Back-to-School Trends in Midstream

Hinds Howard is a portfolio manager at CRBE Investment Management, where he evaluates listed infrastructure and transportation companies in North America and coordinates research of listed transportation companies globally. He is based in Wayne, Pa.

Growing up, I watched a lot of TV, especially in the summer. Scanning the movie channels, multiple times I came across and watched the film “Back to School.” The film’s premise: an old wealthy businessman who likes to party, played by Rodney Dangerfield, decides to return to college with his son and hijinks ensue. Robert Downey Jr. had a small role as the best friend of the son, and “Karate Kid” bad guy Billy Zabka played the “heavy.” The climax of the movie involved a diving competition where Dangerfield’s character Thornton Mellon performs his signature dive, the “Triple Lindy.” Silly, but fun movie.

Anyway, those of you in Texas are Back to School already, and here in the Northeast we’ll be starting soon enough. So, below I try to catch you up on what’s been going on in the publicly traded stock side of the midstream space in recent months.

Valuation data points

The asset sale market has recently offered multiple data points that suggest historical valuations could be coming down, even for the highest quality pipeline assets. The idea that you can slap a 12x-14x multiple on a high-quality natural gas pipeline asset with long-term contracts doesn’t seem to be the case anymore.

Data points:

• In May, Spire acquired the MoGas interstate gas pipeline for an estimated 10x EBITDA multiple;
• In July, Berkshire Hathaway announced the acquisition of 50% of Cove Point LNG from Dominion for around 10.5x EBITDA; and
• Later in July, TC Energy announced the sale of 40% of Columbia Gas to GIP for a 10.5x EBITDA multiple.

These assets are all natural gas infrastructure assets, either regulated or heavily contracted.  Each circumstance was unique and there are reasons each should have been sold for lower valuations than you’d expect. Higher interest rates, terminal value concerns and a limited buyer pool for big pipeline packages are all factors in these deals. 

Even so, this smattering of transactions bunched so closely together are worth noting when assessing valuation for other assets held within midstream companies like Energy Transfer, Kinder Morgan, The Williams Cos. and the rest of TC Energy. 

On the other hand, the scarcity of these types of assets and their astronomical replacement value could argue for these data points being just a blip at a point in time. Just check in on the Mountain Valley Pipeline process for an indication of how tough it would be to build the Transco Pipeline again.

Mixed tolerance for growth capex creep

Big capex increases are still met with skepticism by the market, given the trade-off between capex and free cash flow. However, modest increases for needed infrastructure are being accepted by the market. Capital discipline balance is critical, publicly traded midstream companies seem to be aware of this balance and they are putting forward only their highest quality projects. 

So, there is a bit of nuance playing through with the stocks, where the market is willing to evaluate capex increases on a case-by-case basis. Modest increases to capex plans were announced by Targa Resources (TRGP), Energy Transfer (ET) and DT Midstream (DTM).  The market was more receptive to TRGP’s increase than the others. Generally speaking, if there’s a need for infrastructure, it is backed by customer contracts and doesn’t thwart previous leverage targets or capital return expectations, then the market tends be OK with it.

Equity capital markets thawing

Over the last five to seven years, MLP equity capital markets have been largely closed. There has been basically no activity on the primary side. There have been exceptions, notably HESM, which has executed several offerings of shares held by sponsor entity Global Infrastructure Partners (including another one in August). But primary equity issuance of new common equity from a midstream company has been basically nil. We have had at least one data point this summer that might signal a thawing of the capital markets. 

See below for a list of recent capital markets activity, including an equity offering for a mineral royalty MLP and an IPO for Kodiak Gas Services, a compression corporation. In total, it’s more than $1 billion this summer.

• Aug. 9: NuStar Energy (NS) sold $200 million worth of units in upsized equity offering to fund redemption of preferred units.
• June 28: IPO of Kodiak Gas Services (KGS) raised $256 million.
• Kimbell Royalty Partners (KRP) sold $102 million worth of units in upsized equity offering to partially fund acquisition.
• June 14: Canadian midstream company Gibson Energy sold CA$403 million worth of subscription receipts to partially fund large acquisition of port assets in Corpus Christi, Texas.
• Aug. 16: Hess Midstream (HESM) sold $288 million worth of share in offering of shares owned by sponsor Global Infrastructure Partners.

A functioning equity capital market gives midstream companies another option when it comes to managing growth, leverage and liquidity for sponsor holdings. Not many midstream companies need equity at the moment, in fact, many have plans to buy back stock rather than issue more, but knowing equity capital is an option could change the calculus for M&A going forward.

In summary, valuations for high quality assets are under pressure, growth capex is creeping, and equity capital markets are back open. Companies that are not desperate to sell assets into a buyer’s market should be well-positioned to thrive in the current environment.