CEQP - Crestwood: Steady As She Goes

2023-05-03 06:50:13 ET

Summary

• Crestwood beat EBITDA expectations and exited the quarter at a good velocity.
• Drilling activity continues across the company's three main geographies.
• Lots of opportunities to fill excess capacity with current drilling activity and fill in capacity with minimal capital expenditure.
• Asset sale that closed in April heralds the completion of asset realignment.
• Distribution is extremely well covered. The balance sheet is in good shape and getting better.

The Update

Crestwood Equity Partners ( CEQP ) reported a clockwork quarter today (May 2) beating adjusted EBITDA estimates by a couple of million dollars at $192.6 million. The company reaffirmed every line item of guidance it laid out in January despite the drop in natural gas prices.

In order to hit that $820 million midpoint of adjusted EBITDA, the company had to feel comfortable with the steady ramp in drilling activity and well connects in its three main operating geographies: the Williston Basin, the Delaware Basin and the much smaller Powder River Basin. During the conference call, they affirmed that activity remains robust and they expect a meaningful ramp in the back half of the year from new well connect volumes.

The conference call was quite bullish...and I don't say that lightly. These guys tend to be extremely conservative, almost laughably so. But they are seeing some very bullish developments in their main geographies, particularly the Delaware. CEO Bob Phillips explained the company's enviable position of having spare gathering and processing capacity thanks to last year's acquisition of Sendero that will bolster cash flow at minimal cost. He said:

We have years of great Delaware inventory dedicated to our systems there with access to multiple competitive downstream markets. We're very well positioned for future growth in the Delaware. With in-basin gas production continuing to hit record levels, the market for gas processing capacity has become very tight, which places a significant premium on unutilized processing capacity.

Based on our current schedules, we expect to see a significant amount of organic production growth over the next 12 to 18 months that we think will drive near full utilization of our processing capacity. So good timing on the Sendero and CP JV acquisition last year, great integration effort by our operations team, extremely well done built out by our EPM team with new gathering and compression, and we are beginning to utilize all of that processing capacity that we bought last year."

Capital Allocation

The only negative in my mind is that the company's focus on bringing its leverage ratio back to 3.5x means that all free cash this year (and probably next year) will be dedicated to debt reduction instead of repurchasing shares or raising the distribution. I can't fault the company too much as every energy investor has learned that leverage really kills in down cycles so best to buttress the balance sheet. Fortunately, this company can manage all distributions and capital expenditures (both growth and maintenance) and still generate some free cash. The range is wide at $10-90 million, but if history proves any guide, the company will likely come in at the higher end.

Valuation

Valuation remains compelling just on the 10.76% distribution yield alone (most if not all is return of capital btw). But it's good by other metrics as well.

Risks

Unit price risk and operational risk are not the same for CEQP. The operations usually don't vary very much but the units are extremely sensitive to commodity prices, particularly oil. I have seen it happen many times. Oil takes a dive and takes these units with it, even though EBITDA and cash flow are not affected much by the price of oil unless it's for a multi-year stretch. Still in my mind that's the biggest risk here. There is also the risk of drillers stopping activity. The company's guidance is based on $80 oil and $3.50 gas. We're below those prices now.

Conclusion

I think CEQP compensates investors for the potential volatility of the units. This company is almost a classic example of Warren Buffett's Mr. Market allegory. If you're not familiar with it, Buffett says some days Mr. Market is manic and wants to pay you crazy prices for stocks. It's best not to buy on those days. In fact, one should sell. On other days, Mr. Market is depressed and willingly sells you his shares at absurdly low prices. That's when you should buy. Right now, CEQP is sort of in a middle ground. It offers great yield here, but we've all seen it go below $20 if oil prices really fall. I love it as an income play, particularly a tax efficient one. Just be prepared for potential unit downside in a bad oil tape. Size any positions accordingly or hedge with out of the money puts on oil.

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