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.

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.