After Kinder Morgan (KMI) kicked off midstream earnings season last week, both Enterprise Products Partners (EPD) and ONEOK (OKE) held their 1Q20 earnings calls yesterday. While actual results may be less of a focal point for investors this quarter given a noisy environment (read more), management commentary can provide valuable insight into the outlook for the industry. Today, we discuss some of the key learnings from EPD’s and OKE’s earnings calls.
Financial guidance updates – OKE reported slightly lower than expected adjusted EBITDA for the quarter, but all eyes were on the company’s guidance updates. Management rescinded its previously issued 2020 and 2021 EBITDA guidance given the uncertainty surrounding the broader macro environment but did provide a scenario analysis range of $2.6 billion to $3 billion for 2020 adjusted EBITDA. Management noted that this analysis was based on several different assumptions for the rate of recovery of commodity prices, volumes, and producer activity through the remainder of the year. The scenario analysis midpoint of $2.8 billion represents a 13% reduction from prior guidance for 2020 adjusted EBITDA but a 7% year-over-year increase relative to 2019. Growth capital expenditure guidance for 2020 was also reduced by another $400 million adding to a $500 million reduction announced in mid-March, bringing the company’s total growth capex budget for 2020 to $1.6 billion at the midpoint (down 56% from 2019). Shifting to EPD, the partnership does not provide EBITDA guidance, but EPD lowered its 2020 growth capital budget by $1 billion to $2.75 billion at the midpoint and is forecasting further spending cuts in 2021 and 2022. Capex could see additional reductions later in the year pending negotiations with joint venture partners on upcoming projects. For the space more broadly, midstream capital spending was already in decline coming into 2020 (read more), and these reductions in discretionary spending further demonstrate capital discipline and flexibility amid a pressured energy environment.
Cash flow stability – Midstream operators have been proactive in highlighting investment grade customer bases and fee-based exposure in the last two months (read more), and yesterday’s earnings calls provided EPD and OKE another opportunity to emphasize the stability of their businesses. Taking into account that three of EPD’s customers have been downgraded from investment grade to junk status in recent weeks, 78% of 2019 revenues from the partnership’s top 200 customers came from investment-grade counterparties or were backed by a letter of credit. EPD’s earnings are typically 80%-90% fee-based per management, and roughly half of its fee-based earnings are derived from take-or-pay agreements. The issue of force majeure was also raised given the rapid increase in crude inventories and consequential lack of storage capacity (read more). Management was comfortable that the partnership would not be subject to force majeures in its contracts as a result of lower oil prices. Turning to OKE, nearly 100% of its natural gas pipeline business, representing just over 16% of total 1Q20 adjusted EBITDA, operates under take-or-pay contracts with electric and utility customers, which may benefit from increased demand for natural gas as a source of power generation (read more). The company also noted that it has had one customer in the Williston Basin file for bankruptcy protection. However, this customer continues to provide OKE’s system with volumes, and management does not anticipate notable counterparty risk among its other large customers in the basin.
Returning capital to shareholders – EPD and OKE both maintained their 1Q20 dividends, reporting coverage ratios of 1.6x and 1.35x for the quarter, respectively. On their earnings calls, both companies restated their commitment to their dividends going forward, with EPD noting that it will evaluate distribution growth on a quarterly basis. EPD also repurchased $140 million of common units during the quarter under its buyback program, substantially all of which came before the outbreak of COVID-19 and the subsequent collapse in oil prices. Earlier in the year, the partnership stated its expectation to use 2% of 2020 cash flow from operations to complete unit buybacks. For context, the $140 million in 2020 repurchases represents 2.1% of 2019 operating cash flow. As discussed by management, EPD, along with many other midstream operators, will most likely wait to see how the longer-term economic outlook shakes out before making any further decisions regarding increasing the return of capital to shareholders.
MLP vs. C-Corp commentary – In prior quarters, EPD management has typically fielded questions regarding their thoughts on the MLP structure. However, when asked if their views on EPD’s structure had changed, Co-CEOs Randy Fowler and Jim Teague noted that a C-Corp evaluation has been put on the back burner given the focus on executing in the current environment. Fowler did note that he expects an increase in corporate income tax to be forthcoming, which would disadvantage C-Corps relative to MLPs, given MLPs do not pay tax at the entity level. He also mentioned his surprise at the volatility of some C-Corp names during this downturn. Structure questions are likely to continue to take a backseat to operational execution in today’s challenging environment, especially given the uncertainty that comes with the upcoming election (read more).