MVP - Legacy Ridge Capital - Equitrans Midstream: Most Valuable Pipeline

2023-07-29 05:50:00 ET

Summary

• Equitrans Midstream, operator of the Mountain Valley Pipeline, has faced significant delays and cost overruns in the construction of the pipeline.
• The completion of the pipeline is uncertain due to ongoing litigation and a recent stay issued by the 4th Circuit Court.
• Despite the challenges, Equitrans Midstream remains optimistic about the potential value of the pipeline and its existing assets.

The following segment was excerpted from this fund letter.

Equitrans Midstream ( ETRN )

Equitrans Midstream is a small position in the fund—less than 6%—and has been a decent contributor to performance YTD, but it hasn’t been a smooth ride in the least. ETRN is the operator and majority owner of the Mountain Valley Pipeline ( MVP ), a 303-mile natural gas pipeline proposed in 2014, approved by the FERC in 2017, and started construction in 2018. The estimated build cost was $3.5 billion, and the estimated completion date was early 2019. Now 4+ years behind schedule due to litigation and $3.1 billion OVER budget, and we might have line of sight to flowing gas by year-end 2023.

Maybe. Section 324 of the Fiscal Responsibility Act expedited the completion of MVP by approving all remaining permits and by directing all appeals to the validity of the law to DC district courts. But it appears not even an act of Congress can get the final 10% of the project across the finish line. The 4 ^th Circuit Court has once again issued a stay to halt construction as they consider arguments from environmental groups that the debt ceiling negotiation was unconstitutional.

We started buying ETRN in February 2022 around $7 a share and averaged down when presented the opportunity, resulting in an average cost basis of $6.87 on the common equity. In addition, we added call options to take advantage of the excess volatility, including Jan 24’ $5 strikes for $.55 per contract this past April when the stock fell to $4.60. While I’m generally opposed to catalyst driven investment theses, for some reason the math on this one made sense to me. In the event MVP was scrapped we thought the existing assets were worth $6 - $7 a share, and that the company could possibly maintain the dividend, or would for at least another several quarters, which provided a high-single-digit yield. In other words, at a mid-single-digit entry price we thought our downside was extremely limited.

We also thought there was even odds MVP would eventually get approval since it was over 90% complete and had started to gather bipartisan congressional support. Swing Democrat Joe Manchin was a big proponent of the project because it originates in his home state of West Virginia, and he had received support from the White House for broader permit reform coming out of the Inflation Reduction Act negotiations. Logic suggested it was getting done despite constant roadblocks erected by the 4 ^th Circuit.

If/when MVP is completed we think the stock is worth $10 or more. So, our probability weighted valuation had us somewhere around 5% downside (including dividends) at the time of purchase, and 50%+ upside (including dividends) over 1-2 years. A risk/reward we found favorable.

On July 17 ^th ETRN submitted an emergency request to the US Supreme Court asking it to overturn the 4 ^th Circuit’s stay. As we go to press the stock is ~$9 a share while we wait to hear from SCOTUS. With the stock up 95% from the April low, we’ve completely exited our option position but are holding onto the common for the time being.

Regardless of what happens with MVP and the circus surrounding it, the drama highlights how hard it is to build interstate infrastructure in this country and how valuable existing assets are. At a cost of $22 million per mile built, MVP makes us feel great about the high replacement cost implied for our other holdings and the downside protection that affords us. Enterprise Products’ ( EPD ) 50,000 miles of pipeline alone would be worth as much as NVIDIA using this simple math, while all EPD’s assets (pipes, fractionation towers, storage tanks, export docks, etc.) are currently only worth 7% of NVIDIA! Of course, the math is much too simplistic and pipes in Texas and many other states are easier and less costly to build than those on the East coast, but our hand grenade approach to investing—as opposed to horseshoe—suggests we’re well within range of some decent value!

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

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