It S Time for Corenergy to Go Fishing for Another Whale
It’s Time for CorEnergy To Go Fishing For Another Whale
Recently BofA Merrill Lynch downgraded CorEnergy Infrastructure Trust (CORR) to Underperform from Neutral with a $35 price target. BofA cited “an uncertain growth outlook, YTD performance relative to the midstream MLP sector and a somewhat elevated business risk profile.”
BofA believes CORR's growth is driven primarily by M&A, with management having guided to 1-2 transactions per project range in 2017-18, but recent transactions in the midstream sector suggest valuations for high quality midstream assets in many production basins remain elevated overall despite the commodity pullback.
As my followers know, I have been a shareholder in CORR and this Infrastructure REIT was my overall best pick in 2016 (up over 150% on a year-to-date basis). However, so far in 2017, CORR has under-performed the traditional (or perhaps I should say less traditional) Infrastructure REIT peers.
In an article last week I explained that “infrastructure assets are essential customers’ operations to produce revenue” and CORR fits squarely into the thesis that the Trump Administration’s Infrastructure agenda should boost REIT shares.
I first began covering CORR back in January 2015 (see my article HERE) shortly after the energy infrastructure company became a viable REIT alternative. Formerly, CORR was a business development company (or BDC) and opted to restructure to REIT in 2012.
Although energy infrastructure is comparable to other real estate asset classes (cash flow is a high component of total return), the unique characteristics is that the asset class also enjoys a resilient inflation hedge - the distribution that you get with CORR includes underlying contractual features that give visibility over the long run to inflation-based returns (1% to 3% is a reasonable expectation).
The CorEnergy Business Model
CORR primarily owns midstream and downstream U.S. energy infrastructure assets subject to long-term triple net participating leases with energy companies. The amount of infrastructure assets necessary to support the upstream growth in the U.S. generates ripple effects on asset development needs.
By structuring sale/leaseback deals, CORR has minimal operational and/or maintenance risk and the benefits offer tremendous value for the capital-constrained owner/operators.
This niche infrastructure REIT sector is a small untapped category that is often overlooked by the MLPs, and yields are too skinny for the BDCs. By modifying the capital structure to a REIT model, CORR provides a compelling opportunity for companies that need financing to grow their businesses in the energy sector. As illustrated below, CORR has a differentiated and larger investor audience for REITs than MLPs:
Of course, monetizing real estate using a sale/leaseback structure is nothing new. W.P. Carey (NYSE:WPC), arguably the pioneer of the sale/leaseback model, began financing deals for free-standing property owners over 15 years ago and has since morphed into a globally-recognized financier of standalone buildings. See my recent WPC article HERE.
However, CORR does not own buildings per se. Instead, the externally-managed REIT owns midstream and downstream U.S. energy infrastructure assets including pipelines, storage tanks, transmission lines and gathering systems. Energy infrastructure is utility-like…
The Portfolio
CORR owns mission critical assets and lease payments are “operating” expenses, not “financing” expenses. It’s important to note that in bankruptcy, real property operating leases are subject to special provisions. CORR stock moved with commodity prices; revenue and dividends were stable:
Operating leases have priority in payment and bankruptcy. The CORR revenue stream therefore is resilient and protected even during bankruptcy. Therefore CORR’s stock price moved with commodity prices in this cycle, while revenues and AFFO did not, demonstrating the benefit of CORR’s business model for investors seeking infrastructure assets in their portfolio.
CORR’s assets critically support its partners in conducting their businesses in the U.S. energy industry:
CORR’s tenant base includes these companies: Pinedale Natural Gas, MoGas Pipeline, Portland Terminal, Black Bison, Omega Pipeline, and Energy XXI (NASDAQ:EXXI).
Ultra Petroleum the tenant of the Pinedale Liquids Gathering System announced the completion of its restructuring process for which they raised nearly $3 billion in financing. Energy XXI tenant of the Grand Isle Gathering System recently announced several new initiatives including new members of senior management, the development of a third-party reserve report and a revised drilling plan. Both of these companies have resumed trading of common stock on the NASDAQ.
On the recent earnings call, David Schulte (CEO of CORR) explained,
“The energy markets seem to be adjusting to a new normal of $50 crude, bankruptcies have decreased in size and frequency and companies are emerging from restructuring processes which renewed growth expectations, announcing increases in capital expenditure budgets and resumption of drilling plans.
As you can see from the Baker Hughes data (on Slide below), rigs are coming back online in the United States. However, energy companies are still wary of the downturn they just experienced as are their lenders and equity investors. This is where the opportunity lies for CorEnergy.”
Schulte adds that “in a recent survey, energy companies said they're more likely to sell non-core assets if they're faced with bond-based efficiencies still in 2017.”
CORR can acquire what upstream companies might consider to be non-core, but which are essential to their overall operations such as what CORR did for Energy XX1 and UPL.
The sale of an asset (to CORR) provides an alternative to issuing new equity or increasing debt for companies where capital project opportunities exceed internally generated cash flow, particularly at these commodity price levels. After CORR’s recent equity capital raise, the company appears to be well-positioned to act quickly on these potential opportunities, while minimizing the need for new common equity.
The Balance Sheet
Subsequent to the end of Q1-17 CORR capitalized on favorable preferred market conditions through the reopening of its existing Series A Preferred Stock. On April 18th the company closed on the $70 million offering to the issuance of an additional 2.8 million depository shares which resulted in net proceeds of approximately 67.6 million.
CORR immediately utilized $44 million of the proceeds to pay down the outstanding balance on the revolver. These actions promote CORR’s conservative leverage profile, enhanced liquidity and position the company well as we look to grow in 2017 and beyond.
The preferred stock provides investors with what a stable and safe dividend. The issuance of the additional shares brings the total outstanding Series A preferred to over $125 million which provides enhanced liquidity in the market and promotes broader participation in ownership. CORR has a policy of employing moderate leverage supplemented with equity issuances.
These transactions increased CORR’s total liquidity to approximately $132 million on a pro forma basis. The total debt to capitalization as adjusted is at the low-end of the targeted range of 25% to 50% and the preferred equity to total equity ratio of 27% as adjusted remains below the target ratio 33%.
The increased liquidity and low leverage following these actions has significantly enhanced CORR’s ability to timely react to potential acquisition opportunities. Utilizing current capacity as well as potential leverage on assets acquired, CORR is well positioned to transact on one or more opportunities within its target size range. To put it in the context of my title, It’s Time for CorEnergy To Go Fishing For Another Whale.
Photo Source
The Latest Earnings Results
CORR’s AFFO for Q1-17 was $1 per common diluted share quarter (CORR uses AFFO as a measure of long-term sustainable operational performance). AFFO in excess of dividends is reserved and used for debt repayment, capital reinvestment activities, funding liabilities and other commitments deemed necessary to sustain the business model and dividends.
With CORR’s current asset mix the company targets a coverage ratio of 1.5 times AFFO to dividends. It believes that amount of excess coverage is a prudent level enabling the company to reinvest for dividend stability and growth over the long term.
CORR’s AFFO to dividend coverage ratio for Q1-17 was 1.49x and in the seven quarters since the Grand Isle acquisition (on June 30, 2015) CORR’s coverage ratio has ranged from 1.43 to 1.53x. In late April CORR declared its seventh consecutive $0.75 dividend (or $3 annualized) for the common stock. Here’s a snapshot of CORR’s Outlook for 2017:
It’s Time for CorEnergy To Go Fishing For Another Whale
I believe that BofA is wrong with the CORR downgrade and Underperform from Neutral with a $35 price target. See this illustration of CORR’s terminal value conviction:
- CORR’s assets are essential to the operators’ cash flow to support lease renewal expectations.
- CORR’s tenant may not devalue CORR’s asset, i.e. construct a replacement asset
- CORR targets an AFFO to dividend coverage ratio of 1.5x
On the recent earnings call CORR’s CEO explains,
“We believe we have today 8 to 10 actionable projects that we're various stages of initial evaluation, further due diligence or negotiation. And as we said, we believe we can get one to two of those across the finish line yet this year.”
I find CORR’s dividend yield attractive and while I’m certain that shares will not appreciate to the same extent as 2016, I believe that a Total Return of 20% is reasonable given the under-performance YTD. Once CORR announces a new deal it should further diversify the revenue stream and provide the market with clarity that it can generate sound returns within the energy infrastructure landspape.