CEQP - Crestwood: Marginally Weaker Quarter But Unchanged Thesis

2023-08-01 18:00:52 ET

Summary

• Crestwood reported a small miss on EBITDA largely from one time items.
• Well connections continuing leading to growth in the back half of 2023 and into next year.
• The company is looking to address some preferred shares to lower the cost of capital.

Crestwood's Q2 Update:

Crestwood's ( CEQP ) Q2 was marginally weaker than expected with EBITDA coming in at $176 million, down 2% year over year, and missing consensus estimates of $194 million. This miss was due to lower commodity prices, a non-cash loss on NGL storage and some well shut ins, particularly on the Arrow system in the Williston Basin. I'll take these one at a time.

Most of the company's revenues are strictly volume and have no commodity price exposure. About 15% of contracts, however, are percentage of proceeds. In Q2, oil, natural gas and NGL prices were down year-over-year 30%, 70%, 50% respectively. These price declines impacted EBITDA by about $8 million. Fortunately, prices are already up 10%, 20%, 10% respectively but the damage was done.

NGL logistics also impacted EBITDA by $5 million due to mark to market loss on inventory, which is a timing issue as that inventory is forward sold and the losses will reverse later this year and into Q1 next year. The positive flipside of this price weakness is the company increased its NGL inventory by 50% more than normal. This low cost inventory will hopefully goose NGL performance in Q4 this year and Q1 next year as that inventory is sold.

One other unexpected weakness was the $6 million in lower EBITDA from the G&P segment, largely because of lower volumes at Arrow. Well completion activity was in line but a large number (10-15%) of legacy wells were down. A portion of these offline wells were because of nearby fracking activity, where producers engage in "frack protection" meaning producers temporarily shut in wells to protect them from damage from nearby fracking.

Guidance:

The company continues to expect $780-860 million EBITDA for 2023, although instead of the company hitting the top end of its guidance, it's suggested that marginally weaker commodity prices and the Arrow outages might lead EBITDA to be at the lower end of the range. 2024 is looking great because of producer activity. There have been 73 new well connects so far this year and the company expects 125 new wells for 2023. These well connects are costing $145 million of growth capital expenditure for this year but dropping by 25% next year. However, new wells lead to higher EBITDA, which the company has not guided for, but the company typically invests at 5x EBITDA, meaning $30 million expected organically higher next year. Lower capital expenditure and higher EBITDA should lead to lower leverage and higher cash flow.

The company has $3.3 billion of debt with a leverage ratio of 4.2x. This number is slightly elevated because of higher working capital (primarily in NGL inventories), which will reverse later this year. The company continues to target 3.5x leverage, which I think it can hit next year as EBITDA approaches $900 million and free cash this year goes to lowering debt.

The company mentioned during the call that it expects to take out at least the Niobrera asset level preferred shares in 2024, and that the company has the right to redeem 59% in January 2024, removing a structural complexity and reducing the cost of capital.

Valuation:

The units have had a big run this year but continue to trade well below their pre-COVID highs despite improving the balance sheet and rationalizing the asset base. I can see why some people might punt the units given this quarter, but I think that's short term thinking. The "miss" was small and largely one-time in nature. It also shouldn't obfuscate what is clearly a steadily growing cash flow generator, that is extremely close to reaching its leverage targets. The distributions are also largely return of capital so the numbers quoted below are extremely tax efficient.

Risks:

As with anything in the commodity space, particularly energy, CEQP can and has traded sensitive to commodity prices. As we've seen time and again however, even large moves in underlying commodity prices have relatively small (less than 5%) impact on EBITDA and even less on cash flow.

The other risk is the MLP structure. Many institutional investors can't own MLP's and even more can't own anything tied to energy. MLP's are mainly retail investor structures, thereby limiting the investor pool and buying power. It shouldn't matter over the long term but can cause short term volatility.

Conclusion:

I've owned CEQP for years now. The underlying volatility can be annoying but the cash flows regardless of all noise. For yield and tax sensitive investors who can look through short term volatility I continue to think the units offer great value.

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