Energy Income Weekly: Strong Fundamentals Continue To Drive Equity Outperformance

Energy Income Performance

Energy was the only sector to post a gain this week. The XLE’s 4.9% gain outperformed the 1.1% decline in the S&P 500.

Stocks struggled after having surged in recent weeks in response to strong economic data and more dovish-than-expected comments from the Federal Reserve. This week, the market fell back as it encountered a rise in interest rates and a wider acknowledgment among investors that stocks had run too far too fast.

WTI surged 8.6% higher in response to a strengthening physical market and news that Russia was curtailing 500,000 barrels per day, equivalent to approximately 5% of its total production. Natural gas took a break from its brutal selloff and rose by 4.3%.

The commodity price environment was constructive for gathering and production operators and royalty trusts, which led the way higher.

NGL Energy Partners, LP (NGL) was by far the best performer. NGL units rose 21.6% on Friday after the company reported its fiscal third-quarter financial results. Management announced that it had paid down $98.1 million of unsecured notes and equipment financing during its fiscal third quarter. It also increased its Adjusted EBITDA guidance for the coming year. Most importantly, it anticipates that all 2023 unsecured notes will be repaid by June 30, 2023.

Repaying the notes would stave off bankruptcy risk, so the units returned to levels last seen a year ago, when bankruptcy risk was less of a concern. The company will continue its efforts to sell assets and deleverage. Despite the good news, we still recommend that investors avoid NGL units due to their high risk of permanent loss, particularly if macro commodity conditions deteriorate.

The second through sixth best performers during the week were companies exposed to commodity prices. Royalty trusts like Dorchester Minerals (DMLP) and Viper Energy Partners (VNOM), and gathering and processing companies like Western Midstream Partners (WES), Targa Resources (TRGP), and Crestwood Equity Partners (CEQP), all gained on no news.

Underperformers were a mixed group that fell on little company-specific news. Until this week, Summit Midstream Partners (SMLP) units had a good run after announcing its Outrigger acquisition in October. This week’s selloff brings the units back to pre-deal levels. While their risk of permanent loss remains high, we’ll be watching earnings results closely for signs of improvement.

Tellurian (TELL) continues its efforts to secure financing for its Driftwood LNG project. Most recently, it has approached Indian companies and government entities. Until it can demonstrate success and embrace more shareholder-friendly governance practices, we recommend avoiding the shares.

In earnings news, Enbridge (ENB) reported in-line fourth-quarter results, with Adjusted EBITDA of $3.91 billion versus consensus expectations of $3.90 billion. Management reiterated its full-year 2023 guidance. This week was the calm before next week’s storm of earnings reports.

Plains All American (PAA) beat fourth-quarter consensus Adjusted EBITDA expectations by 4.4%. The company guided for full-year 2023 results in line with previous guidance and consensus expectations. It was notable that management revised down PAA’s Permian oil production forecast by 23%, from 650,000 barrels per day (bpd) to 500,000 bpd. PAA nits trade at an attractive 8.5% yield, and we expect PAA’s distribution to grow in future years. In 2023, the company should generate a large cash flow surplus that it is likely to use to pay down debt and, to a lesser extent, repurchase units. We rate the units as a Buy and maintain our $14.50 price target.

Weekly HFI Research Energy Income Portfolio Recap

Our portfolio had a bi-polar week, with six of our holdings among the top ten performers and four holdings among the bottom ten. Its 0.7% gain for the week outperformed its benchmark, the Alerian MLP Index, by 0.3%.

Western Midstream (WES) was the best performer, up 5.6% on no company-specific news. Its outperformance came as a surprise as management of its anchor customer, Occidental Petroleum (OXY), said it would prioritize stock repurchases over production growth. OXY also noted that it is considering repurchasing Berkshire Hathaway’s (BRK.A) (BRK.B) preferred stake, which could further reduce funds available for drilling capex on WES’s dedicated acreage.

On the positive side, permitting conditions in Colorado have improved in recent months, which bodes well for WES if OXY increases drilling activity in its DJ Basin acreage. In any event, we’ve believed that WES units were too cheap in the mid-$20s. Its gains represent a reversion toward a more appropriate market valuation.

Targa Resources (TRGP) shares were the second-best performer, up 4.6%. This also came as a surprise since the company may report a weaker-than-expected fourth quarter due to lower Permian natural gas and NGL prices and supply disruptions from Winter Storm Elliott. Results will also depend on TRGP’s recently-acquired Lucid assets, which will make their first full-quarter contribution to companywide results.

Our portfolio was held back by poor performance out of some of our larger holdings. Energy Transfer (ET) pulled back by 3.3% on no news after a 12% bull run in the month of January. ET’s fourth quarter will benefit from the contribution of its Woodford Express acquisition and strong export volumes out of its Nederland and Marcus Hook terminals.

Martin Midstream Partners (MMLP) units continued to struggle in the wake of the company’s refinancing. Management will be able to shed light on the situation on Thursday in MMLP’s fourth-quarter earnings call.

Lastly, USD Partners declined after a 37% year-to-date gain that peaked the previous week. On Monday, USDP announced the positive news that it had amended its revolving credit agreement. The amendment will provide the company with the liquidity it needs to get through the contracting phase that we expect to get underway over the coming weeks and months.

News of the Week

Feb. 9. We’ve been following TC Energy’s (TRP) operational issues with concern, as their persistence suggests a broader management problem at the company. This week, TRP said the recent Keystone oil spill was due to bending stress and a welding flaw. It estimated the spill would cost it $480 million, and potentially more, as repair work continues. Keystone has had an unusual number of operational problems for a 12-year-old pipeline. The Keystone news comes after TRP reported cost overruns at its Coastal GasLink project. TRP’s stock has fallen by 30% since its high in June. Its shares are likely to languish at lower levels until it gets its operations in order.

Feb. 10. Enbridge expects higher throughput on its Canadian Mainline system in 2023 due to higher heavy oil production in the Western Canadian Sedimentary Basin. ENB management expects its Mainline system’s utilization to remain high after the startup of the Trans Mountain Pipeline Expansion, which is expected later this year. The Mainline news provides a positive read-through to Pembina (PBA), which will derive more of an impact from WCSB production growth than ENB. Both ENB and PBA have good near-term prospects and are preferable to beleaguered TRP.

Capital Markets Activity

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