The recent bone-crushing drop in the price of oil was worse than had been seen since 1991. The decline destroyed the value of even the best oil and gas leaders by more than 10%, and some saw their values fall 20% to 40% during the panic. It turns out that sometimes volatility and uncertainty, even if it is around the coronavirus and OPEC, still creates perceived value, even in a volatile market like this.
A new Bank of America Securities report discusses how some of the infrastructure players are now facing a new reality. The firm’s Derek Walker and team noted that the oil price collapse has depressed broader energy equity prices to historic lows, with a demand shock from the coronavirus and a supply shock from the disappointing OPEC+ meeting creating a price war between Saudi Arabia and Russia.
The Bank of America commodities team has now slashed its oil targets, with Brent crude oil taken from $54 down to $45 and West Texas Intermediate (WTI) taken down from $49 to $41 on average in 2020. The firm pointed out that spot WTI prices already have tested low-30s levels this week, and this is going to lead to production cuts in 2020 and 2021. The downgrade also addressed a sharp oil price drop challenging U.S. shale production
The Bank of America equity strategy team has now downgraded the energy sector weighting to Underweight. In that context, they noted that midstream investors should focus on factors such as leverage on the books, the distribution coverage, exposure types, free cash flow and flexibility around capital spending. The firm noted:
During the 2014-16 commodity downturn, WTI traded as low as $26/bbl and the AMZ observed an approximate 3x EV/EBITDA multiple drop. Since then the midstream sector has been on a multi-year campaign to incorporate significant lessons learned such as lower leverage ratios, higher distribution coverage ratios, improved governance (simplifications, IDR-buyouts), self-funding the equity portion of capex programs, etc. The midstream sector was arguably in better financial shape prior to the current 2020 black swan events (coronavirus, OPEC+ fallout). However, given the ongoing uncertainty, we adjust our view to the new reality of lower commodity prices and throughput headwinds in the midstream space.
Kinder Morgan Inc. (NYSE: KMI) was raised to Buy from Neutral at Bank of America Securities, but the price objective was lowered to $19 from $23, which compared with a $16.04 prior closing price. Kinder Morgan was trading at $19.33 last Friday ahead of the OPEC+ disaster meeting, and it was above $22 as recently as February 24.
Kinder Morgan’s natural gas midstream business is said to be primarily long-term take-or-pay contracts and that feature created a defensive screen in the firm’s view. The report said:
In 2020, Kinder Morgan expects approximately 64% of EBDA from take-or-pay contracts, 32% from volume sensitive or hedged contracts and approximately 4% from unhedged production or G&P businesses. Although the volume and price sensitive business (CO2 segment) have downside risks, Kinder Morgan’s overall business appears much better positioned than other peers in weathering near-term volatility given its improved balance sheet, reduced capex spending outlook and diversified customer base with higher credit quality.
MPLX L.P. (NYSE: MPLX) and Plains All American Pipeline L.P. (NYSE: PAA) were each downgraded to Neutral from Buy. MPLX saw its price objective reduced to $18 from $32, and Plains All American saw its price objective slashed to $10 from $23.
The Bank of America report suggests that Plains All American is expected to be one of the most affected midstream names in the firm’s coverage. On MPLX, a material slowdown in Permian production growth will complicate its plans to expand Permian G&P and invest in long-haul crude and natural gas liquids pipelines.
Western Midstream Partners L.P. (NYSE: WES) was downgraded to Underperform from Neutral in the call. Its price objective was slashed to $7 from $19. The firm noted that Western Midstream’s leverage ratio may stay elevated, given uncertainty around EBITDA growth and difficulty in making asset sales in the current environment. As such, a potential distribution cut would have a higher probability as a tool to deleverage.
The market drop and the comments about further and longer demand destruction out of OPEC have added drops to the MLPs and infrastructure players noted in this call. Kinder Morgan was last seen down 2.8% at $15.57 on Wednesday after the open. MPLX was down 5.6% at $15.93, Plains All American Pipeline was down 4.4% at $8.39 and Western Midstream was down 7.6% at $6.41.
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