You Cannot Grow an Acre

Right now, there are nine companies in the S&P 500 with market capitalizations over one trillion dollars: NVDA, AAPL, GOOGL, MSFT, AMZN, AVGO, TSLA, META, and MU. (SpaceX has not been added to the index.) These nine trade for 32 times earnings and throw off a 1.5 percent free-cash-flow yield on enterprise value. (All free-cash-flow figures here are net of stock-based compensation.)

We were wondering whether you could hide from this overvaluation elsewhere in the S&P index. The first, obvious thought would be to skip the top nine and own the other 491. They trade for 27 times earnings and throw off 2.6 percent on the same basis. Cheaper, but still expensive.

So we looked at various ways of slicing up SPY. We screened out every company with meaningful stock-based compensation, on the theory that the companies paying employees in stock also have the most overvalued shares. (This line of thought actually gave us a good Apple entry point in April 2024.) The low-SBC survivors yielded 2.1 percent, worse than the index, because the screen mostly caught the bid-up defensive complex: utilities, staples, telecom, the names people own for safety. We tried another screen, keeping only the companies that have shrunk their share count over the past five years. That group was the best of the lot at 3.2 percent, but it is not a number worth writing home about.

Put the four cuts together and the ladder of free-cash-flow yields runs from 1.5 to 3.2 percent of enterprise value. None of them are "cheap." Unfortunately, the 491 are not a bargain hiding behind the nine. They are slightly lower-quality businesses, on average, at a quality-adjusted price that is roughly the same. There is no secret cheap slice in the index, because the index as a whole is pretty expensive on the cash that actually reaches an owner.

One option would be to sit in cash and bonds and wait. If the correction doesn't come in a year, you'll be rooting for the world to end. Also, the U.S. federal debt to GDP and the deficit are both high enough that the government will be sorely tempted to inflate its way out, and a government that wants inflation usually gets it. In that world, cash and bonds hand you a negative real return after tax. 

That is the box. Stocks are expensive, but bonds are expensive too. We need a "third way."

There are two ways for a good business to slip through the cracks and be excluded from the passive, indexation bid. One is structure: a master limited partnership or other pass-through cannot go into the index, because the funds that track it cannot hold those companies without tax problems. The other is size: a company too small to move the index gets no meaningful flows. Either way the price is set by people doing valuation arithmetic rather than by a machine that has to buy. These have been called "orphaned securities."

Take Enterprise Products Partners. EPD is a partnership, so the index cannot own it, trades for 11x ttm EBITDA, which allows a 5.9% dividend that is largely tax deferred to be well covered. That is several times the owner yield of the index, for a toll road whose revenue is largely contracted. The standard objection is obsolescence: pipelines are a melting ice cube in an electrifying world. But a large share of EPD's business is natural gas liquids and petrochemical feedstock, and petrochemicals are a secularly growing market, not a shrinking one. Demand for plastics and chemicals rises with population and income whether or not anyone buys another gallon of gasoline. The terminal-value fear is priced as if the whole franchise rides on crude oil. It does not.

Or take a land base. Rayonier (RYN) owns timberland and trades below what the dirt would fetch in the private market. It is a real-estate trust, so in theory it could be indexed, but it is far too small ($6 billion market cap) for the popular indices. Natural Resource Partners owns mineral and royalty land and is orphaned twice over, a partnership and tiny (only $1.3 billion market cap). Neither one has factories to run or fashions to chase. They own real assets that throw off cash, with no large operating or capital budget to eat into the return. In a world where the currency is being diluted, a perpetual claim on an acre or a ton is exactly the thing to own. 

Something falls out of this search that we did not go looking for. The orphans are close to the perfect assets for a great inflation. In many cases they are inflation-protected bonds wearing equity clothing, and  the index-ignored corner of the market is not where you would expect to find them.

It is not a coincidence. A land or royalty asset returns its cash because there is nothing to reinvest in. You cannot grow an acre. That single fact is why it is the right thing to own in an inflation: a real claim paying a real coupon, with no plant or equipment whose replacement cost keeps climbing. And it is the same fact that orphans it. Cash that has nowhere to compound has no reason to sit inside a corporation paying the double tax, so the asset is wrapped in a partnership. An asset that never reinvests never swells into something the index notices, so it stays small. Return your cash and you are orphaned twice, by structure and by size.

So the index runs an inadvertent filter. It bids up the businesses that retain and reinvest, which is most of what is expensive, and it leaves alone the ones that pay everything out, which is where the yield is. That is the bargain. You collect a real yield on the assets best built for the world the deficits are inviting, and you collect it precisely because the largest pool of money in the market is forbidden to bid against you. The only thing asked of you is the willingness to buy what no one is forced to buy, and to hold it on the days when no one is forced to buy it back.

Earnings Notes I (Q4 2024)

Exxon Mobil Corporation (XOM)
Exxon's free cash flow for the fourth quarter of 2024 was $8 billion, which was the same as a year earlier. For the full year, Exxon generated $34 billion of free cash flow versus $36 billion in 2023. (Note that Exxon acquired Pioneer Natural Resources in May 2024 for $60 billion, which added a large amount of production in the Permian.) The market capitalization of Exxon (at $108 per share) is $478 billion and the enterprise value is $500 billion, which puts the annualized FCF/EV yield at 6.4%.

Exxon's upstream earnings were $6.5 billion for the quarter (up 5.5% y/y), downstream earnings were $0.4 billion (down 70% y/y), chemical earnings were $120 million (down 87% y/y), and specialty products earnings were $746 million (down 6% y/y).

Imperial Oil Limited (IMO)
Imperial's free cash flow for the fourth quarter of 2024 was $3.5 million (USD), which was up 54% from a year earlier. For the full year, Imperial generated $2.9 billion of free cash flow versus $1.4 billion in 2023. The market capitalization of Imperial (at $66 per share) is $34 billion and the enterprise value is $36 billion, which puts the annualized FCF/EV yield at 10.8%.

The share count was down 5% year-over-year. They returned a total of $2.7 billion to shareholders in 2024, which is a shareholder yield of 8%. On the operations side, Imperial's cash cost per barrel in 2024 was $3 (USD) lower than in 2023. (Cornucopian.)

Suncor Energy Inc. (SU)
Suncor's free cash flow for the fourth quarter of 2024 was $2.5 billion (USD), which was up 27% from a year earlier. The market capitalization of Suncor (at $38.41 per share) is $49 billion and the enterprise value is $57 billion, which puts the annualized FCF/EV yield at 17.5%. They returned a total of $2.1 billion by way of share repurchases, dividends, and debt repayment in the fourth quarter, which is a yield on the market capitalization of 17%. Suncor has hit its net debt target and is now focused on buybacks and dividends. The oil sands segment produced 539k bbl/d in the fourth quarter with a cash operating cost of $18.59, which was down 14% ($3 per barrel) from the year earlier. 

Intercontinental Exchange Inc. (ICE)
For the full year 2024, ICE earned $3.9 billion of free cash flow on $9.3 billion of total revenue (less transaction-based expenses) for a royalty-like 42% free cash flow margin. Free cash flow for 2024 was up 26% from the prior year. The current market capitalization is $92 billion and the enterprise value is $113 billion, which makes the FCF/EV yield 3.5%.

Enterprise Products Partners L.P. (EPD)
The $0.74 earnings for the fourth quarter are a 9% annualized yield on the current unit price of $32.78. The quarterly distribution is only $0.535 because they are retaining earnings, so the current dividend yield is ~6.5%. 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.

General Motors Company (GM)
Was surprised to see that General Motors shares outstanding ended the year 17.53% lower. The market capitalization is $48 billion and in 2024 GM generated $20 billion of cash from operations, spent $11 billion on capital expenditures, and did $7 billion of share repurchases.

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.

Earnings Notes (Q4 2023)

Freeport-McMoRan Inc. (FCX)
For Q4 2023, Freeport reported operating cash flow of $1.32 billion and capital expenditures of $1.36 billion, giving a free cash flow for the quarter of negative $42 million. Their quarterly copper production of 1.1 billion pounds was up 2% y/y, at an average realized price of $3.81 per pound. Their guidance for 2024 free cash flow is $1.2 billion (at $3.75 copper), which would be only a 2% yield on the current enterprise value of $57 billion.

FCX’s consolidated operating cash flows are estimated to approximate $5.8 billion (including $0.1 billion of working capital and other sources) for the year 2024, based on current sales volume and cost estimates, and assuming average prices of $3.75 per pound of copper, $2,000 per ounce of gold and $19.00 per pound of molybdenum. The impact of price changes on operating cash flows for the year 2024 would approximate $400 million for each $0.10 per pound change in the average price of copper, $180 million for each $100 per ounce change in the average price of gold and $120 million for each $2 per pound change in the average price of molybdenum.

Capital expenditures are expected to approximate $4.6 billion for the year 2024 (including $2.3 billion for major mining projects and $1.0 billion for the Indonesia smelter projects). Projected capital expenditures for major mining projects include $1.1 billion for planned projects primarily associated with underground mine development in the Grasberg minerals district and potential expansion projects in North America, and $1.2 billion for discretionary growth projects.

FCX’s financial policy is aligned with its strategic objectives of maintaining a strong balance sheet, providing cash returns to shareholders and advancing opportunities for future growth. The policy includes a base dividend and a performance-based payout framework, whereby up to 50% of available cash flows generated after planned capital spending and distributions to noncontrolling interests would be allocated to shareholder returns and the balance to debt reduction and investments in value enhancing growth projects, subject to FCX maintaining its net debt at a level not to exceed the net debt target of $3.0 billion to $4.0 billion (excluding net project debt for the Indonesia smelter projects).

They are quite leveraged to the copper price as you can see: $400 million additional operating cash flow for each ten cent increment in copper price. Yet even $4.75 copper would only give an additional $4 billion of operating cash flow which would be kind of lackluster on the $58 billion EV. They are crazy to be spending money on growth! They should demand contracts in hand for $6/lb before they spend a penny more on capex.

Barrick Gold Corp (GOLD)
For Q4 2023, Barrick reported cash from operations of $1 billion and capital expenditures of $861 million, giving a free cash flow for the quarter of only $136 million on an enterprise value of $25 billion. Gold production was up 1% y/y in Q4. Their cash cost was $982 per oz and their "all-in sustaining cost" was $1,364/oz. 

Like other commodity producers and miners, they are plowing it into capex: They produced 4.05 million ounces of gold in 2023, down from 4.1 million in 2022 and closer to 5 million in 2020. Cash cost has risen from $700/oz in 2020 to $960/oz last year. Operating cash flow for 2020-2023 (four years) totaled $17 billion but they spent $11 billion on capex. So only $6 billion of cumulative free cash flow ($1.5 billion per year) and production is in decline!

Remember that to recover an ounce of gold they have to process 28 tons of ore, and for every ton of ore, they have to also move 6 tons of waste.

Comstock Resources Inc (CRK)
Comstock produces almost 100% natural gas and sells it for the pittance of $2.50/mcf. They reported negative free cash flow for Q4 and FY 2023 yet they grew production 6% y/y. Although they may get some religion about lighting cash on fire now that natural gas is even lower:

"In response to weak natural gas prices, Comstock plans to suspend its quarterly dividend until natural gas prices improve. In addition, the Company plans to reduce the number of operating drilling rigs it is running from seven to five. Two of the five drilling rigs will continue to be deployed in the Company's Western Haynesville play. As a result, Comstock plans to spend approximately $750 million to $850 million in 2024 on its development and exploration projects to drill 46 (35.9 net) operated horizontal wells and to turn 44 (38.2 net) operated wells to sales in 2024. Comstock expects to spend $125 million to $150 million on its Western Haynesville midstream system, which will be funded by its midstream partnership."

Comstock has $3.4 billion of net liabilities and a $2 billion market cap. It is conceivable that the equity here goes to zero.

PrairieSky Royalty Ltd. (PREKF)
PSK reported revenue for 2023 of $380 million, generated $283 million of funds from operations (74% margin). They spend 13% of revenue on income tax, 9% on G&A expense, 3.4% on finance expense (interest), and about 1% each on production taxes and on exploration and evaluation. The $283 million of funds from operations is a 7% shareholder yield on the $4 billion market capitalization. (Based on Q4 would be an 8% yield.)

Horizon Kinetics wrote about PSK in the annual letter for their Inflation Beneficiaries (INFL) ETF:

"With today’s temporarily depressed energy prices, PrairieSky should be able to generate C$1.50 in FFO/share, which equates to a 7.5% yield. This could be viewed as a “base case” minimum return—assuming no improvement in energy prices, production volumes, or Canadian price differentials. Assuming modest improvement here, namely with pricing and volumes, it is reasonable to expect more than C$2.00/share of FFO, or a 10% yield. If prices rebound more fully, and volume grows even moderately, FFO could exceed C$2.50 share, nearly a 12% yield."

One big hope for PSK would be more export of natural gas from Canada. Their share of natural gas production for the quarter was 5.4 million Mcf of gas which was sold for only $2.19 per Mcf.

Intercontinental Exchange Inc. (ICE)
For the full-year 2023, ICE earned $3.05 billion of free cash flow on $8 billion of total revenue (less transaction-based expenses) for a royalty-like 38% free cash flow margin. The current market capitalization is $78 billion the enterprise value is around $100 billion, so at a 3% free cash flow yield, it is not cheap. Something else to note was FCF was flat from 2022 to 2023. Their M&A goals: "deepen moats, gain intellectual property, increase customer wallet-share".

Peabody Energy Corp (BTU)
The market capitalization of Peabody is now $3.35 billion versus $3.3 billion when we wrote about them last quarter. (It was $4 billion when we wrote about them in August 2022.) Total liabilities less current assets are now $335 million, so we would put the enterprise value at $3.7 billion now. For the fourth quarter of 2023, Peabody's adjusted EBITDA was $345 million, up from $270 million in the third quarter. Adjusted EBITDA for the full year 2023 was $1.4 billion which is about equal to the Q4 annualized figure. That puts the EV/EBITDA at 2.7x. Operating cash flow for the quarter was $282 million and $1,036 million for the year. Capital expenditures were $158 million for the quarter and $348 million for the year. So the free cash flow yield on enterprise value is 13% based on the most recent quarter or 19% for the full year.

Thoughts from Coal Trader: "If executed successfully, the Centurion and Shoal Creek organic investments should deliver extremely high IRR's and return significant free cash flow to Peabody in the coming years. Peabody’s team also found a way to further enhance the Centurion investment by acquiring the adjacent Wards Well deposit. These investments will pivot the company more towards the met market where the long term fundamentals are far more favorable compared to thermal. The long term prospects of the company have significantly improved with Centurion being the flagship of their portfolio in the years ahead. The average realizations of the met segment will improve significantly with the addition of Shoal Creek and eventually Centurion. This is probably something that will be overlooked by many analysts, but I believe the 'relativities' in the metallurgical coal market are something the sector if going to have to contend with for far longer than most believe. That is to say, the price spreads between high-quality coking coals relative to lower-quality coking coals may be here to stay..."

Seems cheap and everything, but would rather own coal royalties at current valuations.

Natural Resource Partners, L.P. (NRP)
No year-end results yet, but NRP put out an 8-K in January about a warrant settlement:

On January 29, 2024 (the "exercise date"), holders of Natural Resource Partners L.P.'s (the "Partnership's") warrants to purchase common units ("warrants") exercised 462,165 warrants with a strike price of $34.00. On January 31, 2024, the Partnership settled the warrants on a net basis with $10 million in cash and 198,767 common units. The 15-day VWAP ending on the business day prior to the exercise date was $97.62. Of the originally issued 4.0 million warrants, 1.08 million warrants with an exercise price of $34.00 remain outstanding.

As of the September 30, 2023 quarterly results, NRP had 2,190,000 warrants outstanding. An October purchase (8-K) brought them down to 1.54 million warrants. We had been wondering what they did with their Q4 cash - we won't know for sure for another few weeks until they report earnings, although they did aggressively tackle the warrants. Wonder if they were redeeming the preferred (12% liability) during the fourth quarter?

Exxon Mobil Corp (XOM)
XOM reported cash from operations of $13.7 billion and free cash flow of $8 billion (58% of CFO) for the fourth quarter of 2023. The market capitalization is $400 billion and the enterprise value is $420 billion so the free cash flow yield is 7.6% at current oil (and LNG) price. For the full year of 2023, shareholder distributions were $32.4 billion ($14.9 billion of dividends, and $17.4 billion of share repurchases) which is a 8% shareholder yield.

Imperial Oil Ltd (IMO)
We mentioned IMO last week. Production in the fourth quarter was up 8.5% versus the prior year, while capex for the quarter was down 34% versus the prior year. (See results. Full year capex was down 2% from 2022.) Free cash flow for the quarter was $667 million, which is about an 8.6% yield on the enterprise value. Imperial is a share cannibal. During 2023, they shrank the share count by 8.3%. 

Enbridge Inc (ENB)
Enbridge shares have been really weak, under-performing Enterprise Products, for example. (Also compare with EPD, NTG, and FEI over the past three years.) It's a $70 billion market capitalization company yielding 7.9% (dividend) which is quite high compared to what it has yielded historically. And it is a C-corp so you don't even get the annoying Schedule K-1 that you do from other midstream companies. From the Q4 call:

2023 showcased the predictability of our business amid continued geopolitical instability, persistent inflation and rising interest rates. This is as a result of the 98% of Enbridge's earnings being generated from either cost of service or take-or-pay contract assets. Our debt portfolio is less than 10% exposed to floating rate volatility. Our customer base is over 95% investment grade, and 80% of our EBITDA is earned from assets with protection against inflation. We are rated BBB+ by all rating agencies and remain committed to our long-held leverage target of 4.5x to 5x.

Half of the EBITDA is from their liquids pipelines. They've got the Mainline pipeline from the western Canada oil sands and then the Line 5 that takes it 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.")

A quarter of their EBITDA is gas transmission. They carry from western Canada to export, also to eastern U.S. Connects PA gas to 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 (utility). ("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.")

Allison Transmission Holdings Inc (ALSN)
We keep noticing ALSN on the daily all-time highs list. Per their website, Allison is the world’s largest manufacturer of fully automatic transmissions and hybrid propulsion systems for commercial-duty vehicles. 

On fourth quarter sales of $775 million, they did $170 million of net income and $186 million of adjusted free cash flow (24% free cash flow margin). On full year sales of $3 billion, they did $659 million of adjusted free cash flow (22% FCF margin). Revenue for the year was up 10% for 2022 and adjusted free cash flow was up 37%. They repurchasing $260 million of shares during 2023 (6 percent of outstanding). The market capitalization is $6.25 billion and the enterprise value is $8 billion, so the FCF yield is 8%.

Penske Automotive Group, Inc. (PAG)
Highlight from fourth quarter results:

For the three months ended December 31, 2023, total new and used units delivered increased 8% to nearly 117,400, and total retail automotive revenue increased 5% to $6.2 billion. Same-store new and used units delivered increased 9% to nearly 116,700, and same-store revenue increased 4%, including a 7% increase in service and parts revenue. Total retail automotive gross profit decreased 1% to $1.0 billion, including a 1% decrease on a same-store basis. Same-store service and parts gross profit increased 7%.

Revenue for the fourth quarter was $7.3 billion, gross profit was $1.2 billion, EBITDA was $357 million, and capital expenditures were $103 million. The current market capitalization is $10 billion. Net income was $190 million for the quarter and $1 billion for the full year.

AutoNation Inc (AN)
Highlight from fourth quarter results:

New Vehicle Gross Profit - Decreased $102 million reflecting gross profit per vehicle retailed of $3,653, compared to $5,633 a year ago, partially offset by an 8% increase in unit sales. Used Vehicle Gross Profit - Decreased $27 million reflecting gross profit per vehicle retailed of $1,455, compared to $1,847 a year ago and a 4% decrease in unit sales. After-Sales Gross Profit - $540 million, an increase of $61 million or 13% from a year ago.

Revenue for the fourth quarter was $6.8 billion, gross profit was $1.2 billion, and net income was $216 million. During the quarter, AutoNation repurchased 1.15 million shares of common stock (3% of shares outstanding at start of quarter) for an aggregate purchase price of $151 million. The current market capitalization is $6 billion. Net income was $1 billion for the full year.

Enterprise Products Partners LP (EPD)
Highlights from fourth quarter results:

Enterprise reported net income attributable to common unitholders of $5.5 billion, or $2.52 per common unit on a fully diluted basis, for 2023 compared to $5.5 billion, or $2.50 per common unit on a fully diluted basis, for 2022. Operational DCF was $7.5 billion for 2023 compared to $7.6 billion for 2022. DCF provided 1.7 times coverage of the distributions declared with respect to 2023. Enterprise retained $3.2 billion of DCF in 2023 to reinvest in the partnership, repurchase partnership common units, and reduce debt. Distributions declared with regard to 2023 increased 5.3 percent compared to those declared for 2022 and marked Enterprise’s 25^th consecutive year of distribution growth.

Steady as she goes. The real question will be, do the growth investments pay off? If so, earnings will rise and capex will go down, resulting in a lot more cash for distributions. (As we pointed out in October, the free cash flow per unit of Enterprise has grown substantially (3.3x) over the past five years.)

Altria, Inc (MO)
Highlight from fourth quarter results:

Smokeable products segment reported domestic cigarette shipment volume decreased 7.6%, primarily driven by the industry’s decline rate (impacted by macroeconomic pressures on ATC disposable income and the growth of illicit e-vapor products) and retail share losses, partially offset by trade inventory movements. When adjusted for trade inventory movements, smokeable products segment domestic cigarette shipment volume decreased by an estimated 9%.

Cigarettes volumes down 9%. Cigarette revenues down 2.4% y/y net of excise tax. They are not able to raise price of pack enough to maintain flat revenue. Operating income from cigarettes down 1.3% y/y.

Chipotle (CMG)
Highlights from fourth quarter results:

Total revenue increased 15.4% to $2.5 billion. Comparable restaurant sales increased 8.4%. Operating margin was 14.4%, an increase from 13.6%. Restaurant level operating margin was 25.4%, an increase of 140 basis points.

Market capitalization is $70 billion, they earned $282 million in Q4 on sales of $2.5 billion. Sixty times earnings is steep! Net income for fourth quarter was up 11% year-over-year.

Marathon Petroleum (MPC)
This Marathon is the refiner, not the E&P company (MRO). They refine almost 3 million barrels per day, which is the most in the U.S., followed by Valero (VLO) and ExxonMobil, each with about 2 million barrels per day. Highlight from fourth quarter results:

“In 2023, the business generated $14.1 billion of net cash from operations, driven by strong operational performance and commercial execution,” said Chief Executive Officer Michael J. Hennigan. “This enabled the return of $12.8 billion of capital to shareholders. We believe MPC is positioned to generate strong through-cycle cash flow with the ability to deliver superior returns to our shareholders.”

That's on a market capitalization of $63 billion. 

Marriott International, Inc. (MAR)
We wrote about Marriott in November as a royalty-like business. Highlights from Q4 results:

Adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) totaled $1,197 million in the 2023 fourth quarter, a 10 percent increase compared to fourth quarter 2022 adjusted EBITDA of $1,090 million. The company repurchased 4.7 million shares of common stock in the 2023 fourth quarter for $965 million. For full year 2023, Marriott repurchased 21.5 million shares for $3.9 billion. 

In 2024, we expect another year of solid growth and significant shareholder returns. With normalizing RevPAR growth around the world, we anticipate a worldwide full year RevPAR increase of 3 to 5 percent and net rooms growth of 5.5 to 6 percent. We expect this should yield adjusted EBITDA of approximately $4.9 billion to $5.0 billion for the year and enable us to return $4.1 billion to $4.3 billion to shareholders after factoring in $500 million to purchase the Sheraton Grand Chicago.

That would be quite a nice shareholder return on the current market capitalization of $69 billion.

Warrior Met Coal Inc. (HCC)
The market capitalization of Warrior is now $3.2 billion. Their current assets net of all liabilities (ignoring deferred income taxes) are $660 million, so the enterprise value is $2.5 billion. For the fourth quarter of 2023 (release), Warrior's adjusted EBITDA was $164 million, up from $148 million the prior year. For the full year (2023), adjusted EBITDA was $700 million, down from $1 billion in 2022. That puts the EV/EBITDA at 3.8x using the fourth quarter (annualized) or 3.6x using the entire year.

They sold 1.53 million tons versus 1.45 million the prior year. The average price was $234/t and the average cash cost was $121/t. Cash from operations was $245 million for the quarter and they spent $182 million on capital expenditures. 

For the full year 2023, $700 million of cash from operations, but they spent $525 million on capex. No share repurchases, even though the stock was trading for 1.2x EBITDA earlier last year.

The price per ton of met coal averaged $219 in 2023 vs $304 in 2022. It seems insane to invest so much (~$1 billion for the new Blue Creek mine) in producing more of a commodity that does not have a firm price. There are some good pictures of it in the new investor presentation though.

Coal Trader tweeted: "It seems like they’re really struggling to move this coal. Maybe the transition to more HVA is hurting more than I figured, or maybe the spreads in the Atlantic basin are making it more difficult than I assumed. Prices in Q4 were terrible, and inventories increased A LOT."

That's so brutal. There really shouldn't be any question of being able to move the product if you are expanding production.

Occidental Petroleum Corporation (OXY)
From Q4 results, Occidental's oil volume (total U.S.) was down 2.2% in the fourth quarter (year/year). Their total U.S. production in BOEs though was up 1.3%. In the Permian specifically, oil was flat and natural gas was up 14%. The wells are getting gassier!

Total oil and gas capex in the second half of the year was up 4.5% versus the second half of 2022, but in the Permian was actually down 20%. (They really slashed Permian capex in Q4... in Q3 it was up 8% y/y so maybe we'll see volumes fall off more in Q1 2024.)

Their operating cash flow in Q4 was $2.5 billion with capex of $1.4 billion, giving free cash flow of only $1.1 billion. Market cap is $50 billion and the enterprise value is $80 billion. So EV/FCF is only 5.5%.

Truly no idea what Buffett sees here. 

 

Royal Gold Inc. (RGLD)
Reported results: cash from operations was $101 million for Q4 2023 and $416 million for the full year 2023, virtually the same as Q4 2022 and the FY 2022. There were no capital expenditures in Q4 and only $2.7 million for the full year. They spent $325 million on debt repayment and $100 million on dividends. So the shareholder yield is 5.8% on the $7 billion market capitalization. (Net debt is down to $151 million.)

Kraft Heinz Company (KHC)
Noticing from Q4 results that Kraft's North American volumes were down 5.5% despite 2.5% price increase, resulting in fourth quarter sales down 3%. (They're calling this "headwinds that were driven by ongoing consumer pressure".)

 

The market capitalization is $42 billion and the enterprise value $63 billion. Cash from operations for the full year was $4 billion; surprisingly they actually have $1 billion of capital expenditures, so free cash flow is only $3 billion. They spent $191 million on debt repayment, $2 billion on dividends, and $455 million on share repurchases.

Enterprise Products Partners ($EPD) - Q3 2023

Enterprise Products Partners L.P. (EPD, previously) reported results this morning. Highlights:

• Net income attributable to common unitholders of $1.3 billion, or $0.60 per common unit on a fully diluted basis for the third quarter of 2023, compared to $1.4 billion, or $0.62 per common unit on a fully diluted basis, for the third quarter of 2022.
• Distributable Cash Flow (“DCF”) was $1.9 billion for the third quarters of 2023 and 2022.  Distributions declared with respect to the third quarter of 2023 increased 5.3 percent to $0.50 per common unit, or $2.00 per common unit annualized, compared to distributions declared for the third quarter of 2022.  DCF provided 1.7 times coverage of the distribution declared with respect to the third quarter of 2023.  Enterprise retained $773 million of DCF for the third quarter of 2023, and $3.2 billion for the twelve months ended September 30, 2023.
• Capital investments were $826 million in the third quarter of 2023, which included $727 million of organic growth capital expenditures and $99 million for sustaining capital expenditures.  For the first nine months of 2023, capital investments were $2.3 billion, comprised of $2.0 billion of organic growth capital expenditures and $284 million for sustaining capital expenditures.
• This morning, we announced $3.1 billion of new growth capital projects in our NGL Pipelines & Services segment, our largest business.  In addition to these projects directly integrating with and complementing our entire NGL value chain, these investments also facilitate continued crude oil and natural gas production growth in the basin that will provide benefits to our crude oil and natural gas businesses.  In total, we now have $6.8 billion of organic growth projects under construction. 

The current market capitalization of Enterprise is $56.5 billion and the enterprise value is approximately $87 billion. The third quarter's $1.9 billion of distributable cash flow annualizes to $7.6 billion (compared with $7.8 billion for all of 2022) which implies a shareholder yield of 13.5% on the current market capitalization. Units are trading for 11 times this quarter's (annualized) net income. The actual distribution ($2 per unit annualized) is a 7.7% yield on the current unit price. 

Enterprise has been investing quite a bit in "growth" capital expenditures. It would be nice if these substantial outlays would translate into growth in earnings and shareholder distributions. Last year, Enterprise spent $3.2 billion to acquire Navitas Midstream, plus an additional $1.6 billion for growth capital projects. In 2021, the partnership spent $1.8 billion on growth capital projects. If you add the figures for this year-to-date, it is a total of $8.9 billion spent on growth.

Buying back $8.9 billion of the partnership's own units instead of making growth investments might have allowed the partnership to reduce units outstanding by 15%-20%. Have the acquisitions and capital expenditures done better than this? 

The real test is the same calculation we did earlier this year: free cash flow per unit, over time. Let's look at some income statement, balance sheet, and cash flow statement items for the first nine months of 2023 compared with the first nine months of 2018, which gives a five year comparison:

Revenue ($MM)
2023: $35,093
2018: $27,352

Net income ($MM, common unitholders)
2023: $3,961
2018: $2,888

Net income+depreciation-capex ("FCF," $MM)
2023: $3,439
2018: $1,043

Unit count
2023: 2,182,661,550
2018: 2,194,000,000

Net income/unit
2023: $1.81
2018: $1.32

FCF/unit
2023: $1.58
2018: $0.48

Total liabilities less current assets
2023: $30,363.62
2018: $26,560

It is always tough to tell what is going on as an outsider. Altria's "growth outlays" on Juul and NJOY were really desperate attempts to patch their leaky cigarette boat. The Juul money was thrown away for no increase in earnings, and it is possible that the NJOY acquisition will have the same result.

In contrast, the free cash flow per unit of Enterprise has grown substantially (3.3x) over the past five years. And there are no illicit Chinese competitors offering to move the same shipments of oil, natural gas liquids, and natural gas for half of what Enterprise is charging.

Enterprise Product Partners - Free Cash Flow Per Unit Since Q1 2019

We posted about first quarter earnings for Enterprise Product Partners, but it is worthwhile to go back and put them in historical perspective. Let's look at some income statement, balance sheet, and cash flow statement items for Q1 2023 compared with Q1 2020 and Q1 2019:

Revenue
2023: $12.4B
2020: $7.5
2019: $8.5

Net income
2023: $1.39B
2020: $1.35
2019: $1.26

Unit count:
2023: 2,174,508,951
2020: 2,240,607,595
2019: 2,188,560,672

Net income / unit
2023: $0.63
2020: $0.61
2019: $0.57

Cash from operations
2023: $1.58B
2020: $2.01
2019: $1.16

CFO/unit
2023: $0.73
2020: $0.90
2019: $0.53

NI+depreciation-Capex (FCF)
2023: $1.35
2020: $0.81
2019: $0.61

NI+depreciation-Capex (FCF) / unit
2023: $0.62
2020: $0.36
2019: $0.28

Total liabilities less current assets:
2023: $29.7B
2020: $28.4
2019: $28

It's nice to see the huge increase in "net income plus depreciation less capital expenditure per unit" over the four years from 2019 through 2023: from $0.28 in Q1 2019 to $0.62 in 2023. That measure should hopefully be a good proxy for the cash that the business will be able to use to distribute to unitholders and buy back units.

The current unit price is about $26, so in theory the 62 cents, on an annualized basis, could support a 9.5% unitholder return. Four years ago, the units were trading for more like $29. That was only a 3.9% implied return.

The reason we looked at "total liabilities less current assets" is to make sure that the company has not just been borrowing to pay the distribution.

Note that the First Trust MLP and Energy Income Fund (FEI) has EPD as its largest holding (10.9%) That closed end fund is trading for a 16.4% discount to NAV.

Midstream companies seem much more attractively priced than tobacco companies.

Enterprise Products Partners - Q1 2023

Enterprise Products Partners L.P. (EPD, previously) reported results this morning. Highlights from the results and conference call: 

• Enterprise reported net income attributable to common unitholders of $1.4 billion, or $0.63 per unit on a fully diluted basis, for the first quarter of 2023, compared to $1.3 billion, or $0.59 per unit on a fully diluted basis, for the first quarter of 2022.
• Distributable Cash Flow ("DCF") increased 5.5 percent to $1.9 billion for the first quarter of 2023 compared to $1.8 billion for the first quarter of 2022. 
• Distributions declared with respect to the first quarter of 2023 increased 5.4 percent to $0.49 per common unit, or $1.96 per common unit annualized, compared to distributions declared for the first quarter of 2022. DCF provided 1.8 times coverage of the distribution declared with regard to the first quarter of 2023. Enterprise retained $863 million of DCF for the first quarter of 2023.
  
• Enterprise reported a solid first quarter as we benefited from record pipeline transportation and fee-based natural gas processing volumes and near record marine terminal volumes. In March, our marine terminals handled a record 2.3 million barrels per day of NGL, crude oil, refined products and petrochemical exports.
• Across our integrated system we continue to see crude oil, natural gas and NGL production growth from the Permian Basin. Lower natural gas prices, however, are beginning to temper activity and growth in dry natural gas plays such as the Haynesville and Eagle Ford. 
• For the 12 months ending March 31st, 2023, Enterprise paid out approximately $4.2 billion of distributions to limited partners. In addition, we also repurchased $267 million of common units off the open market. As a result, our payout ratio of adjusted cash flow from operations was 55% for this period and our payout ratio of adjusted free cash flow was 75% for this 12-month period.

The current market capitalization of Enterprise is $56 billion and the enterprise value is $86 billion. This quarter's $1.9 billion of distributable cash flow annualizes to $7.6 billion (compared with $7.8 billion for all of last year) which implies a shareholder yield of 13.6% on the current market capitalization. Units are trading for 10 times this quarter's (annualized) net income. The actual distribution ($1.96 per unit annualized) is a 7.6% yield on the current unit price.

Pipelines - Q4 2022 Earnings Season

Magellan Midstream Partners (MMP) reported results earlier this month. Highlights from the results and conference call: 

• "[N]et income of $187 million for fourth quarter 2022, compared to $244 million for fourth quarter 2021. The 2022 results were negatively impacted by a $58 million non-cash charge for the impairment of our investment in the Double Eagle pipeline joint venture."
• "Diluted net income per unit excluding mark-to-market (MTM) commodity-related pricing adjustments, a non-generally accepted accounting principles (non-GAAP) financial measure, was $1.06 for fourth quarter 2022, or $1.34 excluding the 28-cent negative impact of the Double Eagle impairment. These results exceeded the $1.22 guidance provided by management last fall primarily due to higher-than-expected refined products transportation revenues and improved commodity margin resulting in part from additional blending volumes during the quarter."
• Distributable cash flow (DCF), a non-GAAP financial measure that represents the amount of cash generated during the period that is available to pay distributions, was $345 million for fourth quarter 2022, compared to $297 million for fourth quarter 2021. Free cash flow (FCF), a non-GAAP financial measure that represents the amount of cash available for distributions, additional expansion capital opportunities, equity repurchases, debt reduction or other partnership uses, was $324 million during fourth quarter 2022, versus $291 million during fourth quarter 2021.
• "Magellan wrapped up the year with another solid quarter, supported by record refined products transportation volumes and financial results that exceeded our expectations. During 2022, we delivered over $1.3 billion of value to our investors via opportunistic equity repurchases and Magellan's attractive cash distribution, marking 21 years of continuous annual distribution growth," said Aaron Milford, chief executive officer.
• Refined products operating margin was $303 million, consistent with the prior-year quarter, as higher financial results from this segment's core fee-based transportation and terminals activities were offset by unfavorable MTM adjustments on our commodity hedge positions. Transportation and terminals revenue increased $26 million primarily due to higher average transportation rates and record quarterly transportation volumes. The higher rates were largely driven by our 6% average tariff increase in July 2022. In addition, customers took advantage of the extensive connectivity of our pipeline system to overcome various supply disruptions in the Midcontinent and Texas regions during the current period, resulting in a higher proportion of long-haul shipments.
• Annual DCF was $1,128 million in 2022, or 1.3 times the amount needed to pay distributions related to 2022, compared to $1,118 million in 2021. Annual FCF was $1,486 million during 2022 versus $1,316 million during 2021.
• For the year, Magellan declared cash distributions of $4.17 per unit for 2022 compared to $4.13 for 2021, representing 21 years of uninterrupted annual distribution growth since our initial public offering in 2001. Recognizing that investors value steady increases to the cash distribution, management currently targets annual distribution growth of 1% for 2023, consistent with the increase provided over the last two years.
• During fourth quarter 2022, we repurchased 1.9 million of our common units for $95 million, resulting in nearly 9.6 million units repurchased during 2022 for $472 million. Magellan has repurchased 26 million units for $1.27 billion under our $1.5 billion equity repurchase program over the last three years, representing an 11% reduction in units outstanding. 
• Our 2023 DCF guidance of $1.18 billion would represent an increase of 13% over our DCF of $1.044 billion in 2020, the year we initiated unit repurchases. Assuming no additional repurchases in 2023, DCF per unit for 2023 based on our guidance would equate to approximately $5.80 per unit, an increase of 25% over 2020. Given management's current expectation that FCF after distributions will generally be used to repurchase units (subject to the considerations noted in "Capital allocation" above), DCF per unit is expected to continue increasing at a higher rate than DCF.
• We plan to increase our annual distribution by 1% this year, similar to the past two years, which results in a yield of nearly 8% based on recent MMP trading prices. While we're not providing specific financial guidance beyond 2023 at this time, we expect DCF to continue to grow modestly over the next few years. Combining this modest underlying growth with our expectation to continue to repurchase units results in even higher growth potential for our distributable cash flow per unit as we have seen in recent years. For example, our DCF grew at an average annual rate of just under 4% between 2020 and 2022, while our DCF per unit grew at an annual average rate of just over 8% during the same period. This example, we believe, demonstrates the power in our capital allocation approach and our ability to create long term value for our investors through a healthy current distribution combined with the potential for capital appreciation as DCF per unit increases.
  

They shipped 145 million barrels of refined products in Q4 2022 versus 142 million in Q4 2021 and 131 million in Q4 2019. (Yet more evidence that the EIA is wrong about energy consumption.) Aviation fuel volume hit 9 million barrels this quarter, not quite back to the 11 million in Q4 2019, but a big recovery from 5 million in Q4 2020. Revenue per barrel of refined product shipped was $1.88 in the fourth quarter vs $1.66 in the fourth quarter of 2019.

The current market capitalization of Magellan is $10.9 billion and enterprise value is $16 billion. Their guidance of $1.18 billion of distributable cash flow for 2023 implies a shareholder yield of 10.8% on the current price. Units are trading for 10 times the Q4 annualized net income (excluding the impact of the non-cash Double Eagle impairment).

Over the three year period from December 2019 through December 2022, the CPI rose by 15%. Magellan's revenue per barrel of refined product shipped rose 13% - not quite as much. Corporate level general and administrative expense rose 34% (ouch). Operating expense for the refined product segment was flat and for the crude oil segment it rose 7%. As the company mentioned, above, the distributable cash flow has risen only 13% since 2020, a bit less than inflation.

Adjusted EBITDA for the full year 2022 was $1.43 billion, up only slightly from the 2021 level of $1.42 billion. (It is still below the 2019 level of $1.58 billion.)

We do have to keep in mind that Magellan sold 26 refined petroleum products terminals last summer for $435 million. That divestment would have reduced earnings somewhat, and the proceeds were used to buy back units, which is an example of something that has allowed Magellan's DCF/unit to grow faster than DCF alone.

Also, like many businesses, Magellan's ability to raise prices follows inflation with a lag. Prices are reset at intervals, contracts are renegotiated, and so forth. On this quarter's conference call, they said that they will raise their refined product rates an average of 8% this summer, an amount that will obviously exceed the current rate of inflation.

We want the earnings of our pipeline investments to grow faster than inflation. We can be patient and they will still work out nicely if there is a lag, but we want revenue to at least match inflation and earnings to grow faster than inflation.

Enterprise Products Partners (EPD) also reported results last week. Highlights from the results and conference call:

• Enterprise reported net income attributable to common unitholders of $5.5 billion, or $2.50 per unit on a fully diluted basis for 2022, compared to $4.6 billion, or $2.10 per unit on a fully diluted basis for 2021. 
• Distributable Cash Flow ("DCF") increased 17 percent to $7.8 billion for 2022 compared to $6.6 billion for 2021.
  
• Adjusted cash flow provided by operating activities ("Adjusted CFFO"), increased 13 percent to $8.1 billion for 2022 compared to $7.1 billion for 2021. Enterprise’s payout ratio of distributions to common unitholders and partnership unit buybacks was 54 percent of Adjusted CFFO in 2022. Adjusted Free Cash Flow ("Adjusted FCF") was $3.0 billion for 2022. Excluding $3.2 billion used for the acquisition of Navitas Midstream Partners, LLC ("Navitas Midstream") in February 2022, the partnership’s payout ratio of Adjusted FCF was 71 percent for 2022.
• Enterprise increased its cash distribution 5.4 percent to $0.49 per common unit with respect to the fourth quarter of 2022 compared to the distribution declared with respect to the fourth quarter of 2021.
• Enterprise finished 2022 with a solid fourth quarter, reporting record total gross operating margin. Our quarterly results were driven by record total pipeline transportation volumes of 11.5 million BPD, on a barrel equivalent basis, higher NGL and natural gas pipeline transportation volumes, higher natural gas processing margins and increased fee-based gas processing volumes. 
• Gross operating margin for the NGL Pipelines & Services segment increased 17 percent to $1.3 billion for the fourth quarter of 2022 compared to $1.1 billion for the fourth quarter of 2021.

These Enterprise results are clearly superior to those of Magellan, with earnings, cash flow, and distributions growing by much higher percentages (matching or exceeding inflation).

The current market capitalization of Enterprise is $57 billion and enterprise value is $86 billion. The $7.8 billion of distributable cash flow for last year implies a shareholder yield of 10.8% on the current price. Units are trading for just under 10 times the Q4 2022 (annualized) net income.

The November investor presentation had a great slide showing the growth in EPD's adjusted FCF per unit:

Their "adjusted" free cash flow metric excludes cash used for acquisitions, such as last year's $3.2 billion acquisition of Navitas Midstream. That is reasonable, since when we talk about free cash flow, we are interested in the amount of cash that is produced by the business and available for owners to reinvest. So, we deduct the expenses for maintenance that are necessary to keep the business running as-is, but we can add back what was spent expanding the business.

The November presentation also had a good discussion of the so-called "energy transition."

The EPD investor presentation even cites Vaclav Smil's book How the World Really Works (previously, on CBS) on one slide!

Pipeline Earnings - Q2 2022 ($EPD $MMP)

[Previously regarding Magellan Midstream Partners (MMP) and Enterprise Products Partners (EPD): Magellan Midstream Reports First-Quarter 2022 Financial Results and Raises 2022 Annual Guidance, Enterprise Product Partners L.P. Reports Q1 2022 Earnings, Pipeline Earnings - 2021, Pipeline Earnings - Q3 2021, Magellan Midstream Partners, L.P..] 

Magellan Midstream Partners (MMP) reported results last week. Highlights from the results and conference call: 

• Earlier this morning, we reported second quarter net income of $354 million compared to $280 million in second quarter 2021. As noted in our press release, these results include a $162 million gain in the current period related to the sale of our independent terminals network, which is reflected in income from discontinued operations and a $70 million gain in the prior period primarily related to the sale of a portion of our interest in the Pasadena marine terminal joint venture. Excluding both of these gains, net income decreased about $18 million quarter-over-quarter.
• Drivers of the increase in transportation and terminals revenue included record high quarterly transportation volumes resulting from additional contributions from our recent Texas expansions and higher South Texas volumes, which moved at a lower rate as well as continued demand recovery from pandemic levels, especially of aviation fuel. For the quarter, total refined products volumes were up 3% versus '21 levels.
• During second quarter 2022, Magellan repurchased nearly 3.9 million of our common units for $190 million, resulting in total repurchases of 21.4 million units for $1.04 billion under our $1.5 billion repurchase program authorized through 2024. 
• As we previously announced, we closed on the sale of our independent terminals network on June 8 and have been actively putting those proceeds to work. Including working capital adjustments, we received a total of $447 million for these assets and deployed $190 million during the second quarter into our equity buyback program, underscoring our commitment to maximizing long-term value for our investors.
• Magellan continues to forecast annual DCF of $1.09 billion for 2022. The recent decline in commodity prices as well as the potential for slightly higher expenses during the second half of the year are currently projected to mostly offset our modest financial outperformance year to date. While management continues to monitor general economic conditions, including inflation and refined products demand, we do not expect a material impact to our annual guidance.
• In terms of high commodity prices and the gives and puts on demand, as we've mentioned many times in the past, gasoline and generally transportation demand is fairly inelastic. I think we were maybe testing that a little bit in early July with the prices we saw upon them. But we haven't, I don't think, broken that inelasticity. I still think it's very inelastic. So even with higher commodity prices, as long as they stay within sort of an expected range, not too extreme, we don't see a lot of commodity risk up -- whether prices are up or down really driving that volume one way or the other unless you get to an extreme, which again, we may have tested in July, but we've come off of those extremes. 
• [Guidance implicitly implies about $100 million more DCF in the second half of this year versus the first half of this year. Just wondering if you could walk through some of the drivers?] The first thing I would note is, one, the tariff increase is in the middle part of the year. The second piece I would note is that there is a seasonality to our business. If you look, we often have because of the timing of the butane blending activity, the fall is usually a more significant activity in the fall than it is in the spring. So there's some seasonality that comes with particularly our blending business. And then also our underlying pipeline has some seasonality to it. So there's some seasonality that's just sort of built in. In many ways, the second half of the year just tends to have more activity and do fundamentally better. So it's higher tariff rates, it's more activity due to seasonality in the back half of the year. 
• If you look at the forward curve for the differential between Midland and Houston or East Houston, the forward curve shows that there should be improving differentials over time. If you look right now what's happening, I wouldn't say that we're seeing dramatic improvements today in that differential, what we can earn today versus what we could earn yesterday, but directionally speaking, the forward curve is pricing in wider differentials, so we would expect those to improve from here. You're right, production continues to grow. As that production grows, it should minimize through time the amount of excess capacity out of the [Permian Basin], which should continue to drive. So it all makes fundamental sense that we should start seeing some higher differentials. I still think that the question is, when are they going to show up where you can actually realize them and start seeing them in the results. And we're just not there yet, but we certainly see the potential for improvement as we look out over 2023 and certainly as into 2024 and beyond.
  

The common carrier pipeline system for refined products that Magellan owns is the longest in the United States, extending approximately 9,800 miles from the Texas Gulf Coast and covering a 15-state area across the central U.S. It has 54 product terminals throughout those states. It is interesting to hear their comments that there was only a mild impact on refined product demand even in July. That is consistent with what we have heard from Valero, but not consistent with the gasoline product demand data that has been put out by the EIA - not since they had a two week data delay in June.

They shipped 143 million barrels of refined products in Q2 2022 versus 139 million in Q2 2021 and 132 million in Q2 2019. Aviation fuel volume has recovered to 8 million barrels this quarter, not quite back to the 10 million in Q2 2019, but a big recovery from 3 million in Q2 2020. Revenue per barrel of refined product shipped is $1.73 vs $1.61 in 2019.

Magellan management has said in the past,

"As we go through an energy transition cycle over the next five or 10-years, it's reasonable to assume that you have more refinery rationalization. And typically speaking for a pipeline company that is a net positive, because it creates incremental transportation opportunities basically to fill the hole that if a refinery closure is creating. And we have a system that's ideally situated for that since we're connected to half the refining capacity in the country. And so, we're not supply constrained in any way. So if we have a refinery close in a certain market, we've got plenty of sufficient supply. And in most cases, sufficient capacity to fill that hole with barrels removed over a longer haul, which is typically a higher tariff. So, I think we do have operating leverage going forward around our refined product system."

The current market capitalization of Magellan is $10.3 billion and enterprise value is $15.3 billion. So far this year, they have generated about $490 million of free cash flow (EBITDA less capex, excluding cash from the sale of the independent terminals network). That annualizes to a 6.4% FCF/EV yield. Their guidance of $1.09 billion of distributable cash flow implies a shareholder yield of 10.6%.

Enterprise Products Partners (EPD) also reported results last week. Highlights from the results and conference call:

• Enterprise reported record net income attributable to common unitholders of $1.4 billion, or $0.64 per unit on a fully diluted basis, for the second quarter of 2022, compared to $1.1 billion, or $0.50 per unit on a fully diluted basis, for the second quarter of 2021.
• Distributable Cash Flow, excluding proceeds from asset sales, increased 30 percent to a record $2.0 billion for the second quarter of 2022 compared to $1.6 billion for the second quarter of 2021. Distributions declared with respect to the second quarter of 2022 increased 5.6 percent to $0.475 per unit, or $1.90 per unit annualized, compared to distributions declared for the second quarter of 2021.
• Capital investments were $383 million in the second quarter of 2022, which included $301 million of growth capital expenditures and $82 million for sustaining capital expenditures. Capital investments were $3.9 billion for the first six months of 2022, which included $3.2 billion for the acquisition of Navitas Midstream, $576 million of growth capital expenditures and $157 million for sustaining capital expenditures.
• Gross operating margin from the NGL Pipelines & Services segment increased 21 percent to a record $1.3 billion for the second quarter of 2022, from $1.1 billion for the second quarter of 2021.
• Gross operating margin from the partnership’s Crude Oil Pipelines & Services segment was $407 million for the second quarter of 2022 compared to $419 million for the second quarter of 2021. Gross operating margin for the second quarters of 2022 and 2021 included non-cash, MTM losses related to hedging activities of $38 million and $10 million, respectively. Total crude oil pipeline transportation volumes increased to 2.2 million BPD in the second quarter of 2022 from 2.0 million BPD for the second quarter of 2021.
• Gross operating margin from Enterprise’s Natural Gas Pipelines & Services segment increased 13 percent to $229 million for the second quarter of 2022 from $202 million for the second quarter of 2021. Total natural gas transportation volumes increased 19 percent to a record 16.8 TBtus/d for the second quarter of 2022 from 14.2 TBtus/d for the second quarter of 2021.
• Gross operating margin for the Petrochemical & Refined Products Services segment increased 29 percent, or $95 million to $421 million for the second quarter of 2022 compared to $326 million for the second quarter of 2021. 
• U.S. energy independence is now more valuable than ever. It is clear that Russia has a strangle hold on Europe. And Russia and China appeared to be aligned in policies that are in direct conflict with Western Values. Fortunately, the U.S. has an abundant energy resource. It is the fact that our crude oil, NGLs, LNG cargos are the only short cycle resources the world has left. We have tremendous hydrocarbons potential, but unfortunately it is squandered in the current political climate that is intent on restricting its development. 
• Appalachia alone has over 25 Bcf a day of production upside, that's more than what Europe imports from Russia. However, this potential is unattainable, not by economics or resource, but by massive amounts of laws and regulations that are vague best and consistently applied and consistently. In addition to being the only short cycle resource the world has, our energy is environmentally superior. It's much cleaner because it comes from shale and it's produced here in the U.S. under environmental and safety standards that are second to none, it’s not oil and gas versus renewable debate as so many make it out to be.
• Enterprise’s view has always been, we are absolutely going to need it all. And what most call energy transition is actually going to be badly needed energy additions that will take place gradually. Oil and gas will be in high demand for decades. People who say otherwise are either extremely naive or have their own agenda. Demonizing fossil fuels, overt restrictions on investments and massive layers of regulation that are designed to keep it in the ground will only creep chaos in the form of ever increasing shortages and high prices.
• Moving on to distributions and buybacks, we declared a distribution of $0.475 per common unit with respect to the second quarter of 2022. This is 5.6% higher than the distribution that we declared for the second quarter of last year. This distribution will be paid next week on August 12 to common unit holders of record as of the close of business on July 29. During the quarter, we also repurchased approximately 1.4 million common units at a cost of $35 million. For the 12 months into June 30, we returned over $4 billion of distributions to limited partners and $235 million of buybacks. So for the last 12 months, our payout ratio compared to adjusted cash flow from operations was 56%. And our payout ratio of adjusted free cash flow after excluding the acquisition, the $3.2 billion acquisition of Navitas Midstream was a payout ratio was 72%.

The current market capitalization of Enterprise is $56 billion and the enterprise value is approximately $85 billion. Their free cash flow for the second quarter was $1.75 billion which annualizes to $7 billion a year, an 8% FCF/EV yield. The company is trading for 10 times this quarter's earnings. 

Pipelines are a kind of hedge against over-production by E&P firms. If they bump up against the pipeline transport capacity in a given location (like the Permian), the pipelines' profits should increase sharply since they are bidding for an inelastic supply.

Enterprise Product Partners L.P. Reports Q1 2022 Earnings ($EPD)

[Previously: Pipeline Earnings ($MMP $EPD) - 2021, Pipeline Earnings - Q3 2021 ($MMP $EPD), Hydrocarbon Royalties and Pipelines]

Enterprise Product Partners reported results for the first quarter yesterday. The current market capitalization of Enterprise (at $26.35) is $57 billion and enterprise value is $83 billion. Highlights:

• Enterprise reported net income attributable to common unitholders of $1.3 billion, or $0.59 per unit on a fully diluted basis, for the first quarter of 2022, compared to $1.3 billion, or $0.61 per unit on a fully diluted basis, for the first quarter of 2021. 
  
• Distributable Cash Flow ("DCF") was a record $1.8 billion for the first quarter of 2022 compared to $1.7 billion for the first quarter of 2021. Distributions declared with respect to the first quarter of 2022 increased 3.3 percent to $0.465 per unit, or $1.86 per unit annualized, compared to distributions declared for the first quarter of last year. DCF provided 1.8 times coverage of the distribution declared with regard to the first quarter of 2022. Enterprise retained $814 million of DCF for the first quarter of 2022.
• Adjusted cash flow from operations ("Adjusted CFFO"), which is defined as net cash flow provided by operating activities before the net effect of changes in operating accounts, was $2.0 billion for the first quarter of 2022 compared to $1.9 billion for the first quarter of 2021.
• Our record Adjusted EBITDA of $2.3 billion in the first quarter of 2022 was driven by our petrochemical and refined products services segment, higher natural gas processing margins, and gross operating margin attributable to the Navitas Midstream acquisition, which was completed on February 17, 2022.
  

So, the first quarter's annualized earnings ($5.2 billion) would be an 9.1% earnings yield on the current market cap. The annualized Adjusted EBITDA ($9.2 billion) gives an aEBITDA/EV yield of 11%.

In the first quarter of 2019, Enterprise reported $1.26 billion of net income, $1.6 billion of distributable cash flow, and $2 billion of Adjusted EBITDA. So, profits have grown slightly in nominal terms over the past years, since pre-covid times. Distributable cash flow, for example, has grown by 12.5%.

Pipelines are a kind of hedge against over-production by E&P firms. If they bump up against the pipeline transport capacity in a given location (like the Permian), the pipelines' profits should increase sharply since they are bidding for an inelastic supply.

Pipeline Earnings ($MMP $EPD) - 2021

[Previously regarding pipeline investments: Hydrocarbon Royalties and Pipelines, Magellan Midstream Partners, L.P. (MMP), and  Pipeline Earnings - Q3 2021.]

Some great comments on our pipeline companies' fourth quarter earnings calls. Start with the CEO of Enterprise Products, Jim Teague, on the EPD Q4 call:

I'll finish with our thoughts on the changing sentiments around oil and gas. For some time now, the sentiment toward all traditional forms of energy, especially in political circles has been very negative. Many said that the world should pull the plug on traditional energy as soon as possible and completely devote our capital and efforts toward renewable energy.

Without a doubt, this was always naive. The world now realizes that an overnight transition to renewable sources of energy is not at all possible as evidenced by the rapid development of various global crises, including high natural gas and LNG prices, high crude oil prices and not seen since 2014 and runaway inflation, not seen for about 40 years. Europe is starved for gas and is faced with heat or eat, while Russia, with its major oil and gas supplier, is amassing troops on the Ukraine border. Try as you may, it's hard to blame this crisis on the pandemic.

Over one-third of the world lives in energy poverty, mainly in developing countries. Europe's energy policies have now made energy poverty a reality in first-world countries. As an oil analyst said, energy is the economy. We, in the United States, live in a country of plenty.

We are a rich nation with the high quality of life of creative culture, now also blessed with abundant energy. Maybe that has distorted our thinking about the situation in other countries or regions. People who don't want developing nations to have what we have are either in denial, hypocrites, or both. At Enterprise, we've been outspoken that is going to take all of the above, not for a few years, but for decades to come.

Look to comments made by a variety of sources, everyone from the IEA to the head of Saudi Aramco, members of the European Union, and even the U.S. energy secretary. Ultimately, they all message the same thing. Investment in oil and gas needs to ramp up sharply in order to provide the badly needed baseload traditional sources of energy that will be needed alongside low carbon fuels and green energy to meet the world's growing demand.

And then the CEO of Magellan, Michael Mears, had an amusing comment on the MMP Q4 call about the

James Carreker
Okay. I thought that might be the case. Just wanted to clarify. And then I guess, kind of, a big picture question, and I know we've gotten away from talking about growth versus normal and x growth projects. But when you look at the 2022 refined product outlook, I guess taking into account growth projects that you put into place, like how normal does that feel relative to, say, 2019 levels? Does that feel like we fully caught up? Do you think there's still some parts of the economy holding back when you look at that 2022 number?

Mike Mears
Well, I don't have the numbers in front of me, but I think just directionally, on gasoline, we aren't quite back to 2019 numbers. Diesel fuel is strong and probably above 2019 numbers, and jet fuel, obviously, still not back to 2019 numbers. But I don't have any kind of percentages on my fingertips here to give you on that. And when I say gasoline is not there. I'm not talking about a big miss, I'm talking about it's not above where we were in 2019. And I think -- and again, and I've talked about this before, it really gets into the geography. I mean, as I said, in the rural markets, it's there. In the cities it hasn't quite gotten back there. I mean you still have businesses that don't have people back to work, which is surprising to us, but it's true. And so I think there's still a little bit of a lag there.

Here are the valuation figures and earnings projections last time we checked on EPD and MMP in November:

• EPD market cap was $50 billion and EV was $78 billion. For the first nine months of 2021, Enterprise had earned $3.6 billion, had $6.3 billion of EBITDA, and $4.9 billion of distributable cash flow. The first nine months' annualized earnings ($4.8 billion) looked like an 9.6% earnings yield.
  
• MMP market cap was $11.3 billion and EV was $16.7 billion. For the first nine months of 2021, Magellan earned $738 million, had $1 billion of EBITDA, and $821 million of "distributable" cash flow after maintenance capital expenditures. They had paid $685 million of distributions and repurchased $473 million of LP units for a total of $1.16 billion returned to shareholders through the third quarter. Their first nine months' annualized earnings ($984 million, FY 2021 guidance of $975 million) looked like an 8.7% earnings yield.
  

MMP ended up earning $982 million in 2021, including $244 million in the fourth quarter. The current earnings yield is 9.4% with the stock basically unchanged since early November. During fourth quarter 2021, the partnership repurchased nearly 1.1 million of its common units for $50 million, resulting in a total of 10.9 million units repurchased during 2021 for $523 million.

EPD ended up earning $4.6 billion and had distributable cash flow of $6.6 billion. The current earnings yield is 8.7% with the stock up about 5% since early November.