Midstream Earnings Notes (Q1 2024)

[Previously regarding Enterprise Product Partners, Enbridge, and Genesis Energy. This is our first time writing about the Tortoise Midstream Energy Fund.]

Enterprise Products Partners L.P.
Highlights from the first quarter results from EPD:

Enterprise reported net income attributable to common unitholders of $1.5 billion, or  $0.66 per unit on a fully diluted basis, for the first quarter of 2024, a 5 percent increase compared to $1.4 billion, or $0.63 per unit on a fully diluted basis, for the first quarter of 2023. Distributable Cash Flow (“DCF”) was $1.9 billion for the first quarters of 2024 and 2023.  Distributions declared with respect to the first quarter of 2024 increased 5.1 percent to $0.515 per common unit, or $2.06 per common unit annualized, compared to distributions declared for the first quarter of 2023.  DCF provided 1.7 times coverage of the distribution declared for the first quarter of this year, and Enterprise retained $786 million of DCF. Enterprise repurchased approximately $40 million of its common units on the open market in the first quarter of 2024.  Including these purchases, the partnership has utilized 48 percent of its authorized $2.0 billion common unit buyback program. Adjusted cash flow from operations (“Adjusted CFFO”) was $2.1 billion for the first quarter of 2024, compared to $2.0 billion for the first quarter of 2023.  Adjusted CFFO was $8.2 billion for the twelve months ended March 31, 2024.  Enterprise’s payout ratio, comprised of distributions to common unitholders and partnership unit buybacks, for the twelve months ended March 31, 2024, was 56 percent of Adjusted CFFO. Total capital investments were $1.1 billion in the first quarter of 2024, which included $875 million for growth capital projects and $180 million of sustaining capital expenditures.  Organic growth capital investments are expected to be in the range of $3.25 billion to $3.75 billion in 2024 and 2025.  Sustaining capital expenditures are expected to be approximately $550 million in 2024.

The $0.66 quarterly earnings are a 9.1% annualized yield on the current unit price of $29. The quarterly distribution is only $0.515 because they are retaining earnings, so the current dividend yield is ~7.3%. The big question with Enterprise is whether all of the "growth" investments pay off by resulting in higher free cash flow generation? If so, cash from operations would increase and capital expenditures would (hopefully) decrease, resulting in a lot more cash available for distributions to unitholders.

We just noticed that Bruce Berkowitz owns EPD in his amusingly concentrated Fairholme mutual fund portfolio, where he has 86% in JOE (Florida land) and 9% in EPD.

Enbridge Inc.
ENB is an $80 billion market capitalization company yielding 7.2% (dividend) which is quite high compared to what it has yielded historically. (It rarely yielded more than 7% prior to 2017.) And it is a C-corp so you don't even get the annoying Schedule K-1 that you do from other midstream companies. Their first quarter (release) adjusted EBITDA was $3.7 billion, up 11% year-over-year. Distributable cash flow was $2.6 billion, up 8.9% year-over-year.

Half of the EBITDA is from their liquids pipelines. Segment EBITDA was $1.8 billion in Q1, up 2.2% year-over-year. They own the Mainline pipeline from the western Canadian oil sands and then the Line 5 that takes that crude to eastern Canada refiners. The Flanagan South and Seaway can also take that Mainline oil from Canada down to Gulf Coast refiners. ("We transport about 30% of the crude oil produced in North America. We transport about 65% of U.S.-bound Canadian exports.") The Mainline System moved 3.1 million barrels per day, about the same as last year.

A quarter of their EBITDA is gas transmission. Segment EBITDA was $936 million in Q1, up 4.9% year-over-year. They carry natural gas from western Canada to export, and also to the eastern U.S. Enbridge connects PA gas to the eastern U.S. as well as Gulf Coast. ("Enbridge moves about 20% of the natural gas consumed in the United States. We are the largest natural gas supplier to New England, the Southeast and virtually all of Florida. Our transmission network is also webbed throughout the Gulf Coast. We are also one of the largest offshore natural gas transporters in the Gulf of Mexico.") They are working on LNG export from western Canada, called the Woodfibre LNG project.

Other quarter is gas distribution (natural gas utility). Segment EBITDA was $566 million in Q1, up 6.8% year-over-year. ("Enbridge’s gas utility business, Enbridge Gas Inc., becomes the largest by volume in North America—with about 7,000 employees delivering 9.3 billion cubic feet of natural gas per day (Bcf/d) to about 7 million customers.") The Enbridge Gas business earns the most during the winter - the first and fourth calendar quarters of the year. This year's heating degree days in Enbridge's markets were only 1,377 HDDs, which was 20% lower than last year.

Enbridge also has a renewable power generation business that earned $190 million of EBITDA, up 89% year-over-year.

Genesis Energy Limited
Genesis has four segments: offshore pipelines in the Gulf of Mexico, carrying crude and natural gas produced offshore to refineries along the Gulf Coast; a soda ash business in Wyoming (like the business where NRP owns an interest); sulfur services (which removes sulfur from refinery inputs and sells it as sodium hydrosulfide); onshore pipelines and terminals; and a marine transportation business with boats and barges to transport crude oil and refined products.

For the first quarter of 2024 (results), the offshore pipelines contributed $98 million of segment margin (the same as Q1 2023), soda and sulfur contributed $45 million (down 31% from prior year), marine transportation did $31 million (up 22%), and the onshore pipelines and terminals $6.5 million (up 21%). Total segment margin of $181 million was down 7.2% from the prior year.

The market capitalization of the partnership (at $13 per unit) is $1.58 billion. Genesis has quite a bit of leverage (see 10-Q): $3.84 billion of debt, and $814 million of convertible preferred units. (The distribution rate on the preferred units is 11.24%.) The enterprise value is thus $6.23 billion, and the EV/EBITDA is 9.6 times the first quarter's annualized EBITDA of $163 million.

Their guidance for 2024 had been $680-$740 million of EBITDA and $200-$250 million of capex, which would mean anywhere from $430 to $540 million of cash flow, which is a range of 6.9% to 8.7% on the enterprise value. The first quarter's EBITDA annualizes to $652 million which is below the low end of guidance and would mean the free cash flow on the enterprise value would be 6.5% if capex for the year was $250 million.

Management thinks that cash flow is going to "ramp" from 2025 onwards as offshore volumes grow (with two new platforms coming online) as well as additional soda ash earnings. Concluding an investment cycle is very powerful if it works: you get higher earnings and the capital expenditures decline, resulting in a big increase in free cash flow.

The company just refinanced its 6.25% notes due 2026 with new notes yielding 7.875% that are due 2032.

Tortoise Midstream Energy Fund, Inc.
This (NTG) is a closed end fund that invests in "natural gas infrastructure entities operating real, long-lived, essential pipeline and logistical assets that are actively participating in the energy evolution". Something interesting about closed end funds is that the investors can not redeem from them. As a result from that, there is no arbitrage mechanism to force the market price of a fund unit or share to trade at the fund's net asset value. In this case, the unit price is an 18.9% discount to the net asset value of the fund.

As of April 30, 2024, the top holdings (71% of the fund's investment securities) of NTG were:

Targa Resources Corp (TGRP) 10%
Williams Companies Inc. (WMB) 9.4%
MPLX LP (MPLX) 9.1%
ONEOK, Inc.  (OKE) 8.9%
Plains GP Holdings, LP (PAGP) 8.2%
Hess Midstream LP (HESM) 6.6%
Energy Transfer LP (ET) 5.2%
Enterprise Products Partners LP (EPD) 4.7%
DT Midstream Inc (DTM) 4.4%
Western Midstream Partners LP (WES) 4.1%

Something else unique about closed end funds is that because they have permanent capital (unlike an exchange traded fund), they can use leverage. NTG has total assets of about $300 million and has borrowed $56 million of funds, comprised of $29 million of notes and $12.8 million on a credit facility. There is one note (Series S) for $25 million at a 2.5% interest rate that is due in December 2028. Two other smaller notes yield around 4% and are due in 2025 and 2026. The note at 2.5% is likely worth much less than par and thus the fund's net asset value, which does not discount the note to fair value, is somewhat understated. The credit facility is floating rate, currently 6.7%. In addition to the $42 million of debt, there is also $14 million of preferred shares. The bulk of this is $7.5 million due in December 2027 at a rate of 2.9%, again, so low that it would likely be worth less than par.

Another nice thing about closed end funds is that they "block" the investor from receiving and having to deal with the taxable income (and Schedule K-1) of the underlying investments that are partnerships.

We tend to like midstream investments right now, and investing in a closed end fund gives some benefits, like blocking the K-1s and giving a discount to the value of the underlying portfolio. The dream scenario would be if the midstream companies' earnings grew, they were revalued to higher earnings multiples (i.e. their dividend yields fell), and the closed end fund's 18.9% discount narrowed. 

Activists (such as Boaz Weinstein of Saba) are pressuring closed end fund managers to take steps to narrow the discounts. (Saba owns ~10% of NTG per recent disclosures.) First Trust had a bunch of midstream closed end funds, and they recently merged them into an exchange traded fund (EIPI). When your CEF becomes an ETF, the discount evaporates.

Tortoise has a bunch of midstream CEFs with no clear purpose for being separate, the same way First Trust did. It would be great if NTG were merged with the other, overlapping midstream CEFs and converted to an ETF. Closing that NAV discount would give a 23% return, on top of the underlying investment returns of the midstream investments.

It will be interesting to see whether the new First Trust ETF (EIPI), which its four CEFs were merged into, retains much of the AUM from those CEFs. If so, that would make it more compelling for other managers to convert their jumbles of CEFs into ETFs.

A step short of liquidating or converting to an ETF is for the closed end fund to buy back or tender for its own shares. Last October, all five of the Tortoise midstream funds tendered for up to 5% of their outstanding shares at 98% of net asset value. Not everyone tendered their shares, so for NTG a shareholder who tendered was able to sell the company 10.18% of shares tendered at 98% of NAV. If they continue with this "discount management program," shareholders may be able to eke out a little bit more return.