ET - Crestwood Equity Partners: Strong Value Potential As Acquisition Deal Is Finalizing

2023-09-29 04:14:00 ET

Summary

• Energy Transfer LP's acquisition of Crestwood Equity Partners LP creates a $108 billion enterprise-valued combined business.
• CEQP's strong focus on midstream operations and strategic partnerships with major energy producers make it a valuable asset in the energy sector.
• While there are risks associated with the deal, the potential benefits and sustained dividends make CEQP a favorable investment.

The announcement made by Energy Transfer LP (ET) to acquire Crestwood Equity Partners LP (CEQP) has created an interesting scenario right now in my opinion. I think that CEQP offers a pretty good deal and the risk/reward of there being anything to jeopardize the deal with ET seems slim. The addition of CEQP to ET will be solid so holding shares to get shares in ET seems favorable. The additional cash flows should benefit the combined business, but if there is anything that stops the deal holding shares in CEQP is also very beneficial given the significant amount of distributable cash flows it generates and the sustained dividend it has had through the commodity cycles. This makes me quite bullish on the business actually, and I will be rating CEQP a buy.

Business Performance

CEQP is a prominent energy company with a strong focus on midstream operations. The company boasts substantial expertise in the gathering of natural gas and crude oil across the United States. CEQP's primary activities revolve around the gathering, processing, and transportation of natural gas, managing natural gas liquidity, handling crude oil, and dealing with produced water. Its key operational regions include the Williston Basin, Powder River Basin, and Delaware Basin, all of which play a crucial role in the company's strategic operations.

The announcement of the acquisition is significant news in the energy sector, as it would result in a $108 billion enterprise-valued combined business following the merger. The additional cash flows to ET would be significant, and that I think is much of the appeal of ET making this move. The deal in question is structured as an all-equity transaction, with CEQP unitholders set to receive 2.07 units of ET for each CEQP unit they currently own. Notably, this arrangement does not offer a premium over CEQP's previous trading value. Consequently, CEQP holders should anticipate receiving a distribution per unit that remains relatively consistent. The scheduled timeline for the completion of this deal is during the fourth quarter of this year.

CEQP plays a vital role in the energy supply chain by offering pipeline and storage capacity solutions. These services are instrumental in ensuring the efficient delivery of energy products to end consumers. CEQP's client base comprises some of the largest and most influential energy producers in the United States, such as XTO Energy, Devon Energy (DVN), Exxon Mobil (XOM), ConocoPhillips (COP), Marathon Oil (MRO), and Occidental Petroleum (OXY). These strategic partnerships underscore CEQP's significance in facilitating the energy sector's operations. The company has made a name for itself and the partnerships it has I think are unlikely to be jeopardized following the deal and CEQP can continue generating significant distributable cash flows.

The total asset base of CEQP has been growing steadily over the years and continues to be a highlight in my opinion. We can see a spike in 2013 as CEQP merged with Inergy which greatly boosted the balance sheet. It has had a significant drop which was largely due to goodwill impairments, which I don't think should be viewed as something negative. Goodwill can be a dividing topic, where someplace a great deal of importance on it, whereas some don't. I tend to fall in the latter group, as I don't see the necessity of using it to a significant extent in the valuation. It used to be over $2 billion, so seeing the goodwill around $220 million now seems more realistic.

Looking at the impact of the acquisition and additional assets for CEQP it seems to have positively affected the FCF at least. Over the long term, it has been trending upwards steadily. Being exposed to both natural gas and oil volatility, I wouldn't see it as something necessarily negative that the FCF is volatile. It seems sustainable though now as it remains positive and keeping the high yield of 9% seems possible.

Weighing on the company still though I think is the amount of dilution they have had through the years. The company isn't necessarily in a spot where they are maximizing returns for investors. Even with a high yield, dilution like this is a thorn in the side of an investment thesis, however, not significant enough yet to warrant a lower rating than a buy I think. If the deal would for any reason fall through, the slowdown in share dilution would be a point to watch in my opinion, and an acceleration would be a bearish sign.

Dividend Evaluation

Looking at the distributable cash flows, they seem to have been impacted by the higher interest rates as cash interest expenses have risen to $55 million last quarter, as opposed to $40 million. The rates are likely to remain elevated to the better part of 2024 as the Fed is fighting inflation. However, I think that as they go down the expenses will obviously go down and the distributable cash flows for CEQP grow accordingly. More concrete forecasts on interest rates from the Fed could rally the share price of CEQP as investors estimate higher dividend opportunities.

The yield for CEQP has largely been the same through the years and netted investors with a decent return. Even if the share price is down around 18% in the last 5 years, I find that the returns and value you get from the dividend are helping offset a significant amount of this and still make a buy case justified.

Risk/Reward

One potential but rather unlikely risk associated with this deal is the possibility of it falling through or encountering substantial regulatory opposition. However, it's important to note that such a scenario appears relatively limited, given the size and valuation of the deal. Furthermore, the acquisition by ET is not expected to confer any unfair advantage over competitors, which increases the likelihood of regulatory approval. This suggests that the deal is likely to proceed as planned and could prove beneficial to investors.

CEQP operates within the midstream energy sector, with its revenue and cash flow heavily reliant on natural gas and petroleum products. This dependence on fossil fuels places the company under the influence of the U.S. government and federal regulators. In recent times, these regulatory bodies have demonstrated a willingness to halt or restrict fossil fuel expansion initiatives as part of a broader effort to transition the U.S. energy landscape towards cleaner alternatives.

Keynotes

CEQP is in an interesting position as the proposed plans to merge with ET would provide a company with significant amounts of FCF. The implied upside potential is in the double digits according to the presentation by CEQP and this is a bet that I am willing to make right now. On its own, CEQP has been growing very well over the years and if for whatever reason the merger wouldn't happen, be that regulatory pushback, then CEQP can still deliver significant shareholder value and deserves a buy in my view.

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