Is the state of the midstream as positive as claimed or as negative as feared?

That’s what Hart Energy's editors sought to determine when we created The Midstream 50, the first-of-its-kind published ranking of the top publicly owned players in the sector. With the help of experts at Barclays Capital Inc., we dug into the hard, cold data of Form 10-K annual reports filed with the U.S. Securities and Exchange Commission to ascertain who was at the top of the midstream pile, how they got there and whether they are likely to stay.

What we discovered was a sector in transition but also in a position of relative strength when compared to other divisions of the energy industry. In fact, given the harsh treatment by investors last year, the group delivered a stronger performance than some might have expected.

“There really were not a lot of negative EBITDA declines and it was comforting to see,” Hinds Howard, senior vice president and associate portfolio manager at CBRE Clarion Securities, told Hart Energy. “But it also represented a lot of MLPs that were running really hard to stay flat or stay slightly positive on EBITDA.”

The Midstream 50 provides a snapshot of how the sector performed in 2015, based on a broader universe of 83 companies.

Read: Taking Stock Of The Midstream 50 At Midyear

The Methodology
The complete master ranking—The Midstream 50—was built by Barclays. It includes both the major MLPs and conventional corporations, or C corps, active in the midstream space. Companies on The Midstream 50 are ranked by 2015 EBITDA.

Breakout tables that rank Midstream 50 members by 2015 revenue, assets, distribution yield and year-to-year changes from 2014, as well as charts tracking changes in EBITDA and stock price, were built by the magazine and based on Barclays’ data.

Decisions on methodology were made by Hart Energy editors in consultation with Barclays and other financial experts. The editors chose EBITDA as the primary factor in determining the ranked companies over other factors, such as assets, because it best assessed a company’s performance. The value of EBITDA is that it allows comparison without having to consider financing or accounting decisions.

The Midstream 50

Source: Barclays Capital Inc.


* Southcross Energy Partners LP was not included in The Midstream 50 because the company filed its 10-K form with the SEC too late for Midstream Business publishing deadlines. Based on its 2015 EBITDA, Southcross would have ranked No. 43.

The 50 companies ranked by EBITDA are the only companies included in these tables. As an example of how the methodology determines the rankings, Cheniere Inc. is not included in The Midstream 50 because its 2015 EBITDA (-$319 million) did not land among the top 50 companies. As a result, it is not included in any of the tables. Had the company been included, it would have been ranked No. 9 on the assets list ($19.02 billion) and No. 11 on the list of percentage change of assets from 2014 to 2015.

On a smaller scale, Penntex Midstream Partners missed inclusion in The Midstream 50 (EBITDA of $17 million) but would have made the assets list at No. 47 and ranked No. 4 on the year-to-year assets percentage change list with 113% growth from 2014 to 2015.

Finding Positives

Among the positives revealed by the data: more than 80% of the companies on the ranking reported a year-over-year increase in EBITDA. Those that declined were fairly isolated to big names, Howard said, an indication that speaks less to performance than to the challenges facing any large entity.

“I think that’s reflective of how hard it is to grow a big midstream company,” Howard added. “Whereas if you’ve got a project coming online, you can grow EBITDA as a small entity pretty easily, even if it’s diluted on a per-share basis.”

Michael Underhill, chief investment officer of Wisconsin-based Capital Innovations LLC, agreed with Howard, telling Midstream Business that the widespread EBITDA growth reflected a concerted effort to improve balance sheets.

“They’re trying to lower leverage—trying to, it’s a challenging environment—but they’re trying to lower leverage while they’re undertaking capital projects that have more accretive/positive returns,” Underhill said. “The environment we’re heading into has a heightened cost of capital. We’re seeing capex delays, project delays. Those top 10 names, the investment-grade MLPs, those that remain investment grade are going to continue to gather capital. People are going to trend toward quality and really take a look at gathering and processing MLPs’ exposure to commodity risk, because not all gathering and processing MLPs are alike.”

Andrew Brooks, Moody’s Investors Service vice president and senior analyst, had a similar view in an April report, noting that weakness in gathering and processing resulting from commodity price exposure had left many midstream MLPs overlevered.

Upstream’s reduced need for infrastructure has cut into EBITDA growth, Brooks wrote, adding that he expects midstream capital spending this year to decline after years of growth.

The Midstream 50 stock index

Stock Price

When assembled as a stock market index with companies weighted by market capitalization, The Midstream 50 saw its value chopped by 32.1% in 2015. By comparison, The Wells Fargo Securities MLP Index of 67 midstream MLPs suffered a 38.3% loss in value, and the Standard & Poor’s (S&P) Oil & Gas Exploration & Production Select Industry Index fell 37.4%.

The broad S&P 500 Index dipped by 1.8% in 2015.

Not every company on our list took a hit on its unit price, however. Five companies saw increases, led by Valero Energy Partners LP at 19% and Holly Energy Partners LP at 4%. The units of Delek Logistics Partners LP and Shell Midstream Partners LP each rose 1%, and PBF Logistics LP registered a 1-cent increase in unit price.

Brooks noted that “With uncertain growth prospects, equity markets have soured on midstream MLPs, driving down unit prices.” The Moody’s approach, however, is to acknowledge that the sector’s diverse assets mean that the price impact varies widely and that the service evaluates each company individually.

For Underhill, the key to equities is the price of crude oil. Until Feb. 11 of this year, energy equities and oil traded in sympathy, he said. Both hit bottom on that day, with West Texas Intermediate (WTI) closing at $26.21 per barrel. From then until mid-April, the price of WTI soared by 61% and The Midstream 50 index jumped 45%.

“You saw people realize it’s not the end of the world, we’re not heading into a recession, this is not the global financial crisis of 2008,” he said. “There was a little bit more rational thought. What you’re really seeing here is behavioral finance at its finest, and you’re seeing it in negative sentiment to the downside. We were increasing our positions in MLPs and energy companies in early February, and then Feb. 11 we backed up the truck and took our infrastructure portfolio more than 50% in energy. Conventional oil and gas energy is not going away.”

Bigger Than Belgium

To gauge how much the major players dominate this sector, consider that the top 10 Midstream 50 companies control 75.6% of the total assets owned by all companies on the list. Kinder Morgan alone is in possession of 14.3% of the $590.2 billion in assets possessed by all 50 companies.

As a whole, Midstream 50 assets rose 5.4% from 2014 to 2015, from $560.2 billion. The grip on total assets by the top 10 lessened some, from 79.7% in 2014, as that group only managed a 1.9% increase, from $438 billion to $444 billion.

To put that into perspective, the top 10 companies on The Midstream 50 list own assets that are valued at more than the gross domestic product of Belgium in 2015, according to International Monetary Fund data.

“We see the dominance in the top 10 names because larger-revenue companies will continue to get larger,” Underhill said. “It’s not unlike in the private equity business—size begets size. You have a lot lower-cost capital and access to capital. The smaller ones are capital-constrained and they will get acquired.”

The Midstream 50 revenue leaders

Dominance by the majors in EBITDA mirrors that in assets. The top 10 account for 72.8% of The Midstream 50 total for 2015, and Kinder Morgan is responsible for 20% of the top 10 and 14.6% of the total.

That’s what investors seek, he said. Whether they are individuals, mutual funds, institutional investors or pension funds, investors value companies like those in the top 10. In a tough year like this one, they especially value companies that maintain growth distributions, particularly those with strong balance sheets, high distribution coverage and minimum internal equity requirements.

Other Views

Wells Fargo is quite comfortable with most midstream MLP distributions as secure even during this spell of market shakiness. And the analysts’ long-term view is bullish.

“For investors with a multiyear long-term investment horizon, we believe current levels could represent an attractive entry point,” the team wrote in its April equity research report.

More recently, higher oil prices and solid U.S. economic data in the first quarter have encouraged investors, and the Wells Fargo index outperformed the S&P 500 in March. The analysts, however, are not convinced that oil will not retreat again, noting rising global storage levels. They also doubt that oil prices, though higher, will trigger the kind of increases in drilling in the upstream that the midstream needs.

So, for 2016, Wells Fargo expects “the ‘safety trade’ of owning high-quality, fee-based names to start to wane as investors pivot from safe, more richly valued MLPs to more attractively valued, higher beta names over time.”

Then again, “MLPs trading at more discounted EV/EBITDA [enterprise value to EBITDA] multiples continue to face various headwinds such as stretched balance sheets and commodity/volumetric exposure.”

In short, it’s a stock picker’s market.

Gauging Opposition
David Alton Clark, a financial blogger on CNBC’s website, zeroed in on The Midstream 50’s No. 1 company, Kinder Morgan. Clark is concerned that Kinder Morgan has seriously underestimated environmentalist and political opposition to its pipeline projects, putting billions of dollars at risk.

Clark cited the company’s recent decision to stop work on the $1 billion Palmetto Pipeline in Georgia that would cross five rivers and hundreds of parcels of private property.

“There has got to be an easier way to make money,” he wrote, citing opposition from landowners and environmentalists. Resistance from the political left and right dogs Kinder Morgan’s efforts with the Northeast Energy Direct project (as much as $3.6 billion) and the Trans Mountain Pipeline expansion (now up to $6.8 billion) as well.

“The risk to Kinder Morgan’s future growth prospects is high in my book,” Clark wrote. “Even if the pipelines are eventually approved and put into service, the projected costs will increase dramatically and the time line for completion will be extended substantially.”

Underhill, too, expressed concern about the company.

“I look at a company like Kinder Morgan and historically it’s been a very interesting company,” he said. “You’ve seen an integration of MLPs into sort of a master holding company, if you will. I think Kinder Morgan has been able to have access to capital, scale and, quite frankly, it’s been able to successfully go out and restructure some of its debt. But I still think Kinder Morgan is going to be challenged in this commodity environment.”

Outlook
Looking ahead, The Midstream 50 could face a major rearrangement of its
members.


“There are a lot of names on that list,” Howard said. “I know it’s The Midstream 50, but over time you would hope that we wouldn’t need so many midstream companies and there would be some rationalization and consolidation. But we’re far away from that right now.”


A renaming to The Midstream 40 or 30 might be premature, but some of the stars of the sector may not shine quite as brightly.

“The relevance of some of the smaller ones probably will be a lot less,” Howard said. “Some of them have already been made more irrelevant by the market cap; some of them are trading well below $5 per share and probably won’t come back. You probably will be able to populate a chart, but it’s going to look quite a bit different.”


Howard’s expectation for the next two to three years is that the beneficiaries of dropdowns will rise in the ranking very quickly.

“There’s nothing really standing in the way of Shell, Dominion Midstream, Valero, Phillips 66, even Tallgrass,” he said. “Expect them to grow without having to consolidate.”


Integrated players like Enterprise Products Partners LP, Targa Resources Corp. and Energy Transfer Equity LP can also anticipate significant gains in market share as they exploit their advantage of offering the full suite of services from gathering and processing, to pipelines, to exports, Howard said. MPLX LP and Magellan Midstream Partners LP qualify for that elite group, as well.


“If you had a chart of the E&P 50 or the oilfield services 50, I imagine it would be sort of the opposite,” said Howard, referring to EBITDA gains. “Maybe you’d only find a few that went up and that was due to acquiring other entities.”
Underhill believes that future rankings will probably more or less mirror the first, assuming that the leaders stay on task financially.


“It’s all dependent on how judicious or how disciplined they are with the financials,” he said. “Disciplined management teams at those top names will be rewarded with capital. Those that get a little too aggressive or tend to take a little too much risk a little too soon—you may see a reshuffling of the deck.”


Joseph Markman can be reached at jmarkman@hartenergy.com and @JHMarkman.