2023-12-07 10:44:14 ET
Summary
- Genesis Energy reported better-than-expected 3Q23 results, with adjusted EBITDA of $191M vs $178M/$174M consensus/our estimate.
- The company affirmed its guidance for adjusted EBITDA of $725-$745M for full year 2023.
- Assuming 1.5 standard deviations below the five-year EV/EBITDA multiple suggests Genesis Energy could more than double by the end of 2025.
- Management initiated unit repurchases during Q3, signaling it has both the means and the will to support the unit price.
Investment Thesis
Genesis (GEL) is in the midst of a multi-year turnaround after years of underperformance and an overleveraged balance sheet. Debt leverage peaked at over 6x in 2016 and remained above 4.9x through 2019 and went back over 5.9x in 2021 before dropping two turns to end 3Q2023 at 3.9x.
Genesis 3Q adjusted EBITDA beat at $191M vs $178M consensus, and our $174M estimate or 9%. Segment margins were ahead of our estimate as Sodium Minerals and Sulfur Services delivered $62M vs $49M estimated, Offshore Pipelines beat by 10% at $109M vs $99M estimated, Onshore Facilities beat at $9.5M vs $6.4M estimated, and Marine Transportation beat at $27.1M vs $25.2M estimated. The total segment margin was ahead by $28M relative to estimate or 16%.
Management guided adjusted EBITDA to the higher end of its previous $725-$745M range despite the solid beat on expectations for continuing soft soda ash pricing and some expected maintenance downtime on its offshore pipelines. In addition, volumetric disruption at client refineries in the NaHS business is reducing the contribution by some ~$20M below its typical contribution.
In response to the reiteration of 2023 guidance, we have kept our 2023 and 2024 figures close to our prior numbers. For 2025, management said its offshore pipeline system should be on track to deliver $500M in segment margin, prompting us to raise our numbers by 9%, to $483M. We trimmed minerals outlook out of conservatism on pricing taking our total segment margin +4%/+0%/+3% and our adjusted EBITDA +1%/+0%/+3% for 2023/2024/2025 respectively, to $745M/$795M/$874M which compares to the Street at $741M/$761M/$840M.
Embedded in the forecast is the guide that offshore pipelines should be on a $500M gross margin contribution by 2025. Most of the increase is for volumes related to Argos in 2024 and SYNC in 2025 by assuming an increase on CHOPS and Poseidon of an aggregate of 155k b/d even as there is expected to be an increase of approximately 200k bbl/day between Argos (from ~90k b/d to ~140k b/d or +50k b/d), Shenandoah (+100,000 b/d with first production expected late 2024 or early 2025), and Salamanca (+60,000 b/d first production expected early to mid-2025) as well as not counting any volume from potential opportunities in discussion that are expected to add an incremental 150k-200k b/d.
The applicable narrative from the 3Q earnings release:
“During the quarter, we continued to see a steady ramp in volumes from BP’s Argos facility, which is fast approaching 90,000 barrels per day as well as strong volumes from King’s Quay, Spruance and our other host fields.”
“It is important to remember that we continue to expect to see our volumes grow into 2024 with additional wells at Argos coming on-line and a full year’s worth of production from several new developments and sub-sea tiebacks. Furthermore, we have successfully laid the 105 miles of the SYNC lateral and remain on schedule and importantly on budget with this project and our CHOPS expansion project, both of which we expect to be ready for service in the second half of 2024. The contracted Shenandoah and Salamanca developments and their combined 160,000 barrels of oil per day of incremental production handling capacity remain on-schedule and will be additive to our then base of volumes in 2024. These two new projects, combined with our steady base volumes and an increasing inventory of identified sub-sea tiebacks, provides us with the visibility to generate more than $500 million per year of segment margin starting in 2025.”
Softer soda ash pricing and margin is assumed going forward and which accounts for trimming the sodium and minerals segment outlook for 2024 and 2025 and despite the voracious demand for glass from the very strong growth in solar panels and which accounts for about half of the demand for soda ash per the company investor presentation. Genesis management is referencing weak economic growth from China, early signs of slowing in the US and Europe combined with an increase in new production from Inner Mongolia.
We believe that the long term global demand assumption of 2-3% per year excluding China is conservative given that others forecast a 7.5% growth rate in the soda ash market (see Soda Ash Market Size, Share, Growth | CAGR of 7.5% ) though such forecast does not exclude China.
The company just updated the investor presentation this week and the graphic on page 4 presents the outlook in an easy-to-understand format:
Balance Sheet and Distribution Forecast Update
As a result of taking a more conservative distribution growth trajectory, we are forecasting leverage to drop by 0.2x through the end of 2024, drop by 0.1x in 2025, 0.3x in 2026, to 3.6x/3.5x/3.2x for 2024/2025/2026 before reaching below 3x by the end of 2028.
We are not modeling repurchase of the common units (despite GEL management announcing authorization to repurchase common units) into our forecast, but continue to believe that management is likely to begin repurchasing the preferred units beginning 2H2024 at a rate of $60M/Q through the end of 2027. GEL is forecast to raise the distributions on common units but at a more modest trajectory of increase than what was assumed in the past. Distributions are projected to rise from $0.15 per unit/Q currently, to $0.30/Q ($1.20 annualized) beginning with the 4Q2024 declaration (payable in 1Q 2025) and then increase the distribution by $0.04/unit/Q in 2025 and follow that with $0.02/unit/Q from 2026 through 2028. The growth rate would be triple digits in 2025 over 2024, moderating to 27.5%/15.7%/13.6% for 2026/2027/2028. With an annualized distribution of $1.84/unit by 4Q2025 GEL units, the units ought to rise into the $20’s assuming a 6.5%-9.0% yield range. The low $20s would put GEL at a valuation that is approximately two standard deviations below the average of the last five years as explained further below.
Valuation
Our valuation outlook is mostly modest adjustments to our previous forecast. We believe there are likely to be fewer pullbacks since management has begun executing the repurchase of GEL’s units on an opportunistic basis. Approximately 114,900 units were repurchased during 3Q at an average price of ~$9/unit.
Based on a valuation of 1.5 standard deviations below the five-year historical average EV/EBITDA multiple, GEL units would trade at $14 by the end of 2023 (based on 2023E EBITDA), $18 by the end of 2024 (based on 2024E EBITDA) and $25/unit by the end of 2025 (based on 2025E EBITDA). All these target valuation figures are very conservative since most stocks trade based on forward estimates which suggests they could trade somewhere between $25 and $31 by the end of 2025. If GEL units were to trade at the historical average multiple (which I won’t) would imply ~triple the value of where they trade today. Still, even if the units trade at two standard deviations below the average of the last five years, would suggest upside of ~80% over the next two years.
As shown below using the low multiple of 1.5 standard deviations below the average of the last five years would still result in shares more than doubling based on forecast EBITDA for 2025.
Risks
Weather: With offshore pipelines that deliver services to offshore oil and gas production platforms, volumes are subject to disruption in the event of severe weather such as hurricanes. While the average hurricane season sees ~6 days of down time and guidance has assumed a conservative 10 days of down time, days of disruption is highly variable. Over the last decade the number of days of disruption has varied from 0 to 30. We estimate that 30 days of disruption could negatively impact segment margin by ~$20-$30MM while 0 days of disruption could positively impact segment margin by ~$10MM relative to guidance and our estimate.
Soda ash prices: Full year 2023 guidance was cut earlier this year as a result of softening prices in the soda ash market brought on by a combination of new supply coming into the global market from Inner Mongolia as well as the relatively weak economic recovery in China. There has also been a slowdown in demand coming from U.S. and European markets that could translate into soft prices in the near term. Longer term the soda ash market is expected to show strength from lithium and solar panel customers.
Economy: While a recession has so far been avoided, there are a number of economic indicators signaling a coming recession such as prolonged yield curve inversion, CPI reaching over 5% (latest read was 3.2%), manufacturing PMI in contraction eight consecutive months, Conference Board LEI index below -4%. GDP growth and earnings on the S&P500 usually trough 24 months after interest rates peak (which would suggest such trough would hit 1H2025) but the timing is the subject of debate. The economy in 2023 has proven to be stronger and more resilient than previously expected. With the full impact of higher interest rates usually taking 18-24 months, we would expect some slowing in 2024 with the offset is that the labor market remains tight and federal government spending on infrastructure programs of nearly $1Trillion (IIJA, IRA, Chips Act) has offset the policy actions of the Fed to some extent. Should there be no recession in 2024, we would expect some upside to guidance, particularly in the Minerals and Sulfur Services segment that have more exposure to the economic cycle than the rest of GEL’s businesses. That being said, management has indicated that the soda ash market has softened significantly compared to what they were seeing at the beginning of the year.
Inland Freight Market Prices: As mentioned earlier the inland marine shipping market is very tight with leader Kirby indicating that capacity utilization is running in the mid 90% range. GEL management has seen the utilization of its vessels as at or close to 100% and prices not seen since 2014. There is very little new marine capacity being built and according to Kirby ( KEX ), they are expecting fewer vessel additions than retirements, putting upward pressure on marine transport pricing. For example, barge utilization rates were in the low 90s% range and spot market prices were up mid-single digits Q/Q and mid to high 20% range Y/Y. Should there be any kind of surge in capacity and/or demand for transport services, there could be a downside in the margin contribution from GEL’s marine transport business.
Offshore Pipeline volumes: We have been conservative in our assumptions regarding the volume ramp from the Argos, King Quay, Salamanca, and Shenandoah platforms. None-the-less, there is a risk that the total volumes could arrive slower than our forecast. Delays to the timing and/or volumes could result in lower EBITDA than what we forecast in our model.
Valuation: While applying a valuation multiple 1.5 standard deviations below the average of the last five years suggests that GEL units could more than triple from current levels over the next five years, nonetheless, depressed valuations could continue or even get worse than they are now given the somewhat negative sentiment toward the fossil fuel industry including infrastructure. Both higher expected distributions and/or unit buybacks could mitigate depressed valuations to a large extent.
Conclusion
While 3Q23 results beat and the guidance was affirmed at the high end of the range from the 2Q report, the outlook remains among the best for Genesis Energy in years. Genesis struggled for a number of years but has turned the corner.
We continue to believe that an investment in Genesis Energy units remains compelling and has a high probability of delivering returns to investors that outperform the broader market averages all while delivering attractive income.
For further details see:
Genesis Energy: Q3 Beat, Guidance Maintained, Modest Raise To EBITDA And Longer-Term Outlook