Sizing Up the Dinosaurs
In this issue:
This issue compares the oil supermajors based on a variety of metrics, then goes on to discuss some of the issues weighing the domestic pipeline stocks. So this seems like the perfect time to tackle a recent reader question asking about the relative safety and merits of Chevron (NYSE: CVX) and Energy Transfer Partners (NYSE ETP), in light of the much higher yield currently on offer from the latter.
They are very different businesses of course. Chevron produces oil and gas on every continent other than Antarctica, in addition to operating nine refineries. Energy Transfer Partners mostly processes and transports natural gas, though it has also branched out into crude and natural gas liquids.
Chevron has a market capitalization of $178 billion propping up its $27 billion of net debt. Its investment grade credit ratings from Moody’s and Standard and Poors are just one rung below the highest level.
ETP has nearly $29 billion of consolidated debt above a market capitalization that’s down to just $20 billion. Its credit ratings cling to the lower end of investment grade, And of course it is a master limited partnership, so while its distributions are tax deferred, they also obligate ETP to pay a generous chunk of its cash flow to its general partner.
While ETP’s cash flow is made up largely of fixed pipeline transportation fees, it’s also dependent on sales of the natural gas liquids it processes. Their low prices have dunged ETP’s bottom line over the past year. Chevron is much more exposed to commodity volatility but it’s also much less leveraged as a result. And its downstream refining operations tend to counter the profitability swings of its upstream arm, as recently.
Chevron’s debt-to-EBITDA ratio nevertheless stands at 1.4, while Exxon Mobil’s (NYSE: XOM) is 1.1. Compare these with ETP’s debt-to-EBITDA of 4.5. Midstream cash flows have historically been much steadier than upstream or downstream ones, and the low cost of debt and equity in recent years encouraged MLP sponsors to pursue the aggressive growth in order to boost their incentive fees.
Chevron’s balance sheet and profitability make it a much safer business than ETP, but not necessarily a safer investment. Like ETP it’s been borrowing money in order to pay its dividends and invest in growth projects.
In these circumstances, Chevron’s 4.5% current annualized yield likely reflects expectations of continued outperformance. In contrast, ETP’s 14.8% current yield is much more vulnerable to a cut near-term if that proves necessary to defend its credit rating. But it’s also way above historic MLP norms, in a reflection of recent investor panic about the pipeline sector’s prospects.
So while Chevron is much safer in absolute terms, we believe that ETP has much more upside.
That said, MLPs also have some very specific risks you simply can’t ignore. One is that their driller customers will go broke and won’t live up to their commitments, a threat advanced by an unfavorable recent bankruptcy court ruling.
But drillers accounting for most of U.S. output will not be filing for bankruptcy, and midstream profits also crucially depend on energy consumers flush with fuel savings. The risk that pipeline traffic will slow to a crawl as a result of upstream turmoil seems exaggerated to us, another symptom of midstream investors’ recent trauma.
On the other hand, the likelihood that MLP sponsors will place their interests above those of their outside investors has clearly increased amid financial strains, and the convertible offering issued by ETP’s general partner last week is a case in point. Ostensibly designed to offset the cash cost of a troubled merger bid, it also shields management from the effects of a potential distribution cut.
Fifteen percent yields almost always carry high levels of risk. Energy Transfer Partners is in the Conservative Portfolio because it is a large and diversified operator in the historically steady midstream sector. On that basis, it’s certainly more conservative than the driller, tanker and renewables picks residing in the Aggressive and Growth portfolios. And while ETP isn’t nearly as safe as Chevron it remains much more attractively priced based on their historical valuation ranges.
Oil prices have pulled back as this issue goes to press, but are nevertheless up since our previous update. West Texas Intermediate (WTI) rose $2.39 to $37/bbl after briefly flirting with $40. Brent crude did breach the $40 mark, but has pulled back slightly to $39.34/bbl. Natural gas prices have also started to show some life. Since our previous issue the Henry Hub benchmark has added 15 cents to reach $1.86/MMBtu.
In Other News
- Natural gas prices dipped to the lowest levels in 18 years
- Despite testimony in court that there was no evidence of fracking contaminating the plaintiffs’ water wells, a jury awarded $4.2 million to two Pennsylvania families, finding that drilling by Cabot Oil and Gas (NYSE: COG) had created a private nuisance
- A judge has authorized bankrupt Sabine Oil & Gas to break certain pipeline contracts, fueling concerns that midstream companies may suffer from upstream bankruptcies
- The EPA said it is expanding its previously announced restrictions on methane emissions to include the wells already drilled
- The International Energy Agency (IEA) suggested that while there are still risks ahead, “there are signs that [oil] prices might have bottomed out”
- A new article on nuclear power highlights a point I have made many times — nuclear energy’s future is bright in Asia.