2023-06-07 17:37:32 ET
Summary
- Genesis Energy, L.P. is a unique midstream company that operates in many sectors that peers do not.
- The company has significant near-term growth potential in both the traditional and green energy sectors.
- The company has largely addressed the debt problems that it had prior to the pandemic and is now one of the strongest companies in the industry financially.
- Genesis Energy's 5.99% yield is easily sustainable and could be increased in the near future.
Genesis Energy, L.P. ( GEL ) is a rather unique midstream master limited partnership, or MLP, that operates in several areas that other midstream companies do not. This is something that could allow the company to provide a certain degree of diversification to a portfolio that consists of more traditional master limited partnerships.
Unfortunately, the company's current 5.99% distribution yield is not as impressive as some of its peers, but the company has made strong strides at improving its balance sheet and it is likely to experience relatively strong growth over the near term, so we might see it increase its distribution in the near future. The fact that Genesis Energy has been improving its balance sheet is something that is quite nice to see since this has been one of our biggest concerns about this company since we began discussing it here at Energy Profits in Dividends nearly five years ago. As the company does share several of the characteristics that we appreciate in income plays, such as remarkably stable cash flows over time, it continues to be worth watching and considering as an addition to a portfolio today.
About Genesis Energy
As stated in the introduction, Genesis Energy is a rather unique midstream master limited partnership because it operates in several business segments that other midstream companies do not. The company's four business segments are:
- Offshore Pipeline Transportation: Genesis Energy owns and operates approximately 2,400 miles of pipelines that transport resources produced by offshore production platforms in the Gulf of Mexico back to the shores of Texas and Louisiana.
- Soda and Sulfur Services: Genesis Energy owns the largest trona deposit in the world, giving it control of approximately 80% of the world's natural soda ash reserves. Natural soda ash is used in a variety of products, including many of which are necessary for the production of "green" technologies.
- Marine Transportation: Genesis Energy owns a fleet of marine vessels that are used to transport fossil fuels along America's waterways.
- Onshore Facilities and Transportation: The company owns and operates a comparatively small (relative to peers) network of onshore pipelines and storage facilities.
Of these, the first two are rather unique in the sector as there are very few midstream companies that still operate offshore in the Gulf of Mexico. In the past, we had companies such as BP Midstream Partners with significant operations in this space but many of them have been merged back into their general partners and sponsors. This leaves Genesis Energy as one of the only independent companies with a significant pipeline infrastructure servicing the region. As already stated, the company owns approximately 2,400 miles of pipelines that carry resources from various production platforms located in the central part of the Gulf of Mexico to the shore:
These pipelines utilize the same business models as the onshore pipelines operated by Genesis Energy's peers. Basically, Genesis Energy enters into long-term contracts with its peers under which the company uses its pipelines to transport the customer's resources from the offshore production platform to the shoreline. In exchange, the customer compensates Genesis Energy based on the volume of resources that are transported and not their values. This provides Genesis Energy with a significant amount of insulation against resource price changes.
The company also has a certain amount of protection against the fact that we frequently see energy production decline when resource prices are low. First, the contracts that Genesis Energy has with its customers specify a certain minimum volume of resources that must be transported through the company's pipelines or paid for anyway. In addition, it is much more difficult to shut down or reduce production at an operating offshore well than it is at an onshore shale operation. We can see this general stability by looking at the historical resource volumes flowing through Genesis Energy's pipelines. Here they are:
As we can clearly see, there was not a significant decline in volumes during low crude oil price years such as 2015 or 2020. This lends itself well to giving Genesis Energy relatively stable cash flows regardless of the conditions in the broader economy. We can certainly see this as the company's segment margin (a proxy for gross profit) has been relatively stable during each of the full-year periods from 2019 to 2022:
This is exactly the kind of thing that we like to see in an income-focused investment since general financial stability lends a considerable amount of support to the distribution. After all, it is much easier for a company to pay out a substantial portion of its cash flows to investors if it has some certainty that it will earn about the same amount of money next year. It is a similar situation to how a salaried employee has more confidence in their ability to carry a large mortgage than a self-employed person.
The Gulf of Mexico has admittedly not been as much of a production hotbed as other areas like onshore shale plays over the past fifteen years or so. This is due to a variety of reasons, including the Macondo disaster in 2010 and the fact that shale production requires a much smaller upfront investment. However, the region is still seeing some development and this should benefit Genesis Energy. There are currently two major projects within the footprint of Genesis Energy's infrastructure in the Gulf of Mexico that are scheduled to come online between now and early 2025:
These two projects have been in development for a number of years, which is yet another reason why offshore has not seen as much production growth as onshore shale and similar plays. It takes many years to bring a field to full production and crude oil companies are increasingly unwilling to make that sort of commitment given the somewhat hostile environment that many governments around the world have created for fossil fuels.
These two projects that are going to come online in the near future will have a direct beneficial impact on Genesis Energy, however. This is because the operators of the respective projects have already entered into transportation contracts with Genesis Energy. Thus, once the Shenandoah and Salamanca projects come online, resources should start flowing through the company's pipelines and directly boost its cash flows due to the volume-based business model. Thus, Genesis Energy is not simply a bastion of stability but is also positioned for growth.
As mentioned earlier in the article, Genesis Energy owns the largest trona deposit in the world, which contains approximately 80% of the world's natural soda ash reserves.
Natural soda ash is not a resource that we hear very much about in the media. However, it is used in a variety of products that most people use every day including glass, soap, and various other chemicals. All of these are products that tend to enjoy relatively stable demand during both economic booms and recessions, which works out pretty well for Genesis Energy since it supports the financial stability thesis that we discussed earlier.
However, there is one source of future demand that could provide Genesis Energy with substantial growth prospects. Natural soda ash is used in the production of lithium carbonate, which is essential for the production of lithium iron-phosphate batteries that are used in next-generation electric vehicles as well as energy storage solutions to help manage the fact that renewable energy generation suffers from a severe reliability problem. As anyone that has invested in Tesla ( TSLA ) and similar companies over the past decade will tell you, electric vehicles are expected to account for an increasing percentage of the cars on the road going forward. For its part, the Federal Government through the Inflation Reduction Act of 2022 is offering enormous subsidies to try and make this happen.
Thus, the demand for these batteries will likely increase over the coming years as this story plays out. That will increase the demand for natural soda ash as a vital component in these batteries. When we consider that Genesis Energy controls most of the world's reserves of this compound, it should be pretty easy to see how Genesis Energy will see growing demand for its product.
As we discussed in previous articles on Genesis Energy, the company has been working to increase its production of natural soda ash in order to meet this emerging source of new demand. Earlier this year, the company completed the restart of its Granger production facility, which is capable of producing approximately 500,000 tonnes of natural soda ash per year. The company also has an expansion to this plant in the works, which will add another 750,000 tonnes of annual production capacity when it comes online during the second half of this year. These two projects combined will result in Genesis Energy exiting the year with 1.25 million tonnes of incremental production capacity above what it had at the start of 2023. This should obviously have a very positive impact on the company's cash flow as we enter 2024.
Financial Considerations
It is always important that we investigate the way that a company finances its operations before making an investment in it. This is because debt is a riskier way to finance a company than equity because debt must be repaid at maturity. That can cause a company's interest expenses to increase following the rollover in certain market conditions. As interest rates in the United States are currently at the highest levels that we have seen since 2007, that is a very real concern today. In addition to interest-rate risk, a company must make regular payments on its debt if it is to remain solvent. Thus, an event that causes a company's cash flows to decline could push it into financial distress if it has too much debt. Although midstream companies like Genesis Energy tend to enjoy remarkably stable cash flows, this is not a risk that we should ignore.
One metric that we can use to judge a midstream company's ability to carry its debt is the leverage ratio, which is also known as the debt-to-adjusted EBITDA ratio. This ratio tells us how many years it would take a company to completely pay off its debt if it were to devote all of its pre-tax cash flow to that task. As of March 31, 2023, Genesis Energy had a leverage ratio of 3.99x based on its trailing twelve-month adjusted EBITDA. This is reasonable as Wall Street analysts generally consider anything below 5.0x to be acceptable.
However, I am more conservative and like to see this ratio below 4.0x in order to add a margin of safety to the position. This is the level that many midstream companies have been working to achieve ever since the COVID-19 pandemic and it is also the maximum possessed by all of our recommended companies here at Energy Profits in Dividends. It is nice to see that Genesis Energy is now in this category, as the company's debt level has long been one of the biggest problems with it.
Another very nice thing to see with respect to Genesis Energy's debt load is that the company does not have any near-term maturities. We can see this here:
The reason why this is nice to see is the aforementioned interest rate risk. As mentioned earlier, interest rates are currently at the highest levels that we have seen in more than fifteen years. As such, it would be reasonable to assume that any debt that the company has to roll over today will be done in a much higher interest-rate environment than previously. Thus, a debt rollover will almost certainly raise its interest expenses.
As we can clearly see though, it does not appear that Genesis Energy will need to roll over any debt until 2025. A lot can happen in that time and it is certainly possible that rates will be lower at that time, thus allowing a reasonable interest rate following the rollover. More importantly, though, Genesis Energy's cash flow should climb going forward so it has the opportunity to pay off some of this debt out of its cash flow before it comes due. Thus, there may be less debt that needs to be rolled over, offsetting some of the interest rate risks.
Distribution Analysis
One of the biggest reasons why we invest in midstream master limited partnerships is the high yields that these companies typically possess. Genesis Energy is certainly no exception to this as the partnership units yield 5.99% at the current price. Unfortunately, the company's distribution history leaves something to be desired. As we can see here, the company cut its payout back in 2020 and has yet to restore it to its previous level:
Indeed, the company has failed to raise its distribution at all, which is a stark difference from companies like Energy Transfer LP ( ET ) that have made efforts to restore their distributions as their finances and business prospects improved over the past few years. The reason for the initial cut is simply that the pandemic crashed energy prices and upstream companies reduced their capital investments and growth plans, which created a lot of uncertainty for companies like Genesis Energy. While the company's cash flows were largely unaffected by the fall in crude oil prices, the sector was cut off from the capital markets and transportation contracts do not last forever. In the case of Genesis Energy, it also had a need to substantially reduce its debt at the time.
Of course, anyone buying the partnership units today does not really have to worry about the company's past. This is because an investment today will deliver the current distribution at the current yield. Thus, the most important thing for our purposes today is that Genesis Energy can maintain its current payout at the current yield. After all, we do not want to be the victims of another distribution cut since that would reduce our incomes and almost certainly cause the stock price to decline.
The usual way that we judge a midstream company's ability to cover its distribution is by looking at its distributable cash flow. However, Genesis Energy does not report this figure. The comparable equivalent used by this company is "Available Cash Before Reserves," which is a non-GAAP measure that theoretically tells us the amount of cash that was generated by the company's ordinary operations and is available for distribution to the limited partners. During the first quarter of 2023, Genesis Energy reported an available cash before reserves of $77.672 million but the distribution only costs $18.387 million. This gives the company a distribution coverage ratio of 4.22x, which is incredibly high. Wall Street analysts generally consider anything above 1.20x to be sustainable over the long term.
I am more conservative and like to see this ratio over 1.30x to add a margin of safety to the investment. As we can clearly see, Genesis Energy easily meets both of these requirements and should easily be able to sustain its distribution at the current level. Indeed, the company could double its distribution and still have a substantial amount of cash left over for other purposes, such as debt reduction. Overall, we have nothing to worry about here.
Conclusion
In conclusion, Genesis Energy, L.P. is a very unique midstream partnership, but this certainly does not make it a bad investment. In fact, there are many reasons to like the company today, as it has mostly resolved the problems that it had prior to the pandemic and is very well-positioned for near-term debt. The 5.99% yield is easily sustainable and will probably be increased at some point as the growth story plays out. Overall, Genesis Energy, L.P. stock might be worth adding to a portfolio today.
For further details see:
Genesis Energy: A Unique High-Yielder In The Midstream Sector