Sunday, August 7, 2022

Earnings Roundup Q2 2022 ($TPL $RGLD $DMLP $MRO)

In the "What I Would Buy Instead of Tesla" post back in October 2020 (almost two years ago), we mentioned Texas Pacific Land Trust as one investment idea:

Texas Pacific Land Trust (TPL) for $3.6 billion. At $460, the market capitalization is $3.6 billion and the enterprise value is about $3.3 billion. (They have a net cash position.) They get a royalty from their land in the Permian and do not do any production themselves. No debt and royalty ownership protects against the risk of ruin in the scenario where there is "deflation first" before an inflation. In 2019, they did $318 million of net income. In the 1H of 2020, they did only $85 million (which annualizes to $170mm). It's a higher quality asset than companies that are more expensive. I think it's a better inflation hedge than precious metals. The big question to me would be whether we overpaid if there's an extended period of deflation. But at least it would be far more likely to survive than something like XOM which has 3x its EBITDA in debt.

Texas Pacific Land has subsequently converted from a trust to a corporation, and has also greatly increased in price (increased 3.6x). The market capitalization is now $12.8 billion and the enterprise value is $12.3 billion. Second quarter 2022 net income was $118.9 million, or $15.37 per share, and adjusted EBITDA was $158.3 million. First half of 2022 net income was $216.8 million, or $28.02 per share, and adjusted EBITDA was $288.1 million. So the FCF/EV yield is 4.7% (based on first half results).

From their investor presentation: only about 12% of royalty acreage is developed with 20,000 gross undeveloped locations remaining. On their acreage, operators have 2,883 wells currently on production, 207 completed (but not producing), 452 drilled but uncompleted, and 480 that have been permitted. The 1,139 additional wells will drive quite a bit of cash flow when they come online. The company estimates that their acreage has 25 billion barrels of oil equivalent (gross). At a 4.4% average royalty, that would be 1.1 billion net barrels, an enterprise value of around $11 per barrel.

Another idea that we mentioned in that post was Royal Gold:

Royal Gold (RGLD) for $7.9 billion. A great business model - streaming/royalty interests on gold mines with no debt. Net income of $200 million for the past year is expensive, but it could/should grow as more mines come into production. (They have interests in 41 producing mines and 16 in development, plus more in the pipeline.) They do about 1 transaction a year but it's lumpy - they did none from 2006-2008 or from 2016-2018.

The market capitalization has actually fallen and is now $6.7 billion. They are debt free with cash of $280 million so the enterprise value is $6.4 billion. For the second quarter of 2022 they reported revenue of $146.4 million, operating cash flow of $120.2 million, and earnings of $71.1 million. On an annualized basis, the company is trading for 23x earnings (of $284 million) and an OCF/EV yield of 7.5%.

We mentioned Dorchester Minerals in that post too:

Dorchester Minerals LP (DMLP) for $358 million. They own producing and non-producing mineral, royalty, overriding royalty, net profits and leasehold interests. They have no debt. Net income for 1H 2020 of $10 million vs $28 million for 1H 2019. Prices were obviously down during the covid crash, and operators also curtailed production. They bought back some of their own units during April.

The market capitalization is now $1 billion. For the year to date 2022, they have earned $68 million and over the past two quarters (i.e. not counting January) they have distributed $65 million to unit holders. That is a distribution yield of 13% on the current market capitalization. See our past posts, "Is Dorchester Minerals LP Just a Depleting Asset?" and "Dorchester Minerals LP Retrospective".

We mentioned Marathon Oil Corp in a blog post in May of this year:

Marathon is an independent E&P company, based in Houston, with operations in the Eagle Ford, Bakken, STACK/SCOOP and Permian. It's a bit smaller than our Canadian oil majors - the market capitalization (at $27) is $18 billion and the enterprise value is $21 billion. [T]hey repurchased 3% of outstanding shares in one quarter. They're trading at 6 times annualized, adjusted net income, and the FCF/EV yield based on guidance for 2022 is 21%.

The market capitalization is down to $15 billion now and the enterprise value is $18.3 billion. They reported second quarter 2022 net income of $966 million, operating cash flow of $1,678 million, and free cash flow of $1,323 million. Their projection is $4.5 billion of 2022 free cash flow, assuming $100/bbl WTI and $6/MMBtu Henry Hub. (A $1/bbl change in WTI is ~$60MM of annual CFO, which would imply $3.9 billion at $90 WTI.) 

So they are now trading for less than 4 times annualized net income, and the annualized FCF/EV yield is currently 29%, and is likely still north of 20% at $90 oil based on their projections.

They have returned over $1.7 billion of capital to shareholders year-to-date. Over the past 10 months (since October 2021) they have reduced share count by 15%, and year-to-date they have reduced it by 7.3%. 

A great comment from the conference call:

We're trading at a free cash flow yield more than 25%, one of the lowest trading multiples in the entire S&P 500. We continue to believe that our equity is fundamentally mispriced. And as long as that's the case, we'll aggressively repurchase our stock. As I've said before, it's the best acquisition we can make.

We notice that their sales volumes are down 1% year over year from 348k boe/d to 343k. In general, oil companies are responding to their distressed valuations by using their cash flows to buy back stock and pay dividends, not grow production.

Saturday, August 6, 2022

Canadian Natural Resources Limited Announces 2022 Second Quarter Results ($CNQ)

[Previously regarding Canadian Natural Resources (CNQ) (one of the Canadian oil majors along with Cenovus and Suncor): Canadian Natural Resources Limited Announces 2022 First Quarter Results, Canadian Natural Resources Limited - Q4 and FY 2021 Results and Canadian Natural Resources Limited.]

Canadian Natural Resources (CNQ) reported results last week. Highlights from the results and conference call

  • Our second quarter financial results were very strong on the back of safe, effective, and efficient operations and a robust pricing environment, including a strong SCO premium to WTI. In Q2 net earnings were $3.5 billion and adjusted funds flow were $5.4 billion, allowing for significant allocation to shareholder returns through dividends and share buybacks, further debt repayment, and to the strategic growth opportunities, all providing long-term shareholder value. Returns to shareholders have been significant and increasing through 2022. As we have returned a total of approximately $6.4 billion to shareholders through $2.4 billion in dividends, and $4 billion through share repurchase equaling about 56 million shares year-to-date, up to an including August 3.
  • A substantial portion of our unique and diverse asset base consists of long life low decline assets which have significant, low risk, high value reserves that require lower maintenance capital than most other reserves, making Canadian Natural a truly robust and resilient energy company.
  • We continue to strengthen our balance sheet, having reduced net debt by approximately $1.4 billion in Q2/22, ending the quarter with approximately $12.4 billion in net debt. Returns to shareholders year-to-date in 2022 have been significant as we have returned approximately $2.4 billion through dividends and approximately $4.0 billion through share repurchases, for a total of $6.4 billion, up to and including August 3, 2022.
  • Our free cash flow allocation policy is unique in that shareholder returns are not impacted by strategic growth capital or acquisitions given our current net debt position is below $15 billion, and that our free cash flow is net of dividends. Through Q3/22, we will continue to target to allocate 50% of our free cash flow to share repurchases and 50% to the balance sheet.
  • Strong execution across the Company's operations year-to-date has resulted in substantial free cash flow generation driven by our top tier long life low decline assets with low maintenance capital requirements and our low cost structure. As a result, our financial position continues to strengthen, allowing for incremental returns to shareholders. Reflecting this, in August 2022, the Board of Directors approved an increase in returns to shareholders by declaring a special dividend of $1.50 per share, payable on August 31, 2022 to shareholders of record on August 23, 2022. This is a step towards the previously announced target to increase shareholder returns when net debt reaches $8 billion, which the Board of Directors see as a sustainable base level of corporate debt.
  • Year-to-date up to and including August 3, 2022, the Company has returned a total approximately $6.4 billion to shareholders through approximately $2.4 billion in dividends and approximately $4.0 billion through share repurchases via the cancellation of approximately 55.9 million common shares at a weighted average price of $71.47 per share.
  • Canadian Natural delivered record quarterly average natural gas production of 2,105 MMcf/d in Q2/22, increases of approximately 5% and 30% over Q1/22 and Q2/21 levels respectively. [...] As a result of the Company's diversified sales points, our natural gas production captured strong realized natural gas pricing of $7.93/Mcf in Q2/22, a 51% increase above Q1/22 levels and approximately 30% higher than the AECO benchmark price in Q2/22.
  • Canadian Natural had, as at December 31, 2021, the largest reported natural gas reserves in Canada with a proved and proved plus probable basis of approximately 12.2 Tcf and 20.2 Tcf respectively.
  • Canadian Natural has been a supporter of incremental pipeline projects, to ensure Canadian crude oil and natural gas can reach the world markets. It is important to have global market access to deliver the most responsible and leading ESG preferred barrels that the world needs. As per the latest public update provided by Trans Mountain Corporation on February 18, 2022, construction of the 590,000 bbl/d Trans Mountain Pipeline Expansion, on which Canadian Natural has committed 94,000 bbl/‍d, is targeted to be mechanically complete in Q4/23.
[Following figures in USD at an 0.774 exchange rate.]

The current market capitalization of CNQ (at a $52 share price) is $60 billion, and the enterprise value is $70 billion. With net earnings of $2.7 billion for the quarter, shares are trading for 5.5 times annualized earnings. The adjusted funds from operations of $4.2 billion for the quarter is an annualized AFFO/EV yield of 24%. For the year-to-date 2022, EBITDA of $8.8 billion less capex of $2.1 billion gives free cash flow of $6.7 billion, for an annualized FCF/EV yield of 19%.

CNRL proved reserves of liquids at the end of the 2021, net of royalties, were 9 billion barrels, calculated based on a $66 price for WTI. You are paying less than $8 per barrel of proved reserves of liquids at the current share price, not counting the 12 trillion cf of natural gas reserves. 

The PV-10 of proved reserves at the end of 2021, again assuming a $66 oil price and a $3.70 Henry hub natural gas price, was $65 billion at the end of 2021. With the share price decline since we posted last quarter, the enterprise value is now under 1.1x the present value of the proved reserves.

The difference between Canadian Natural Resources and our other Canadian majors (Cenovus and Suncor) is that CNRL does not have any refining or retail businesses, although they do upgrade the bitumen produced by their oil sands. Also, while they are an oil sands producer, both by mining and in situ extraction, they also have assets in the U.K. North Sea and Africa offshore (Côte d'Ivoire), plus conventional oil and gas production in Canada, including much more natural gas production than the other two companies. 

Remember what it is that we like about royalty trusts and long reserve life, slow decline Canadian oil companies. They both avoid the principal-agent problem that afflicts other types of oil and gas producers with small amounts of reserves that need to be replaced often in order for managements to keep their jobs. Those companies have a poor track record of creating long term value for shareholders because management's incentives are bad. They need to buy assets to keep their companies from liquidating (and losing their jobs), but they only have the money to buy assets at the top of the cycle when properties are expensive. The companies that fracked for shale over the past decade managed to transfer almost all of their investors capital (both equity and debt!) to sellers of land and service providers.

Suncor Energy Reports Second Quarter 2022 Results ($SU)

[Previously regarding Suncor: Suncor Energy Reports First Quarter 2022 Results, Goldman Sachs on Suncor and Cenovus, Canadian Oil Sands Earnings (Suncor and Cenovus) - Q4 2021, Suncor Energy Inc..]

Suncor Energy (SU) reported results last week. Highlights from the results and conference call (note that these figures are Canadian dollars, but we will translate to USD for discussion at the end):

  • Driven by a strong business environment, Suncor generated record adjusted funds from operations of approximately $5.3 billion, or $3.80 per common share, in the second quarter of 2022, as we executed planned maintenance across our asset base," said Kris Smith, interim president and chief executive officer. "Our confidence in our business and expected annual cash flows enabled us to return approximately $3.2 billion of value to our shareholders, which includes both the highest dividend per share and highest rate of share repurchases in the company's history.
  • Adjusted funds from operations increased to $5.345 billion ($3.80 per common share) in the second quarter of 2022, compared to $2.362 billion ($1.57 per common share) in the prior year quarter. This was the highest in the company's history, exceeding the prior per share quarterly record, from the first quarter of 2022, by 33%. The company's net earnings increased to $3.996 billion ($2.84 per common share) in the second quarter of 2022, compared to $868 million ($0.58 per common share) in the prior year quarter.
  • For the second consecutive quarter, Oil Sands delivered record adjusted funds from operations of $4.231 billion in the second quarter of 2022, compared to $1.844 billion in the prior year quarter, driven by significantly higher price realizations. Production from the company's Oil Sands assets increased to 641,500 barrels per day (bbls/d) in the second quarter of 2022, compared to 615,700 bbls/d in the prior year quarter, due to increased production at Syncrude and Fort Hills in the current period, partially offset by the impact of maintenance activities at Oil Sands operations, including the largest turnaround in Firebag history, which was completed subsequent to the quarter.
  • Refining and Marketing (R&M) generated record adjusted funds from operations of $2.127 billion in the second quarter of 2022, compared to $677 million in the prior year quarter. In the second quarter, refinery utilization averaged 84% and crude throughput was 389,300 bbls/d, compared to 70% and 325,300 bbls/d respectively in the prior year quarter. Solid utilizations in the current quarter outside of planned turnaround activities allowed the company to capture significant benchmark crack spreads and refining margins. Following the completion of planned turnaround activities, the company's refineries exited the quarter with an average refinery utilization of over 100%.
  • In the second quarter of 2022, Suncor continued to deliver on its strategy of growing shareholder returns, returning record value to its shareholders of approximately $3.2 billion, through approximately $2.6 billion in share repurchases and the payment of $657 million of dividends. Both the dividend per common share and the rate of common share repurchases during the quarter are the highest in the company's history. As at August 2, 2022, since the start of the year, the company has repurchased approximately $3.9 billion of Suncor's common shares, representing approximately 88.5 million common shares at an average share price of $44.40 per common share, or the equivalent of 6.1% of its common shares as at December 31, 2021.
  • The company has also made disciplined decisions to adjust and streamline its portfolio to enable a greater focus on its core business, to safely increase the reliability, utilization and integration of its assets while continuing efforts to sustainably reduce controllable costs. In the first six months of 2022, the company announced that it was taking steps to optimize its asset portfolio through the planned divestment of its E&P assets in Norway and its wind and solar assets. Subsequent to the second quarter of 2022, the company reached an agreement for the sale of its Norway assets, pending regulatory approval, for gross proceeds of approximately $410 million (Canadian dollar equivalent), before closing adjustments and other closing costs. The sale is expected to be completed in the fourth quarter of 2022, with an effective date of March 1, 2022. The sale process for the company's wind and solar assets is progressing, with a sale expected to close early in 2023. Based on interest received in the company's E&P assets in the U.K., the company has also commenced a sale process for its entire U.K. E&P portfolio.
  • Suncor will also be undertaking a strategic review of its downstream retail business with the goal of unlocking shareholder value. With the support of external advisors, this review will evaluate and consider a wide range of alternatives, from a potential sale of the business to options to enhance the value of its retail business.
  • With the company's confidence in its expected cash flows, the current business environment and expected proceeds from the dispositions of assets, the company expects to achieve the lower end of its 2025 targeted net debt range of $12 billion during the second half of 2022. Once net debt has been reduced to $12 billion, the company expects to allocate 75% of excess funds towards share buybacks and 25% towards debt repayment. Once the company's net debt balance is at its $9 billion floor, the company expects to allocate excess funds fully towards shareholder returns.
  • [Why is $9 billion the hard floor for net debt? Why is that the right number?] That's a good question, Doug. If you actually look at it in a low commodity price environment, and we're using $35, $40 WTI, if you look back at our history, we generally have made around about $6 billion of cash flow in that environment. The commodity price, much lower crack spreads. So the $9 billion is derived from one and a half times coverage on -- we would be one and a half times our cash flow at $9 billion.

[Following figures in USD at an 0.774 exchange rate.]

The market cap of Suncor is $42 billion and EV is $53 billion. With net earnings of $3.1 billion for the quarter, shares are trading for 3.4 times annualized earnings. The adjusted funds from operations of $4.1 billion for the quarter is an annualized AFFO/EV yield of 31%.

Suncor's proved and probable reserves are 5.8 billion barrels, so that's an enterprise value of $9 per barrel. The PV-10 of their proved and probable reserves was $50 billion at year-end 2021, which was calculated based on the $66.56 average WTI price last year. That means the present value of the reserves at a much lower oil price than current WTI covers almost all of the current enterprise value and puts a $3 billion enterprise value on the refining and marketing operations which earned $2.2 billion after tax in 2021 (and $1.6 billion this quarter).

Valero and Magellan Midstream on refined product demand

The Biden administration is claiming that refined product demand in late July was lower than in July 2020... here's what Valero (2nd largest refiner in the U.S.) has to say about it:

Manav Gupta -- Credit Suisse -- Analyst
Guys, I would actually ask only one question, and that is basically, can you help us understand the demand dynamics out there, there were some worries on demand destruction than there were some worries on recessionary demand. The conversations we are having indicates that's not the case, but you have the most diversified footprint. So help us understand gasoline or diesel, what are you seeing in terms of demand out there? And I'll leave it there. Thank you.

Gary Simmons -- Executive Vice President and Chief Commercial Officer
Manav, this is Gary. I can tell you through our wholesale channel, there's really no indication of any demand destruction. In June, we actually set sales records. We sold 911,000 barrels a day in the month of June, which surpassed our previous record in August of '18 where we did 904,000 barrels a day.

We read a lot about demand destruction, mobility data showing in that range of 3% to 5% demand destruction. Again, we're not seeing it in our system. We did see a bit of a lull in the first couple of weeks of July, but our seven-day averages now are back to kind of that June level, with gasoline at pre-pandemic levels and diesel continuing to trend above pre-pandemic levels.
And Magellan Midstream (54 refined product terminals in 15 states):
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.
We'll see who's right.

Note that when fuel prices spiked in June, the EIA did not publish their data for two weeks because of a "voltage irregularity," and once publication resumed after this "pause," the data has no longer seemed congruent with what other sources are reporting.

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.

Thursday, August 4, 2022

Thursday Night Links

  • When Cleveland-Cliffs acquired AK Steel in March of 2020, AK Steel, as a stand-alone company, was ready to walk away from electrical steel. It was ready to shut down Butler Works in Pennsylvania. Butler Works produces electrical steel, a type of steel used to make transformers. If AK Steel had done that as a stand-alone company, today the U.S. would not be able to produce any grain-oriented electrical steel for transformers or nonoriented electrical steel, among several other things. That was the scenario that I inherited at Cleveland-Cliffs, as far as electrical steel goes, when we acquired AK Steel. Then, I made the decision not to shut down Butler Works, and now Cleveland-Cliffs is the only producer of grain-oriented steel products in the U.S. [S&P Global]
  • The cost of "renewable" energy technologies like solar, wind, and batteries was falling because we were in a commodity bear market (2008-2020) with the necessary materials being sold below the long run sustaining cost of production. If someone had actually disrupted gasoline/ICE vehicles, or fossil fuels, you would have heard about it by now. There is nothing better than petroleum for transportation fuel. (Nuclear is better than fossil fuels for generating electricity, but that doesn't work for transportation without better batteries.) That means we are probably going to be using it for a long time - probably until it is exhausted. Royalty trusts are yielding 15% and the EV/FCF on Canadian oil producers is north of 20% while Biden is dumping a million barrels a day oil from the SPR and the industry is drawing down its backlog of drilled uncompleted wells. This is perhaps the greatest mispricing we have seen since we started this blog. [CBS]
  • Separate from science and policy, a slew of sober influencers and self-help books emerged during the late 2010s. First came “This Naked Mind” by Annie Grace in 2015. “The Unexpected Joy of Being Sober” by Catherine Gray followed in 2017. Then, in late 2018, Ruby Warrington published “Sober Curious,” coining a term for the movement and giving people a new way to talk about what they were experiencing, a different path from declaring their problem drinking to be “alcoholism.” (I use “alcoholism” in quotes here because alcohol use disorder is the clinically preferred term now.) The following year, Holly Whitaker published a more pointedly anti-alcohol book, “Quit Like a Woman,” in which drinking is portrayed as useless, toxic and anti-feminist. Whitaker went on to publish an opinion piece in the New York Times with a headline that dismissed Alcoholics Anonymous as “The Patriarchy” and then raised millions to create Tempest, an online alcohol-counseling service geared toward women that costs $59 per month. All of this messaging seems to be having an effect. In 2017, wine consumption shrank for the first time in more than two decades, and in 2021, according to a Gallup survey, just 60 percent of Americans reported drinking any alcoholic beverages, down from 65 percent in 2019 and tied for the lowest level in two decades. Not only are fewer adults drinking, but those who do are consuming less. In the same Gallup survey, Americans who drink said they consumed 3.6 drinks per week, the lowest level in 20 years. Google searches for the term “nonalcoholic” rose in both 2021 and 2022. Each year millions of Americans participate in Dry January. [WaPo]
  • Our investment case on Altria is based on the continuing ability of its cigarette business to deliver on its traditional earnings algorithm, which includes: A low-to-mid single-digit annual decline in cigarette volumes, A mid-to-high single-digit annual rise in average cigarette prices, Together these give a low-single-digit annual growth in revenues, Revenues After Excise tend to grow even faster as excise growth lags, EBIT margin expands with higher unit price and operational savings, Including buybacks, EPS tends to grow at mid-to-high single-digits. At $44.00, Altria shares are trading at a 9.3x P/E and a 10.7% Free Cash Flow ("FCF") Yield (normalized). [Seeking Alpha]
  • The Two-Income Trap: Why Middle-Class Parents Are (Still) Going Broke (2/5) Based on the title, I thought that Pocahontas understood the two income trap. Unfortunately, her book does not discuss positional goods or the way that oligarchs profit by flooding the country with cheap labor, driving up rents and land values and driving down wages. She recognizes that there is a bidding war - now recruiting two parents' incomes - for houses in "good" neighborhoods with "good" schools, but she is either lying or ignorant about what makes them "good." Everything she talks about is better understood by Steve Sailer or LoTB. [CBS]
  • “One way to interpret the results is to think in terms of the equilibrium cost of capital. Firms with such a bad ESG rating that they are excluded from the GPFG may be facing an uphill struggle in raising capital for new investments. They, therefore, have to offer higher returns to the investors willing to ‘dirty their hands’ by providing capital. From society’s point of view, this is a good thing, the higher capital cost will actively discourage investment in low-rated ESG projects, as fewer projects will be able to sustain such high returns. [Alpha Architect]
  • “We live in a swamp”, my wife says to me our 2nd month living in Florida. The moisture and environment is so oppressive. Roaches, mosquitos, 2 feet of leaves in the side yard, constant barrage of rain that brings mildew, algae, and mushrooms in the most surprising places. 500 tadpoles have taken up refuge on one of our side roads in the standing water. Hopefully they eat mosquitoes. The constant barrage of carpenters, painters, and pressure washing just to keep nature at bay. Saw DeSantis at my local FBO my first for fun flight after arriving. Not all bad I guess. [Phil G]
  • Why don’t you start a self-experiment, and refrain from reading sports, politics, business, and technology news as much as possible for a while? Reduce your smartphone time drastically for one or two weeks, and enjoy the time gained with a good book, a personal conversation or dare to do a previously abandoned activity that has been left undone so far (due to a perceived lack of time…) [Gernot Starke]
  • Someone beat me to the punch in coining the phrase re-nicotization, but I am happy to embrace it. I first heard the term here. The thought process is simple and works along the lines of: Humans, historically, embrace substances to enhance/alter how they think and feel. Awareness of the negative health consequences of smoking paired with certain regulations is reducing smoking rates. What would happen if people could easily access nicotine while avoiding many of the health concerns as well as social stigma? If you conclude nicotine usage would increase, you are correct. [Devin LaSarre]
  • The magic trick in any environment where you're asked to bet on confidence intervals—especially an adversarial one where someone is either testing your skills or trying to make money from betting with you—is that your confidence intervals should be much wider than you'd intuitively think. [Byrne Hobart]

Monday, August 1, 2022

Tobacco Earnings - Q2 2022 ($MO $BTI $PM $SWMAY)

Tobacco stocks had a bit of a rough quarter and have had a rocky year so far. Altria fell from a 52 week high of almost $56 to as low as $41, but has recovered to about $44. Philip Morris collapsed from a 52 week high of almost $110 when Russia invaded Ukraine, almost got back there in late May, but took a tumble as well. British American Tobacco was affected by Russia/Ukraine exposure as well, and had a particularly ugly day this past Friday.

We don't care so much about the share prices, we care about how the businesses are doing and what kind of owner earnings and dividends we will be receiving. Maxim: "share prices are more volatile than corporate cash flow, which is more volatile than asset replacement cost." So, let us take a look at the product sales and earnings for our four companies.

British American Tobacco

British American Tobacco (previously) sells cigarettes (Camel, Lucky Strike, Newport, American Spirit) and "New Categories" (safer nicotine) products: the Vuse vape, the Glo heat not burn product, and Velo "modern oral" nicotine pouches. The safer nicotine products grew revenue 45% for the first half of 2022 vs 2021, and now represent 15% of total revenue. The biggest contributor is the Vuse vape product, responsible for about half of total new category revenue. Also notice that new category revenue was up more than volumes meaning that these products have pricing power. (But note that the reduced risk product category is not making money yet - the new category segment lost about $300 million the first half of 2022.)

In the U.S., the new category revenue was up 70% (1H 22 vs 1H 21), and that is almost entirely from the vape product. (Re-nicotinization! The concept is taking off.) Also noteworthy, the U.S. cigarette volumes were down 13% but revenue was still up 3% (though down 3.4% in constant currency). Overall, profit was up 9% in the U.S. and operating margin here improved slightly to 47%. Here is what management said about its U.S. vaping regulatory progress:

In May 2022, we were delighted to receive Vapour marketing authorisations for Vuse Ciro and Vibe in original flavour from the FDA. Together with our Vuse Solo authorisation from last year, this gives the Group the broadest portfolio of market authorisations provided to any vapour company in the U.S., and we believe it also supports further confidence in our Vuse Alto Premarket Tobacco Product Application (PMTA), which shares the same foundational science. Subject to the ongoing FDA discretion, all Vuse products currently available in the U.S. may continue to be marketed.

BTI had a market cap of $92 billion and net debt of $50 billion dollars for an enterprise value of $142 billion. During the first half of 2022, BTI generated about $5.2 billion of cash flow and returned $4.5 billion to shareholders. If you annualize that, it is a cash flow yield on the enterprise value of about 7%. The earnings multiple on the stock will of course be more attractive than this because of the leverage, probably about 10x or just below.


Altria (previously), of course, sells Marlboro cigarettes, Copenhagen and Skoal oral tobaccos, the On! nicotine pouch, and owns 35% of Juul, 10% of BUD, and 45% of Cronos. 

During the second quarter, Altria's smokeable products segment reported domestic cigarette shipment volume decreased 11.1%. That is a bad decline, but it was during the quarter with sky-high gasoline prices. Also, revenues net of excise taxes were only down 0.7% and the operating income for smokeable products was only down 0.5%. (It was $2.76 billion for the quarter and $5.3 billion year-to-date.) The smokeable operating margin is 59%.

Selling Marlboros in the U.S. is still a business that makes close to $11 billion a year pre-tax. Altria's market capitalization is $79 billion and enterprise value is $108 billion. The market cap of BUD is $92 billion, which is $9.4 billion for Altria's stake. If you adjust for that the MO market cap is $70 billion and the EV is $99 billion. So the valuation for the tobacco/nicotine business is currently about an 11% FCF yield on the EV, and about 8 times earnings. (And that is ignoring whatever value Juul and Cronos may have.) (Their guidance is for 2022 full-year adjusted diluted EPS in a range of $4.79 to $4.93, which would be a 9x P/E on the low end.)

Oral tobacco (which inclides on!) made $430 million in Q2 and $837 million YTD. Altria paid $11.7 billion for U.S. Smokeless Tobacco in 2008 and also got Ste. Michelle Wine Estates, which they sold for $1.2 billion last year. It was a great acquisition

What is sad is that the failure of the panicked, desperate investment of $13 billion in Juul at a $38 billion valuation has made them shy about strategic investments. I thought that Altria could and would buy Swedish Match:

If Juul's PMTA is approved, it makes sense for Altria to take-under the remaining Juul stake that it doesn't own, possibly structuring the transaction in a way that sheds the startup-era liabilities. (Maybe a bankruptcy or purchase an exclusive license of Juul combined with a sale of their minority stake back to the company for $1 to realize the tax loss.)

Altria should reunite with Philip Morris, and together they should buy Swedish Match. Together they would have the #1 cigarette (Marlboro), #1 closed tank vape (Juul), #1 oral nicotine lozenge (Zyn), #1 snus (General), #1 heat not burn tobacco product (IQOS), and the #1 and #2 dipping ("moist snuff") tobaccos (Copenhagen / Skoal).

And then... no more acquisitions! All that cash flow could roll on home to shareholders.

But as is often the case, after making one type of error (of commission), they proceed to make the inverse type (of omission). They are letting Philip Morris steal Swedish Match, which would've been a great acquisition in its own right, and a blocking move against PM, who want to take away distribution for IQOS from Altria and use the network Swedish Match has built up in the U.S.. Altria isn't even lobbing in a bid to make it more expensive for PM!

Altria's on! product is junk, so their only hope of being involved in re-nicotinization is to get PMTA approval for Juul. (Which is a great product.) The good news is that at the price we are paying for MO, we should do OK even if none of the reduced risk bets work out and we just get the tobacco earnings runoff. It is also interesting that tobacco gets hurt when oil prices squeeze and will presumably benefit in Q3 now that oil has fallen - it diversifies the energy portfolio.

Philip Morris

Philip Morris (previously) reported cigarette volumes up 1% in Q2 versus the prior year and heated tobacco units up 1.9%. (These numbers are dragged down by the loss of Russia and Ukraine business.)

Net revenues for the quarter were flat at $7.8 billion and operating income was down 2% at $3.1 billion. Note that the E.U. region contributes half of PM operating income ($1.55 billion) and the next largest, Middle East & Africa, contributes $500 million.

The current market capitalization at $99 per share is $153 billion, and the enterprise value is $178 billion. During the first half of this year, the company has generated about $4.8 billion of free cash flow. (And has returned $4 billion to shareholders, mostly through dividends.) This is pretty consistent with our past thinking of $10 billion of free cash flow for the year. (Current management guidance is $10.5 billion for this year.) 

That puts PM at a FCF/EV yield of 5.6%, noticeably more expensive than BTI or MO. The valuation premium exists because PM has a cigarette business that is still growing volumes, has a strongly growing reduced risk business (revenue up 10% over last year), is more geographically diversified, and in recent years has allocated capital better than Altria. You'll notice that when the regulatory capture revolving door swings, PM is where you go:

A Food and Drug Administration official with considerable power over authorization decisions for e-cigarettes and products aimed at curbing smoking resigned on Tuesday to work for Philip Morris International, the global tobacco conglomerate and maker of Marlboros.

The official, Matt Holman, was chief of the office of science in the agency’s Center for Tobacco Products. In a memo to the staff on Tuesday, Brian King, the center’s director, wrote that Dr. Holman had announced that he would be leaving — effective immediately — to join Philip Morris. The memo said Dr. Holman had been on leave and, consistent with agency ethics policies, had recused himself from all tobacco center work “while exploring career opportunities outside of government.”

An example of the great capital allocation is the purchase of Swedish Match. While I suspect that they are going to have to raise their bid, they're probably going to pay on the order of what Altria paid for just a 35% stake in Juul, and get whole ownership of a business that earns $643 million net, growing at a double digit rate.

Swedish Match

Swedish Match (previously) reported smokefree sales up 29% in the second quarter, with revenue in the US up 26%. We had called Swedish Match our "growth stock," and it looks as though it is going to be stolen from us too soon. (CBS: "Our style of value investing rarely buys hockey stick growth, but here is hockey stick growth available for 18x earnings.") 

As most are already aware, Philip Morris reached a deal to acquire Swedish Match for SEK 106 per share. (That is USD $10.47, a market capitalization of $16 billion.) While we think that PM will have to up their bid, it appears likely that this business is going to go into the PM fold, where it will contribute to profits and be used as a battering ram against Altria's on! and as a backdoor to distribute IQOS in the U.S. without Altria. Also disappointing that the Swedish Match board didn't negotiate for PM stock - we would rather be able to roll the exposure into PM tax-free.

Swedish Match was a great investment but it is also interesting because of what it is saying about re-nicotinization. Given a safe way of dosing nicotine (such as an oral pouch with no tobacco leaf carcinogens), thoughtfully designed with good user attributes, lots of people who were never smokers are going to want to use nicotine for a mood/productivity boost. (See Tucker Carlson and Edward Luttwak.) From the Q2 call:

[T]he nicotine pouch category is rapidly growing relative to cigarette. Measured by volume and according to IRI data, and we make 1 can of nicotine pouches equivalent to 1 type of cigarettes, nicotine pouch volume for the year-to-date period was well above the 10% benchmark in the west and exceeded 4% on a national level. Based on indications of average weekly consumption levels for consumer ranging from 2 to 3 cans, our estimate of the number of ZYN users relative to the number of cigarette smokers on a national level is in the range of 5% to 7%.

The FDA is attempting to stand in the way of beneficial re-nicotinization, just like they are constantly gunning for our OTC supplement regimens. But in a sclerotic country, it may be good to bet on regulatory capture and the status quo prevailing.