Copano Energy CPNO
December 30, 2008 - 9:38am EST by
dle413
2008 2009
Price: 9.78 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 580 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

Intro and Brief Thesis

I am recommending Copano Energy (CPNO) as a long. CPNO is a gathering and processing (G&P) company trading near a trough valuation that reflects market expectations of revenue and profit declines and a distribution cut. CPNO has a strong asset base, ample liquidity, a strong balance sheet, limited current dependence on natural gas (NG) and natural gas liquids (NGLs) prices, and built-in-growth for the next three years – which, at the least, will protect against a decline in the current business. Though CPNO trades in line with many of the smaller G&P master limited partnerships (MLPs), many factors differentiate CPNO.
 
With a 23%+ dividend yield, a 138% dividend coverage ratio and 80% tax deferral, the company is providing great value to its shareholders/partners. Further, the company is structured as an LLC, not an MLP, so all future growth goes to the current shareholders. Perhaps the biggest margin of safety is derived from the fact that the built-in growth should more than offset any potential declines in the current business due to volume and price (NG and NGL) declines. Normalized distributable cash flow is greater than $3.00 per share. In that scenario, it is fairly easy to extrapolate the math and look two years out at a total return of 80 to 100%. The math is: 22 to 25% dividend yield (assuming no change from the current dividend) plus an increase in the stock price to the $14 to $17 range (which would imply a mid-teens yield on the stock). And, of course, this is mostly tax-deferred. Note that for a medium or high-grade junk bond, the required interest (yield) would need to be over 35% to match the current 23% CPNO yield.

Company and Industry Background

CPNO is a growth-oriented midstream energy company structured as a Limited Liability Company.  CPNO provides services to natural gas producers, including natural gas gathering, compression, dehydration, treating, transportation, processing and conditioning. As an LLC, there is no double corporate taxation and no separate general partner (GP) that receives half the profits above a certain threshold, This creates a lower cost of capital for its investors versus MLPs and corporations.   Further, unlike an MLP, the board is elected by unit-holders – so there is some sense of control by shareholders.   Further, a simple corporate structure enables the company to buy or be bought more easily in an industry ripe for consolidation.


As to natural gas usage, historically it has not declined materially in past downturns – though I am not assuming that now. Virtually all of the fields that Copano services are traditional wells, which require constant flow (by producers) to prevent permanent shut-in. Lifting costs for most of their fields are in the 1.70 to 3.00 per MCF range.

In an effort to keep this easier to parse through, the rest will be in outline structure.


What
: The company has pipes running from the well-heads to their processing facilities and into the distribution system.
 
Cash Flow Mix:

-          >55% is fee based

-          16% is keep-whole (KW) – where CPNO guarantees the producer a certain fee for its production based on its BTU (heat) content. CPNO then sells the production volumes for its own account taking all risk. The company uses simple hedging (through puts) and extra fees to cover their risk. The 10Q gives detailed information on the hedges – information that you can actually understand)

-          7% is percent of proceeds (POP) – the most exposed sector to pricing. To hedge out risk, the company buys puts as well

-          20% percent of liquids (POL) – also exposed to pricing and again hedged


Products
- Typical breakdown of 1 unit of nat gas:

-          40% Ethane which is turned into ethylene for plastic bags and the like

-          30% Propane: 60% for heating, powering forklifts, etc. and 40% is for chemical feedstock

-          20% Butane – mostly used as octane enhancer for motor gasoline.

-          10% is natural Gasoline


Risks
:

-          Volume declines: The key risk is that in a declining economy, volume demand will fall off forcing producers to cut back production (from current wells and new drilling projects). Prices for natural gas must also stay above the incremental lifting costs for production to remain economical. In Copano’s case, nat gas would need to fall another 40% to have a material impact on a large portion of their customers’ production rates. 

-          The location and type of production sources (geography and geology). In CPNO’s case, both are favorable – particularly on a relative basis

-          NGL Pricing - NGL’s compete directly with crude oil derived feedstocks – particularly for ethylene. Thus in a declining oil price environment, NGL prices have and will continue to come down. Again, CPNO hedges against this

-          Natural Gas Pricing: Evidently, this too impacts revenues and profits for CPNO and its peers when not dealing in fixed fee contracts.   Again, the company has hedged out much of this risk through puts on a significant portion of its forward production volumes out into 2010 as well as over half of the volume through 2011


Hedging
:

-          They are currently hedged with product specific puts and swaps through 2011. 

-          Copano has no dirty hedges – where one hedges NGL risk through crude oil derivatives

-          Although it varies a bit product by product, for 2009 and 2010, CPNO is fully hedged against NGLs, 80% hedged against natural gas, and 80% hedged for non-ethane products. 

-          These hedges, for the most part, were locked in earlier this year when prices were inflated. 

-          For 2011, they are 50-60% hedged for 80% of production.

-          Counterparty risk is limited due to diverse group of counterparties. Hedges they have all privately arranged with Goldman, Barclays, Deutsche Bank, and some with Morgan Stanley although very small portion.


Asset Base and Regional Exposure

-          Over 85% of operations are in non-shale. So they have very little exposure to the plays that are most susceptible to depressed pricing environment.


Liquidity demands, Debt and B/S strength

-          $550MM revolver with a rate of Libor +175 due October 1st 2012. Revolver is with BofA, JP Morgan and Wells Fargo, but they have 31 banks in total.

-          They have two senior notes totaling roughly $650 from May 2008 with avg. life of 8.5 yrs. Earliest is due in 2016

-          In good shape in terms of covenants, comfortably within their covenant range.

-          They have $174mm in cash and $345mm remaining on their revolver for a total of $519mm liquidity.

-          4Q08 capex is expected to be $30mm.

-          For 2009 the maximum capex they would spend is $180mm

-          2009E expansion capital is $70mm with an additional $110mm for McMullen Lateral Acquisition (the 150 mile Texas pipe). So total capex for 4Q08 and 2009 is $210mm and they have over $500mm in liquidity.

-          The McMullen acquisition requires FERC approval so 2009 capex spending could be significantly lower than this if FERC doesn’t approve the acquisition until the back-half of 2009. In that case, some of the capex for the acquisition would spill over into 2010

-          Have over $3.00 a share in cash, about that in the hedge book.


Valuation

-          The primary valuation metric for the MLP space is yield and the primary yardstick for this measurement is the difference between 10-Year Treasuries and the company yield. 

-          A common valuation technique in the industry is to divide a projected distribution, generally one year forward, by a distribution yield assumption and then apply a yield spread to 10-year Treasury to represent a risk premium. This way, the target unit price is equal to the projected distribution divided by the yield assumption. The yield assumption reflects the risks associated with achieving the distribution level, as well as the overall visibility of the partnerships ability to generate and grow cash flow. A partnership that has strong potential to grow the numerator (distribution), should trade at a lower yield than a partnership with less growth visibility.

-          For the past 18 years there was a strong correlation between the 10 year treasury yield and yields on MLPs (CPNO trades with MLPs) but recently the relationship has deteriorated. The spread between MLP yields (exGP) versus 10-Year Treasury securities averaged 258bps over an 18 year period and today the spread is 650bps, the highest it has ever been. CPNO’s spread is over 2000bps and many smaller MLPs have a yield similar to CPNO’s.

-          One way to value Copano would be to assume a reversion to the mean spread between G&Ps and the 10-Year Treasury. But in this credit environment, particularly for smaller players like CPNO, that is non-sensical. So, let’s assume the spread between the 10-Year Treasury and Copano’s yield comes in to 1300 basis points (13%) within the next two years, which is more than double the current and unprecedented 650bp mean spread between G&P yields and 10-Year Treasury securities, an investor would still realize a very attractive return. 

-          For example, if we conservatively assume by 2010 the spread between the 10-Year Treasury and Copano’s distribution yield comes in to 13% (650bp + 650bps) and we also conservatively assume Copano doesn’t grow distributions for the next two years, (current distribution is $2.28 and guidance is $3.00 for 2010), then Copano would trade at $14.39 ($2.28/15.1% = $15.10). Based on the current price of under $10, this is unit appreciation of roughly 54%. If you include the annual unit distributions from 2009 and 2010 of $2.28 each year, you have an additional $4.56 which brings your total (undiscounted) return to 111%.

-          Furthermore, Copano trades below P/B and well below net asset value. 

o        Historically, Copano has traded well above book value and even remained well above 3x book value from 2004 – 2007. Currently Copano trades at nearly half of book value

o        Book value is $19.07 and if Copano traded at 1x BV by 2010 and maintained distributions, an investors total return would be roughly 142% ({[$19.07 + $4.56] - $9.78} / $9.78)

-          Copano also trades well below a conservative estimate of NAV.

-          Copano’s NAV (which for the sake of the example I calculate as Total Assets, excluding Risk Mgmt. Assets and Intangibles, less Total Liabilities) is $660mm or $13.66 a share.

o        This is a 38% premium to the current valuation of $9.78.

o        If we assume Copano trades at $13.66 by 2010 and maintains distributions for the next two years, we have a total return of 85.3% ([$13.66 + $4.46] - $9.78} / $9.78)

-          While Copano appears undervalued based on the previously discussed measures, it is also at a fairly low valuation based on EV/EBITDA.

o        Copano currently trades at an EV/EBITDA multiple of 7.25x. This is a trough valuation based on historical company comps, but its still above the average trough valuations for the G&P names in past downturns. In the 2003, average G&P transaction multiples fell to EV/EBITDA multiples of around 6.25x and in 1992 they fell as low as 4.5x. It is highly unlikely Copano units would decline much lower than 6.3x EV/EBITDA due to the premium multiple they deserve for reasons presented earlier; however, at 6.3x EV/EBITDA, Copano would trade at $7.00. This is a 28% downside.

-          So, if we assume a 28% downside and roughly 100% upside (an average of all three valuation methods) we have a fairly attractive reward:risk ratio of roughly 3.5:1. Recall this is all based on the assumption that Copano maintains a distribution of $2.28, despite guiding toward a $3.00 distribution in 2010.


What the market is missing

-          Built-in-growth in North Texas (cryogenic plant coming online in 2Q’09), Oklahoma and Cantera acquisition in Rockies (backlog of completed wells now being connected)

-          McMullen acquisition should boost to earnings. This is a 150 mile pipe with gas already on it. The pipe will take gas to Houston Central without relying on Kinder Morgan

-          CPNO has THREE different processing modes, one of which is conditioning mode:

o        Full Recovery: (Texas and Oklahoma) – If the value of recovered NGLs exceeds the fuel and gas shrinkage costs of recovering NGLs (this is most profitable mode, but they need a positive spread between the cost basis (nat gas) and the product (NGLs)

o        Ethane Rejection: (Texas and Oklahoma) – If the value of ethane is less than the fuel and shrinkage costs to recover ethane (in Oklahoma, ethane rejection at Paden plant is limited by nitrogen rejection facilities)

o        Conditioning Mode: (Texas) – Copano has the ability to go into conditioning mode at their Houston Central Plant (this will also be available at the St. Joe plant in North Texas when completed), which enables them to limit losses on their G&P business

-          Volumes more resilient than most G&Ps because many of their producers can’t take volumes and shut them in due to the nature of their fields – else they risk permanent shutdown

-          The current price is implying the company cannot grow as demonstrated above

-          The current price also implies a distribution cut despite recent management confirmation of distribution increases

-          With its hedges and ability to move between full recovery, ethane rejection and conditioning mode, the company is not a typical G&P company yet is priced that way


Management

-          CEO and founder owns 10% of company

-          Highly incentivized

-          Board elected by unit-holders.

-          Board is also completely independent. The board was chosen through rigorous interview process. They interviewed people with no ties to the company or management.


Summary of Risks

-          Volume growth in North Texas, Oklahoma and Rockies (Cantera Acquisition) is significantly less than the company has projected.

-          Cut 2010 unit distribution guidance of $3.00 – apparently well-built-in..

-          Rising interest rates

-          All operations in shale (although limited to less than 15% of business) cease due to depressed commodity price environment.

-          FERC doesn’t approve acquisition of 150 mile pipe to Houston Central.

-          Volumes decline due to unforeseeable events such as weather.

-          The company continues to do more acquisitions – accretive or not – that stretch the balance sheet going into what could be a prolonged economic downturn.

Catalyst

- Production stays at a reasonable level and revenues and profits continue to grow – even if at a snail’s pace

- The above would push the stock back to mid-teens which could enable them to do accretive acquisitions which could create further upside
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    Description

    Intro and Brief Thesis

    I am recommending Copano Energy (CPNO) as a long. CPNO is a gathering and processing (G&P) company trading near a trough valuation that reflects market expectations of revenue and profit declines and a distribution cut. CPNO has a strong asset base, ample liquidity, a strong balance sheet, limited current dependence on natural gas (NG) and natural gas liquids (NGLs) prices, and built-in-growth for the next three years – which, at the least, will protect against a decline in the current business. Though CPNO trades in line with many of the smaller G&P master limited partnerships (MLPs), many factors differentiate CPNO.
     
    With a 23%+ dividend yield, a 138% dividend coverage ratio and 80% tax deferral, the company is providing great value to its shareholders/partners. Further, the company is structured as an LLC, not an MLP, so all future growth goes to the current shareholders. Perhaps the biggest margin of safety is derived from the fact that the built-in growth should more than offset any potential declines in the current business due to volume and price (NG and NGL) declines. Normalized distributable cash flow is greater than $3.00 per share. In that scenario, it is fairly easy to extrapolate the math and look two years out at a total return of 80 to 100%. The math is: 22 to 25% dividend yield (assuming no change from the current dividend) plus an increase in the stock price to the $14 to $17 range (which would imply a mid-teens yield on the stock). And, of course, this is mostly tax-deferred. Note that for a medium or high-grade junk bond, the required interest (yield) would need to be over 35% to match the current 23% CPNO yield.

    Company and Industry Background

    CPNO is a growth-oriented midstream energy company structured as a Limited Liability Company.  CPNO provides services to natural gas producers, including natural gas gathering, compression, dehydration, treating, transportation, processing and conditioning. As an LLC, there is no double corporate taxation and no separate general partner (GP) that receives half the profits above a certain threshold, This creates a lower cost of capital for its investors versus MLPs and corporations.   Further, unlike an MLP, the board is elected by unit-holders – so there is some sense of control by shareholders.   Further, a simple corporate structure enables the company to buy or be bought more easily in an industry ripe for consolidation.


    As to natural gas usage, historically it has not declined materially in past downturns – though I am not assuming that now. Virtually all of the fields that Copano services are traditional wells, which require constant flow (by producers) to prevent permanent shut-in. Lifting costs for most of their fields are in the 1.70 to 3.00 per MCF range.

    In an effort to keep this easier to parse through, the rest will be in outline structure.


    What
    : The company has pipes running from the well-heads to their processing facilities and into the distribution system.
     
    Cash Flow Mix:

    -          >55% is fee based

    -          16% is keep-whole (KW) – where CPNO guarantees the producer a certain fee for its production based on its BTU (heat) content. CPNO then sells the production volumes for its own account taking all risk. The company uses simple hedging (through puts) and extra fees to cover their risk. The 10Q gives detailed information on the hedges – information that you can actually understand)

    -          7% is percent of proceeds (POP) – the most exposed sector to pricing. To hedge out risk, the company buys puts as well

    -          20% percent of liquids (POL) – also exposed to pricing and again hedged


    Products
    - Typical breakdown of 1 unit of nat gas:

    -          40% Ethane which is turned into ethylene for plastic bags and the like

    -          30% Propane: 60% for heating, powering forklifts, etc. and 40% is for chemical feedstock

    -          20% Butane – mostly used as octane enhancer for motor gasoline.

    -          10% is natural Gasoline


    Risks
    :

    -          Volume declines: The key risk is that in a declining economy, volume demand will fall off forcing producers to cut back production (from current wells and new drilling projects). Prices for natural gas must also stay above the incremental lifting costs for production to remain economical. In Copano’s case, nat gas would need to fall another 40% to have a material impact on a large portion of their customers’ production rates. 

    -          The location and type of production sources (geography and geology). In CPNO’s case, both are favorable – particularly on a relative basis

    -          NGL Pricing - NGL’s compete directly with crude oil derived feedstocks – particularly for ethylene. Thus in a declining oil price environment, NGL prices have and will continue to come down. Again, CPNO hedges against this

    -          Natural Gas Pricing: Evidently, this too impacts revenues and profits for CPNO and its peers when not dealing in fixed fee contracts.   Again, the company has hedged out much of this risk through puts on a significant portion of its forward production volumes out into 2010 as well as over half of the volume through 2011


    Hedging
    :

    -          They are currently hedged with product specific puts and swaps through 2011. 

    -          Copano has no dirty hedges – where one hedges NGL risk through crude oil derivatives

    -          Although it varies a bit product by product, for 2009 and 2010, CPNO is fully hedged against NGLs, 80% hedged against natural gas, and 80% hedged for non-ethane products. 

    -          These hedges, for the most part, were locked in earlier this year when prices were inflated. 

    -          For 2011, they are 50-60% hedged for 80% of production.

    -          Counterparty risk is limited due to diverse group of counterparties. Hedges they have all privately arranged with Goldman, Barclays, Deutsche Bank, and some with Morgan Stanley although very small portion.


    Asset Base and Regional Exposure

    -          Over 85% of operations are in non-shale. So they have very little exposure to the plays that are most susceptible to depressed pricing environment.


    Liquidity demands, Debt and B/S strength

    -          $550MM revolver with a rate of Libor +175 due October 1st 2012. Revolver is with BofA, JP Morgan and Wells Fargo, but they have 31 banks in total.

    -          They have two senior notes totaling roughly $650 from May 2008 with avg. life of 8.5 yrs. Earliest is due in 2016

    -          In good shape in terms of covenants, comfortably within their covenant range.

    -          They have $174mm in cash and $345mm remaining on their revolver for a total of $519mm liquidity.

    -          4Q08 capex is expected to be $30mm.

    -          For 2009 the maximum capex they would spend is $180mm

    -          2009E expansion capital is $70mm with an additional $110mm for McMullen Lateral Acquisition (the 150 mile Texas pipe). So total capex for 4Q08 and 2009 is $210mm and they have over $500mm in liquidity.

    -          The McMullen acquisition requires FERC approval so 2009 capex spending could be significantly lower than this if FERC doesn’t approve the acquisition until the back-half of 2009. In that case, some of the capex for the acquisition would spill over into 2010

    -          Have over $3.00 a share in cash, about that in the hedge book.


    Valuation

    -          The primary valuation metric for the MLP space is yield and the primary yardstick for this measurement is the difference between 10-Year Treasuries and the company yield. 

    -          A common valuation technique in the industry is to divide a projected distribution, generally one year forward, by a distribution yield assumption and then apply a yield spread to 10-year Treasury to represent a risk premium. This way, the target unit price is equal to the projected distribution divided by the yield assumption. The yield assumption reflects the risks associated with achieving the distribution level, as well as the overall visibility of the partnerships ability to generate and grow cash flow. A partnership that has strong potential to grow the numerator (distribution), should trade at a lower yield than a partnership with less growth visibility.

    -          For the past 18 years there was a strong correlation between the 10 year treasury yield and yields on MLPs (CPNO trades with MLPs) but recently the relationship has deteriorated. The spread between MLP yields (exGP) versus 10-Year Treasury securities averaged 258bps over an 18 year period and today the spread is 650bps, the highest it has ever been. CPNO’s spread is over 2000bps and many smaller MLPs have a yield similar to CPNO’s.

    -          One way to value Copano would be to assume a reversion to the mean spread between G&Ps and the 10-Year Treasury. But in this credit environment, particularly for smaller players like CPNO, that is non-sensical. So, let’s assume the spread between the 10-Year Treasury and Copano’s yield comes in to 1300 basis points (13%) within the next two years, which is more than double the current and unprecedented 650bp mean spread between G&P yields and 10-Year Treasury securities, an investor would still realize a very attractive return. 

    -          For example, if we conservatively assume by 2010 the spread between the 10-Year Treasury and Copano’s distribution yield comes in to 13% (650bp + 650bps) and we also conservatively assume Copano doesn’t grow distributions for the next two years, (current distribution is $2.28 and guidance is $3.00 for 2010), then Copano would trade at $14.39 ($2.28/15.1% = $15.10). Based on the current price of under $10, this is unit appreciation of roughly 54%. If you include the annual unit distributions from 2009 and 2010 of $2.28 each year, you have an additional $4.56 which brings your total (undiscounted) return to 111%.

    -          Furthermore, Copano trades below P/B and well below net asset value. 

    o        Historically, Copano has traded well above book value and even remained well above 3x book value from 2004 – 2007. Currently Copano trades at nearly half of book value

    o        Book value is $19.07 and if Copano traded at 1x BV by 2010 and maintained distributions, an investors total return would be roughly 142% ({[$19.07 + $4.56] - $9.78} / $9.78)

    -          Copano also trades well below a conservative estimate of NAV.

    -          Copano’s NAV (which for the sake of the example I calculate as Total Assets, excluding Risk Mgmt. Assets and Intangibles, less Total Liabilities) is $660mm or $13.66 a share.

    o        This is a 38% premium to the current valuation of $9.78.

    o        If we assume Copano trades at $13.66 by 2010 and maintains distributions for the next two years, we have a total return of 85.3% ([$13.66 + $4.46] - $9.78} / $9.78)

    -          While Copano appears undervalued based on the previously discussed measures, it is also at a fairly low valuation based on EV/EBITDA.

    o        Copano currently trades at an EV/EBITDA multiple of 7.25x. This is a trough valuation based on historical company comps, but its still above the average trough valuations for the G&P names in past downturns. In the 2003, average G&P transaction multiples fell to EV/EBITDA multiples of around 6.25x and in 1992 they fell as low as 4.5x. It is highly unlikely Copano units would decline much lower than 6.3x EV/EBITDA due to the premium multiple they deserve for reasons presented earlier; however, at 6.3x EV/EBITDA, Copano would trade at $7.00. This is a 28% downside.

    -          So, if we assume a 28% downside and roughly 100% upside (an average of all three valuation methods) we have a fairly attractive reward:risk ratio of roughly 3.5:1. Recall this is all based on the assumption that Copano maintains a distribution of $2.28, despite guiding toward a $3.00 distribution in 2010.


    What the market is missing

    -          Built-in-growth in North Texas (cryogenic plant coming online in 2Q’09), Oklahoma and Cantera acquisition in Rockies (backlog of completed wells now being connected)

    -          McMullen acquisition should boost to earnings. This is a 150 mile pipe with gas already on it. The pipe will take gas to Houston Central without relying on Kinder Morgan

    -          CPNO has THREE different processing modes, one of which is conditioning mode:

    o        Full Recovery: (Texas and Oklahoma) – If the value of recovered NGLs exceeds the fuel and gas shrinkage costs of recovering NGLs (this is most profitable mode, but they need a positive spread between the cost basis (nat gas) and the product (NGLs)

    o        Ethane Rejection: (Texas and Oklahoma) – If the value of ethane is less than the fuel and shrinkage costs to recover ethane (in Oklahoma, ethane rejection at Paden plant is limited by nitrogen rejection facilities)

    o        Conditioning Mode: (Texas) – Copano has the ability to go into conditioning mode at their Houston Central Plant (this will also be available at the St. Joe plant in North Texas when completed), which enables them to limit losses on their G&P business

    -          Volumes more resilient than most G&Ps because many of their producers can’t take volumes and shut them in due to the nature of their fields – else they risk permanent shutdown

    -          The current price is implying the company cannot grow as demonstrated above

    -          The current price also implies a distribution cut despite recent management confirmation of distribution increases

    -          With its hedges and ability to move between full recovery, ethane rejection and conditioning mode, the company is not a typical G&P company yet is priced that way


    Management

    -          CEO and founder owns 10% of company

    -          Highly incentivized

    -          Board elected by unit-holders.

    -          Board is also completely independent. The board was chosen through rigorous interview process. They interviewed people with no ties to the company or management.


    Summary of Risks

    -          Volume growth in North Texas, Oklahoma and Rockies (Cantera Acquisition) is significantly less than the company has projected.

    -          Cut 2010 unit distribution guidance of $3.00 – apparently well-built-in..

    -          Rising interest rates

    -          All operations in shale (although limited to less than 15% of business) cease due to depressed commodity price environment.

    -          FERC doesn’t approve acquisition of 150 mile pipe to Houston Central.

    -          Volumes decline due to unforeseeable events such as weather.

    -          The company continues to do more acquisitions – accretive or not – that stretch the balance sheet going into what could be a prolonged economic downturn.

    Catalyst

    - Production stays at a reasonable level and revenues and profits continue to grow – even if at a snail’s pace

    - The above would push the stock back to mid-teens which could enable them to do accretive acquisitions which could create further upside

    Messages


    SubjectNew Writeup
    Entry12/30/2008 09:48 AM
    Memberdle413
    Description:

    Intro and Brief Thesis

    I am recommending Copano Energy (CPNO) as a long. CPNO is a gathering and processing (G&P) company trading near a trough valuation that reflects market expectations of revenue and profit declines and a distribution cut. CPNO has a strong asset base, ample liquidity, a strong balance sheet, limited current dependence on natural gas (NG) and natural gas liquids (NGLs) prices, and built-in-growth for the next three years – which, at the least, will protect against a decline in the current business. Though CPNO trades in line with many of the smaller G&P master limited partnerships (MLPs), many factors differentiate CPNO.
     
    With a 23%+ dividend yield, a 138% dividend coverage ratio and 80% tax deferral, the company is providing great value to its shareholders/partners. Further, the company is structured as an LLC, not an MLP, so all future growth goes to the current shareholders. Perhaps the biggest margin of safety is derived from the fact that the built-in growth should more than offset any potential declines in the current business due to volume and price (NG and NGL) declines. Normalized distributable cash flow is greater than $3.00 per share. In that scenario, it is fairly easy to extrapolate the math and look two years out at a total return of 80 to 100%. The math is: 22 to 25% dividend yield (assuming no change from the current dividend) plus an increase in the stock price to the $14 to $17 range (which would imply a mid-teens yield on the stock). And, of course, this is mostly tax-deferred. Note that for a medium or high-grade junk bond, the required interest (yield) would need to be over 35% to match the current 23% CPNO yield.

    Company and Industry Background

    CPNO is a growth-oriented midstream energy company structured as a Limited Liability Company.  CPNO provides services to natural gas producers, including natural gas gathering, compression, dehydration, treating, transportation, processing and conditioning. As an LLC, there is no double corporate taxation and no separate general partner (GP) that receives half the profits above a certain threshold, This creates a lower cost of capital for its investors versus MLPs and corporations.   Further, unlike an MLP, the board is elected by unit-holders – so there is some sense of control by shareholders.   Further, a simple corporate structure enables the company to buy or be bought more easily in an industry ripe for consolidation.


    As to natural gas usage, historically it has not declined materially in past downturns – though I am not assuming that now. Virtually all of the fields that Copano services are traditional wells, which require constant flow (by producers) to prevent permanent shut-in. Lifting costs for most of their fields are in the 1.70 to 3.00 per MCF range.

    In an effort to keep this easier to parse through, the rest will be in outline structure.


    What
    : The company has pipes running from the well-heads to their processing facilities and into the distribution system.
     
    Cash Flow Mix:

    -          >55% is fee based

    -          16% is keep-whole (KW) – where CPNO guarantees the producer a certain fee for its production based on its BTU (heat) content. CPNO then sells the production volumes for its own account taking all risk. The company uses simple hedging (through puts) and extra fees to cover their risk. The 10Q gives detailed information on the hedges – information that you can actually understand)

    -          7% is percent of proceeds (POP) – the most exposed sector to pricing. To hedge out risk, the company buys puts as well

    -          20% percent of liquids (POL) – also exposed to pricing and again hedged


    Products
    - Typical breakdown of 1 unit of nat gas:

    -          40% Ethane which is turned into ethylene for plastic bags and the like

    -          30% Propane: 60% for heating, powering forklifts, etc. and 40% is for chemical feedstock

    -          20% Butane – mostly used as octane enhancer for motor gasoline.

    -          10% is natural Gasoline


    Risks
    :

    -          Volume declines: The key risk is that in a declining economy, volume demand will fall off forcing producers to cut back production (from current wells and new drilling projects). Prices for natural gas must also stay above the incremental lifting costs for production to remain economical. In Copano’s case, nat gas would need to fall another 40% to have a material impact on a large portion of their custome
    Catalyst: - Production stays at a reasonable level and revenues and


    SubjectRE: fcf
    Entry12/31/2008 09:35 AM
    Memberdle413
    you can look at it as a MLP or you can look at it as a piece of real estate. i look at it primarily as a piece of real estate with tenants renting out space on their pipelines. and no it is not as unique as a great infill grocery-anchored shopping center in the heart of a mid-size town, but pipelines do have value as it is hard to get them built - at least the backbones that run from the fields to the processing plants. i like copano because it is a LLC and not a GP/LP split. It is simple in that way. They raise money for asset acquisitions that make sense. they don't just buy to make a spread. having said that, the market looks at it on a yield spread, etc. and i am not ignoring it - though i do think that model is broken for a long time. i thought most MLP's were shorts in the past 2 years but hesitated because of the dividends. now, certain assets are great longs. in the case of cpno, they have some capex obligations that will have to get done so i have to include that. after that, with recently acquired assets and the regular costs of hooking up the six-inch pipes to the well heads, there is little other cost and they can keep growing through 2011. again - the way i look at it is that if volumes come down and prices come down, they will take a hit on their existing business. it is the additional business that i think has a good chance of offsetting any decline in the incumbent business. as to returns on capital on the new business, i am still going through estimates but they seem be fairly strong - certainly above their cost of capital and well above their incremental cost of capital

    SubjectRE: fcf
    Entry12/31/2008 09:35 AM
    Memberdle413
    you can look at it as a MLP or you can look at it as a piece of real estate. i look at it primarily as a piece of real estate with tenants renting out space on their pipelines. and no it is not as unique as a great infill grocery-anchored shopping center in the heart of a mid-size town, but pipelines do have value as it is hard to get them built - at least the backbones that run from the fields to the processing plants. i like copano because it is a LLC and not a GP/LP split. It is simple in that way. They raise money for asset acquisitions that make sense. they don't just buy to make a spread. having said that, the market looks at it on a yield spread, etc. and i am not ignoring it - though i do think that model is broken for a long time. i thought most MLP's were shorts in the past 2 years but hesitated because of the dividends. now, certain assets are great longs. in the case of cpno, they have some capex obligations that will have to get done so i have to include that. after that, with recently acquired assets and the regular costs of hooking up the six-inch pipes to the well heads, there is little other cost and they can keep growing through 2011. again - the way i look at it is that if volumes come down and prices come down, they will take a hit on their existing business. it is the additional business that i think has a good chance of offsetting any decline in the incumbent business. as to returns on capital on the new business, i am still going through estimates but they seem be fairly strong - certainly above their cost of capital and well above their incremental cost of capital

    SubjectRE: dle...Please respond to Ti
    Entry12/31/2008 09:44 AM
    Memberdle413
    Not sure how this space is that much different than REITs. i am not a fan of companies that pay out everything and then depend on the capital markets for growth. C-corp structures are best as i believe companies should flow capital to investors in good times while still holding back a decent part unless the stock gets way overvalued. and they should hoard capital during tougher times. CPNO has no GP/LP split. They have real cash-flow producing assets many that have long-term contracts. They have hedges that have a current value of just under $400mm or roughly 2/3 of the market cap and they have good assets. I am not a huge fan of the processing business but this company has hedged itself well and can do certain things to mitigate their risk of loss or profit deterioration that comes with falling prices of NGLs and natgas itself. As to Ponzi scheme, that title is usually reserved for situations where you are constantly returning new investors' money to pay current people's capital. usually, the cash that comes in goes straight out the door and does not buy other assets. you are dependent on getting more money coming in than going out. last i checked, if you you have good management that understands capital allocation, they will buy good cash flow producing assets with that capital. and while from a tax perspective, you get a return of capital, it is a return of your capital and the depreciation well exceeds the required capex. so again, i don't see how investing new proceeds in new cash-flow producing assets equates to a ponzi scheme. Madoff was a classic Ponzi Scheme, KL was one too. Bayou as well. They played the greater fool game. CPNO, OKE, Boardwalk, etc. do not do that. The guys at Loews are too smart to buy the Boardwalk assets and then keep pumping money into it. i just don't see it unless the assets being bought are junk.

    SubjectRE: RE: dle...Please respond t
    Entry12/31/2008 09:47 AM
    Memberangus309
    Great responses...thanks so much. Cheers

    SubjectReminds me of CanRoys
    Entry12/31/2008 01:02 PM
    Membersparky371
    Barclays put out a piece the other day saying the divvie is safe/growing through like 2010 if I recall. After that, they need "accretive acquisitions" to keep divvy going. Kinda reminded me of my CanRoys in their heyday..... I owned a little of this before your writeup. Thanks for posting it.

    SubjectRE: Reminds me of CanRoys
    Entry01/02/2009 08:27 AM
    Memberdle413
    you are welcome. FYI - Morgan Stanley cut their numbers 2 weeks ago on CPNO and cut price target from mid 20's to 16. The one page of bullet points makes virtually no mention of the hedges or anything else the company has going for it. Such is Wall Street...

    SubjectCPNO / dle
    Entry02/24/2009 11:06 AM
    Memberangus309

    Dle: Are you aware of any technical issues (more TRS unwinding?) or funamental issues that would give you any guidance as to the incredible sell-off of CPNO and for that matter, the entire space over the last week? Regards, Angus

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