Midstream & MLPs: Bring on the Buybacks

11/10/20 | Stacey Morris

Summary //

  • With double-digit yields common across midstream, payouts feel largely underappreciated by the investment community, and those elevated yields make the case for stock repurchases all the more compelling.
  • Third quarter earnings announcements saw five new buyback authorizations in the midstream space, bringing the total number of companies with buyback programs to 14.
  • For midstream investors, the proliferation of buyback authorizations is a welcome development and provides tangible benefits of the anticipated free cash flow inflection in the space. Importantly, buybacks can help support midstream equity prices into a macro recovery.

The potential for midstream buybacks as free cash flow generation ramps has been a recurring comment in Alerian’s research. With six repurchase authorizations announced since October, including five in the past week or so, buybacks are a timely topic to revisit. Today’s note provides an update on buyback authorizations, amounts spent on repurchases through the third quarter for those with existing programs, and the competition between dividends and buybacks in capital allocation decisions.

Buybacks gaining traction.
Third quarter earnings announcements saw five new buyback authorizations in the midstream space – MPLX (MPLX), Plains All American (PAA), EnLink Midstream (ENLC), Rattler Midstream (RTLR), and Western Midstream (WES). With these additions, there are now 14 companies with buyback authorizations in the broad Alerian Midstream Energy Index (AMNA), which has 42 total constituents. The companies with buyback authorizations represent a diverse group in terms of size, structure, and sector classification. Of the 14, eight are structured as MLPs, and only one Canadian corporation has a buyback program. The table below includes the midstream companies with repurchase authorizations and their weightings in the AMNA Index, Alerian MLP Infrastructure Index (AMZI), and Alerian Midstream Energy Dividend Index (AEDW).

11.10.2020 - Table 2

Buybacks vs. dividends.
With double-digit yields common across midstream, payouts feel largely underappreciated by the investment community, and those elevated yields make the case for stock repurchases all the more compelling. From a capital allocation standpoint, companies are weighing the best way to return cash to investors. As discussed in a note earlier this month, Kinder Morgan (KMI) signaled flexibility in its approach to returning excess cash flow to shareholders, mentioning dividend increases and/or share buybacks in its 3Q release and omitting the prior target of achieving an annualized dividend of $1.25 per share. Perhaps the best example of weighing dividends and buybacks is RTLR reducing its distribution by 31% while simultaneously announcing a $100 million repurchase authorization. As reflected in the quote below from the 3Q call, the decision to cut the distribution and deploy buybacks was an opportunistic move to reallocate capital in response to market conditions, and management believes the decision will ultimately reward RTLR unitholders.

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While a case can be potentially made for reducing dividends to repurchase shares in some situations, it seems unlikely that many names would follow RTLR’s example. For one, several midstream companies stand to generate meaningful free cash flow after dividends, supporting both steady dividends and opportunistic buybacks (read more). Additionally, many management teams are sensitive to investor desires or needs for the income these companies provide. Instead of cutting payouts to repurchase shares, midstream companies may continue to put dividend growth on hold until yields improve and prioritize buybacks over increases to dividends. In the wake of macro headwinds and elevated yields, dividend growth has already been widely suspended with only a few notable exceptions (read more). For those companies generating meaningful free cash flow with comfortable leverage positions, buybacks will likely represent a more compelling way to return cash to shareholders until equity values improve and yields return closer to historical averages.

What does this mean for investors?
For midstream investors, the proliferation of buyback programs is a welcome development and provides tangible benefits of the anticipated free cash flow inflection in the space. Buybacks represent a significant reversal from the old MLP model of issuing equity. Importantly, buybacks can help support midstream equity prices into a macro recovery, which is self-help that was not available coming out of past energy downturns.

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