this position?
Elliott Gue: Sure, NuStar GP, this is actually the general partner for NuStar, which is another MLP; the symbol there is (NS). This is a company that got involved in a terrible acquisition a few years back. They purchased these asphalt refining operations, where they were refining basically crude oil into asphalt.
Demand for asphalt collapsed during the financial crisis and this turned out to be a lot more cyclical business than they expected it to be and really way too cyclical for the MLP industry as a whole. They got rid of that asset. They sold that off.
They also replaced their management team and I think they’ve got a much stronger management team in place right now and they’re making a lot of, I think, very, very positive decisions. For example, they’re been accelerating their growth opportunities in the Eagle Ford Shale.
They acquired a crude oil and natural gas liquid pipeline in that region, as well as some related storage assets. This is, again, a very fast growing area that I think is going to see a lot of drilling activity, even with oil and gas prices down where they are.
They also have an agreement with Occidental Petroleum, which is one of my favorite larger oil and gas producers, and basically, they’re going to reactivate and reverse a pipeline, so reverse the direction of a pipeline in Texas that we think is very attractive.
They also have a lot of dock space in the Gulf Coast region and what that is, is that it positions them very well to benefit from increased US energy exports.
As you know the US government prohibits the export of crude oil, but they do allow the export of some minimally processed condensate and this dock space that NuStar has, again it is a very valuable asset. This is dock space that could be used to actually export US condensate and maybe even in the future US crude oil.
Right now it’s still very useful, still very valuable for loading oil in the Houston area for transport over to refineries in Louisiana, but long term we think that dock space could be very valuable because regardless of what happens over the next year or two, ultimately the US will be a much larger exporter of hydrocarbons and crude oil and condensate.
Steve Halpern: Again, our guest today is Elliott Gue, editor of Energy and Income Advisor. Thank you for joining us and that was a fascinating discussion.
Elliott Gue: Thanks for having me.
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