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Why Does the Market Hate This High Yielder?

By Ari Charney on October 13, 2017

Uncertainty is the bane of most investors.

That’s especially true when you’re talking about the prospects of a small-cap stock that isn’t widely followed on Wall Street.

When the future becomes cloudy in such cases, fearful investors are inclined to sell first and ask questions later.

On its face, Cone Midstream Partners LP (NYSE: CNNX) has just about everything income investors could want.

The Pennsylvania-based master limited partnership (MLP) currently yields 7.1% on a forward basis.

And ample cash flows from serving natural gas producers in the prolific Marcellus Shale formation have allowed it to boost its distribution every quarter since its first payout nearly three years ago.

As a relatively young MLP, Cone isn’t saddled with the crushing debt that nearly suffocated so many of its peers during the energy crash.

At the end of the second quarter, total debt to equity stood at just 22.2%, while net debt to EBITDA (earnings before interest, taxation, depreciation, and amortization) was just 0.99 times. By contrast, Cone’s average MLP peer shoulders more than five times as much debt.

Meanwhile, Cone is forecast to grow cash flows nearly 23% annually over the next two years, which is expected to drive distribution growth of 12% annually over the same period.

If Cone can fulfill these lofty expectations, investors who buy now will enjoy an effective yield of more than 9% in just two years.

And when valued on the basis of its cash flows, which is appropriate for yield vehicles like MLPs, Cone is one of the cheaper players in its space.

Yes, But …

A high-and-rising yield, minimal debt, and a bargain price—sounds great, right?

Unfortunately, Cone’s units have fallen more than 33% from their trailing-year high and may not have found their bottom yet.

When surveying the carnage in the MLP space early last year, I identified Cone as one of the few MLPs whose superior fundamentals left it bloodied but unbowed.

However, I had one pretty big misgiving about it. Like some of the other smaller MLPs, Cone is essentially a captive entity of its sponsors, who at the time were Consol Energy (NYSE: CNX) and Noble Energy (NYSE: NBL).

That means Cone generates most of its cash flows by providing midstream services to these two energy producers. The resulting lack of customer diversification was worrisome, especially given the fact that Consol still derives roughly half its revenue from coal, an industry in the midst of a secular decline.

Although I was less concerned about Noble, it turned out to be the entity that’s left Cone in its current predicament.

Earlier this year, Noble executed a significant strategic shift that entailed selling its natural gas assets in the Marcellus in order to focus on the oil-rich Permian Basin in Texas.

The resulting series of divestitures not only include selling its stake in Cone, but also the assets the MLP previously serviced.

Affiliates of Houston-based Quantum Energy Partners acquired both pieces, effectively making the private-equity firm Consol’s new joint-venture partner.

However, that has since left an informational vacuum, namely what Quantum affiliate HG Energy’s plans are for developing Noble’s former producing assets, which, in turn, has implications for Cone’s future cash flows. Cone’s management expects to know more by the end of the year.

While a lot remains to be seen, HG is expected to be a much more active developer than Noble was.

Further, Quantum’s portfolio of companies could give Cone a stronger pipeline of future asset drop-downs, which is essential for an MLP to continue growing its payout.

Additionally, Quantum’s portfolio companies, access to capital, and industry connections could help Cone finally diversify its customer base.

In other words, Quantum’s involvement should ultimately be a good thing for Cone, perhaps even an improvement over Noble.

But you wouldn’t know it from the market’s reaction. Even so, as a risk-averse investor, I’d like a bit more color on Quantum’s plans before I’ll be ready to hit the “Buy” button.

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