JotCast | Energy & Income Advisor Live Chat June 2020

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Energy & Income Advisor Live Chat June 2020

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Roger Conrad

2:00

Welcome everyone to this month's Energy and Income Advisor live chat. As usual, there is no audio. Just type in your questions and Elliott and I will get to them as soon as we possibly can. We will keep the chat open as long as there are questions in the queue, or yet to be answered in emails we received prior to now.

2:01

There will also be a complete transcript of all Q&A published shortly after we conclude the chat. You'll be sent a link to the document, which will also be posted on the EIA website.

2:02

By way of introduction, I hope everyone has had a chance to check out the current issue of EIA that posted yesterday. It's been interesting times for the energy sector but our long view has shifted increasingly bullish the past couple months. And our focus remains on bringing you the best in class companies up and down the energy value chain.

2:04

Q. Roger and Elliott. Some of your recommendations confuse me.

1. Enterprise Products Partner’s (NYSE: EPD) yield of 10% is ludicrous if they are as strong as you insist. Is it time to "back up the truck?" I know you advise never overloading on anything, but one cannot achieve superior performance by being "average". If EPD can keep paying their current dividend, I don't care if it takes doubters 10 years to get the price back up to your suggested buy price of "up to 33".

2. I too was "Kindered", but over many, many years, KMP/KMI has been profitable for me when I listened to you. Isn't KMI another EPD? A "dream price" of 15 must assume a complete reversal of fortune. Is the consistent insider buying for real or some sort of Rich Kinder PR to hype the price? I seem to remember Jon Frederickson buying SDRL all the way down the drain. (Thank God you got me out of that one in time!)

3. Why are you so negative on BEP, even as you keep it on your buy list, but with a collapsing dream price of 25 (and a top b

buy price of 35) when the shares stay consistently in the high 40's? It can't be currency risk, since your dream price on PBA is more in line with its current price.

Thanks as always for answering questions.—Ken V.

A. Thanks as always for your questions Ken. We fully agree that Enterprise’s 10 percent yield is extreme in light of the company’s strong market position facilitating US energy exports, particularly natural gas liquids that are cheap and abundant in this country. Today in fact management announced a long-term agreement to supply Marubeni Corp with polymer grade propylene from a new facility that will begin service in Q2 2023.

2:05

As we wrote in the EIA issue that posted this week, Enterprise has traded at this level of valuation before. And those entering at these levels have historically enjoyed a windfall at most 2 to 3 years later. Our view is that there are several other midstream companies that should do the same, and that it makes more sense to diversify funds between them rather than load up on one name.

A good example of another in fact would be Kinder Morgan. Yes there are examples of CEOs buying their companies’ stocks all the way into bankruptcy. FerrellGas Partners looks like it might be almost there, though the Ferrell family has remained supportive. Even the greatest skeptic, however, would have a hard time making the case Kinder is heading there.

We’ll get another progress report when management issues Q2 results on or about July 17. But recent share price action notwithstanding, this company is covering the sum of CAPEX and dividends comfortably with free cash flow. And from all indications, its portfolio is perfor

performing well and the shares look cheap to us.

Finally, we remain cautious on Brookfield Renewable Partners because of valuation. At our highest recommended entry point of 40, it would yield of roughly 5.4%, which with a sustainable mid-single digit payout growth rate would be attractive. At the current price of around 48, the yield is only about 4.5%.

It’s fair to ask why we don’t raise the highest recommended entry point, given shares have traded above it for a while. And as they raise the dividend and grow the business—which is what we expect—we will do so. On the other hand, this a business that grows as management adds new contracted renewable energy generation. And that process is only sustainable if Brookfield is opportunistic and doesn’t try to force transactions.

We’re encouraged the company has resisted that temptation consistently. But in our view, the current price reflects expectations of better numbers than management may deliver in this environment. And while investors are pretty excite

d about renewable energy now, emotions are obviously fickle. And Brookfield did give everyone an opportunity to buy well below 40 earlier this year. This is a market that rewards patience.

2:06

Q. I was rather disappointed by ONEOK’s (NYSE: OKE) recent decision to sell additional shares of stock at a significantly lower price than it was selling at the time. It was also selling for less than half the price it was selling at just 4 months ago before the virus related shutdown. Does that make sense to you? With its stock price low, and interest rates very low, wouldn't it have made more sense to sell bonds, rather than issue stock? It's causing me to question the company's judgment. Your thoughts? Thanks.—Jack A.

A. You weren’t alone in being disappointed. I think it’s likely the investment banks handling the sale (Barclays, JP Morgan, Citigroup, Bank of America, Credit Suisse, Wells Fargo) were also surprised at the sudden negative market reaction to the announcement, which took the shares down from nearly $50 earlier this month to the current low 30s price.

That said, a couple of things are worth pointing out. First, while the selling price for the 29.9 million share offering was $32—and $10 below the initial target of $42 just a few days before—management made the decision to sell stock when the share price was upper 40s, and more than four times the mid-March low.

If anything, I would blame the lower price on poor luck and questionable execution by the investment banks. Mainly, the offering was announced the same day as the S&P 500’s biggest decline since mid-March.

But in any case, they still got a price roughly three times the low, so not a total loss. And this equity raise does keep ONEOK solidly investment grade, while arguably further protecting the dividend against an uncertain outlook in the Bakken.

ONEOK is expected to release Q2 results on or about July 30. Before that on July 22, it’s projected to declare its dividend for payment in August. Both will give us a further window on how this midstream company is faring in this industry crisis. Note that management did present to the JP Morgan Virtual Energy Conference following the equity issuance and basically stuck to previous guidance.

As we said in the current EIA issue, the Great North American Midstream Shakeout we first flagged about a year ago was accelerated greatly by the combination of Covid-19 fallout and the Saudis ramping up of output this spring. We’re convinced ONEOK is a survivor and are staying with it, at least until developments give cause not to.

Q. Elliott and Roger. Thank you for all the work you do in bringing us your guidance on the energy industry, corporations and MLP’s. Can you give us your thoughts on the quantum glass battery and whether you think it will be as efficient as claimed? Could you also give us some thoughts on the company that owns the most patents on this item for a possible investment too. It would be most appreciated.—Ron H.

A. Ron, a lot of money is being spent right now on battery technology to improve efficiency, life and charging capability. But while it’s easy to see the potential applications—from industrial uses to power grid level storage and electric vehicles—history shows that at this stage of development it’s very difficult to pick winners as far as technology.

It is a pretty high percentage bet that there will be more production of batteries going forward. But really the best that small developers can hope for is to be bought by a major company that has the market reach and deep pockets to roll out whatever it is on a massive scale. And at some point it becomes impossible for a new technology to dislodge one that’s already established and growing rapidly like lithium ion in batteries—unless it’s truly revolutionary.

When we hear about a technology with potential industry disruption capabilities, we have several questions. First, what does it purport to do and does it provide a large enough improvement for users of what it would replace?

2:07

Promised efficiency gains are obviously important. But at a time when businesses are really watching CAPEX, cost savings are likely to be even more so. And the benefit of adoption has to be weighed against the cost of businesses not changing anything, or even just postponing a decision to adopt until the economics improve.

Second, how long will it take for this technology to create a product that can be easily adopted by consumers and businesses? In the case of batteries, how does the time to development for weigh against the innovations on cost and efficiency being pursued by rivals—in this case the 20 largest producers of lithium ion batteries, which include the giant Chinese companies that lead the world in scale.

Third, does the developer have the deep pockets behind it to take the technology from the laboratory to commercial production where it can compete in the marketplace? The annual ARPA-E conference highlights literally hundreds of new energy technologies in development phase every year, with batteries a popular subject in recent years. The vast majority, however, encounters enormous hurdles making the needed jump in scale. And as a result, they lose out to others.

Finally, the march of technology especially in something like batteries is continuous, mainly because it’s such a huge potential market. That means there’s always another promising development coming along.

Bottom line is we’re always going to be in the skeptics camp when it comes to new technologies, unless it meets the hurdles of superior efficiency/cost, time to development and deep pockets—preferably in the form of a strong partner. And as far as investing goes, we’re going to be a lot more excited about something a company can adopt that will m

ove the profit meter this year, or at least sometime in the next 2 or 3.

Q. Gentlemen. I’m curious. Why is TC Energy (NYSE: TRP) so much favored in investment circles such that its’ dividend is 5% vs 7.5% for Enbridge Inc (NYSE: ENB)? They are both well-diversified Canadian heavyweights. Perhaps TRP has a slightly better balance sheet, bond rating, and dividend safety? Nonetheless, TRP seems to be greatly favored over ENB. What gives?--David O.

A. Actually, on a forward earnings basis, Enbridge draws the higher valuation of 16.5 times expected 2020 results versus 14.5 times for TC, formerly known as TransCanada. Both of these stocks are being affected by prospects for major pipeline projects. For TC it’s Keystone, which is hung up in the courts. For Enbridge, it’s completing Line 3 in Minnesota and to a lesser extent winning approval from Michigan regulators to revamp its Line 5 oil pipeline.

2:08

We believe both of these companies will be able to continue to grow cash flow and dividends going forward without these major pipelines. And we believe both of these stocks are attractive buys at current prices as well. As for why TC would yield less than ENB, one reason is a slightly higher credit rating. Another would be a higher payout ratio—66.9% in Q1 versus about 42% for TRP, which means TRP has slightly more latitude for increases.

Q. Gentlemen. Thanks, as always, for hosting these chats. I like a lot of the midstream companies in the Model portfolio, and would like to put some money to work. I feel that, from a long-term perspective, prices look fairly cheap. Thus, for me the difference in these stocks comes down to growth potential over the intermediate term. Which of the Model portfolio stocks do you feel have the most price growth potential over the next few years as crude prices get in the mid 40s (i.e. over about 2 years)? Thanks for the great work!—Michael L.

A. Great question. If you’re talking purely about midstream companies and MLPs, the highest quality have historically benefitted first when the cycle turns back up for good—which we believe will be confirmed by stabilization of oil prices in the 40s, and we may be seeing now.

Basically, that level of oil prices—and commensurate levels of NGL prices—will differentiate the business performance of the best-run, best-diversified midstreams with strong balance sheets from the rest of the industry.

We continue to believe there are too many owners of midstream infrastructure in the US and that most are not capable of surviving a sub-$50 oil price environment the next couple years, mainly because their producer customers won’t be. They will eventually have to sell to the stronger players, which will eventually reduce competition for capital as well as new business.

Proving resilience will enable the strongest players to separate themselves from the pack. And our top candidates are Enterprise as mentioned above, along with other portfolio fare like Hess Midstream (NYSE: HESM), Magellan Midstream Partners (NYSE: MMP) and TC Energy. For more on midstream, see the current EIA issue.

2:09

Q. Hi Roger and Elliott! I always stick to the conservative recommendations and I know that just because an investment is conservative doesn't mean it will always stay that way... But, what is changing in your view of High Yield Energy List member OKE that caused you to change its classification from conservative to aggressive in the most recent issue? Thanks, Marty L.

A. Basically, it was the sudden negative impact of Covid-19 fallout and the Saudis’ oil ramp up on North American shale, which dramatically shifted drilling economics in many parts of the country. That’s greatly increased uncertainty for oil and gas production in areas where it didn’t appear to be greatly at risk last year, and by extension it’s decreased visibility of cash flows for several midstream companies that also didn’t appear to be at risk.

One of those is ONEOK, which is at risk to potential cuts in output from the Bakken. Management has been steady with guidance. Q1 was better than expected and there’s no reason to expect Q2 results expected July 30 will reveal any glaring weakness either. But circumstances have increased uncertainty and therefore risks, so this company cannot currently be called a conservative recommendation.

Phil

2:19

British Petroleum has recently announced that it will take a $17.5 billion charge as a result of changing its assumptions about average oil prices going forward, which is likely to make some of its oil prospects uneconomic to exploit. Royal Dutch Shell has also indicated that it will take a $15+ billion charge for the same reason. Both have also linked this decision to their intentions to pursue a more green future. Could you please comment on the implications of such corporate thinking for investment decisions in the oil patch more generally. Isn't this likely to influence investors to consistently shy away from the oil sector, much as we have seen in the coal sector? Will it no longer make sense to pursue a buy-and-hold strategy for oil shares but rather to expect to have to engage in more short-term trading, if not to avoid the sector altogether?

Elliott Gue

2:19

In my view, the more important impact of these shifts is the billions in capital spending (CAPEX) underinvestment in upstream oil and gas developments around the world, particularly for the sort of long-cycle investments that have traditionally been the province of the large integrated oil companies. The issue is that, due to the record-setting decline in CAPEX over the past 5 years, there just aren't many new projects coming onstream in the next few years to offset declining production from existing projects. Over time, that means we'll see an acceleration of the base decline rate for global oil production. With demand weak now, that has little or no impact but I think that over the next 2 to 3 years you'll see supply-shortage driven spikes in oil prices. It's one reason we like XOM, which is nearly unique among the majors in following a growth strategy. I don't think the comparison to coal is relevant because you can easily substitute natgas for coal while there is no practical scalable substitute for oil.

Roger Conrad

2:23

Q. Roger. Would you comment on current thoughts re Tesla Energy and Tesla Inc (NSDQ: TSLA) in general.—John C.

A. Bold statements are one thing. Concrete actions are another. Elon Musk’s companies have some noteworthy accomplishments, such as Space X rockets and arguably the leading global brand name for EVs. But the record in electricity has fallen well short of the rhetoric, starting with SolarCity’s busted business model.

That rooftop solar company was absorbed into Tesla, where it’s proceeded to shrink as a percentage of revenue. Maybe that changed in Q2 and we’ll see it in results that are expected out around July 24. But more likely, the rooftop business too another hit, as social distancing measures shut down sales channels and made installation problematic.

Also, Tesla is far from the only company in this business and no longer has the market position SolarCity once did, so it could well have done worse still. It is true that rooftop solar is cheaper than ever, mainly because Chinese production has boosted supply and brought down components prices even after US tariffs. But SolarCity never figured out how to make money in distributed energy and neither have what are now much larger competitors.

CEOs are in the business of talking up their companies’ prospects. And few have done as good a job of it as Elon Musk over the past decade or so. But its fortunes are all about selling autos at this point. And until there are numbers to back up the claims on the electricity side, a healthy dose of skepticism is essential.

Pat M.

2:26

Hello Elliott and Roger,
Would you do a follow-up review of your gold miner recommendation from last year, AEM, BTG, FNV ect.. They have performed very nicely and I’m interested in what things look like going forward.
Does HESM now have a corporate structure rather than an LP?
Thanks for all your efforts !

Elliott Gue

2:26

We cover the gold miners and gold itself in more depth in our Deep Dive Investing service; however, the outlook remains bullish and gold prices are now challenging their 2012 highs. I am looking for gold to set fresh all-time highs at some point this summer. The biggest driver of gold prices over the intermediate term is real interest rates -- when real rates (nominal rates less inflation) go down that's bullish for gold. And, with the Fed driving down rates even as market inflation expectations firm up, US real rates are negative and declining. Gold mining firms all have operational leverage -- cash flow rises faster than gold prices -- so should outperform gold on the way up. Adding to the list of names you asked about I'd highlight NEM, which is the world's largest pure-play miner. I think their free cash flow generation ability at current gold prices is totally underappreciated.

Elliott Gue

2:37

And regarding HESM, the company completed a transaction last year, which eliminated incentive distribution rights (IDRs) to the general partner. It is now taxed as a corporation.

Mack

2:47

I hold nine midstream companies. They are sorted by smaller, mid-size and larger positions. The larger are the 'tent poles' meant to hold up the group. They are EPD, MMP and KMI. For the fourth I'm considering HESM, MPLX and WSM. Of those three which do you think has the most promise of very safe payout, and, share price growth. Are there others I should be looking at for the fourth tent pole? Thanks.

Roger Conrad

2:47

I think you probably mean WMB (Williams Companies) rather than WSM (William Sonoma). Of those three, Williams has the greatest reliance on utilities as customers, which means it has fewer counter party concerns for payment as well as demand. There's been some concern about exposure to Chesapeake Energy, which recently declared bankruptcy and has been contributing a mid-single digit share of revenue. But CHK's problems have been well known for a long time and Williams CEO Armstrong pretty much reaffirmed guidance at the JP Morgan conference in mid-June, which means there's probably too much risk priced in at a yield of 8.5%. I like the "tent poles" analogy--and certainly EPD, MMP and KMI has been strong in this storm.

Ron

2:54

I realize your outlook for AM is nehative but it appears very positive developments with AR is occurring which should benefit AM. I see that AR is fully hedged through 2021 and they are projecting self generated positive cash flow for this year in this challenging environment while paying down completely their 2020 and 2021 debt

Elliott Gue

2:54

We're bearish on natural gas prices as the industry continues to face a persistent glut. A producer can certainly hedge away near term commodity price risk, as AR has done but we question the company's ability to generate consistent free cash flow over time given the bearish long-term gas outlook. In addition, AR doesn't have much debt due in 2020-21 -- just about $500 million in 2021 of a total of more than $3.5 billion in debt. Make no mistake -- AR is a very weak credit with the cost of insuring their 5-year bonds at a whopping 22.94%. The best-positioned Appalachian gas producer is COG but even there I just think there are better opportunities on the oil side.

Mack

2:57

If Biden is elected president and pushes through tax reform that causes ordinary divs to be taxed at the same rates as ordinary income, won't that make K-1 payout/income attractive by comparison? (Unless there is some change to K-1 tax policy too.) Thanks.

Elliott Gue

2:57

The best answer I can give you (which isn't very satisfying) is "perhaps." If you remember, when the Trump Administration's tax reform was making its way through Congress there was a ton of back and forth between the MLP Association and lawmakers to avoid putting the MLPs in a disadvantaged position and the stock saw wide swings as a result. The proverbial devil is in the details and it's impossible to know how any tax reform would impact the MLPs vs. Corporations based solely on the vague policy outlines we've seen to date.

Arnold S

3:04

Good afternoon. I have a couple of stocks that I had forgotten about in an IRA account (one of them being Forum Energy FET). They have lost so much value that I'm not sure whether to just wait and see if they make a comeback some day, or to just sell them now and buy a new mop

and buy a new iPhone with the proceeds. In a future issue, could you maybe make a top-ten+ list of those energy-related stocks that you feel where bankruptcy is inevitable? I don't mind letting the stocks sit there for a few years if there is any hope they could even come back to half of what I paid for them. Thanks

Elliott Gue

3:04

Sure, that's a good idea. Some energy companies just won't pull through this, which is why we've been so focused on high-grading our picks this year. It's been a while since I looked at FET because we sold it out of the portfolio some years back. However, it's probably a good example of a name that's going out of business -- you might see short-covering rallies in names like that when investors rotate into energy but given the state of drilling activity and their weak balance sheet I just don't see how FET pulls through.

3:06

Roger/Elliott, hope all is well.
Can you confirm or explain exactly and if it is going to help EPD or is it a setback, very hard to determine.
It must be with the purchase of Oiltanking Partners, that the seller is now part or is Skyline North Americas, Inc. They are choosing to sell $500,000,000. worth of stock.
a. In the open market
b. Back to EPD
c. They are warrants and now EPD needs to create enough stock for that amount of money.
I hope your able to explain, gets really confusing to pinpoint all the legal jargon.

Second note, pipeline stocks are seeing a lot of downside and it seems heading towards March lows. One article says option implied volatility for pipelines stocks.

http://archive.fast-edgar.com/20200625/A52Z8G2DZZ2R5ZZZ27Z62ZYPTO3BZZ2...

http://archive.fast-edgar.com/20200625/A72ZDG2DZZ2R9ZZZ27ZC2ZYOMC7NZZ2...

I know you likely read these articles, and appreciate your advice with knowledge and guidance in energy investments.
Thanks to both of you for all you do.

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