Sanchez Under the Gun
When a stock yielding 12% tumbles 30% in price, no one has a right to be shocked: after all, that double-digit yield was flagging high risk, especially in the current low-yield era.
But that doesn’t make it any less of a pain, or any less of an urgent matter to figure out the why and the what’s next. And that’s where we are today with Sanchez Midstream Partners (SNMP).
The first 20 percentage points or so of its decline since late May could be chalked up to general weakness among midstream MLPs and bearish sentiment in oil. Sanchez was particularly vulnerable to the latter as a small issuer of relatively illiquid equity that relies heavily on the production plans of its small-cap sponsor.
But most MLPs have since bounced while SNMP has not, despite a fully-covered yield that’s now up to 17%. At this point it’s fair and even wise to look for alternative explanations.
I believe the leverage and recent capital spending cuts unveiled by that sponsor, Sanchez Energy (SN), are weighing heavily on SNMP’s share price right now.
Since spending $2.1 billion in a partnership with Blackstone to acquire 318,000 acres of Eagle Ford, Sanchez Energy has seen its own share price shrink from $12 to $4 and change. That’s left it with a market cap of just $353 million riding atop approximately $1.8 billion in debt.
On the other hand, the bulk of the expected production gains from the acquired turf is decently hedged over the next few years, and Sanchez noted as recently as May that it had plenty of headroom on its credit covenants.
Still, the incredible shrinking market cap reflects market concerns and adds to them in something of a negative feedback loop. Sentiment recently grew worse after Sanchez said it would reduce capital spending to better match its operating cash flow, resulting in slower production growth than previously planned.
While this seems like a sensible response to low oil prices, it underscores the fact that those prices remain stubbornly low. The slower volume growth also diminishes the margin of error for Sanchez Partners. The partnership will also have to decide how to deal with a yield that makes equity financing unaffordable right now. Some MLPs in similar circumstances have chosen to cut the payouts.
I think the current price of SNMP discounts all of this bad news and then some. I remain hopeful that higher oil prices will eventually power a recovery. But I’ll also be listening closely to what Sanchez Energy and Sanchez Midstream CEOs say on Aug. 15 after the companies report quarterly results.
If the thesis changes, so will the recommendation. For now, SNMP is downgraded to Hold.