The energy space, especially the energy income space, continues to reorganize itself through cuts in capital spending, the elimination of dividends, and the sale or reshuffling of assets.
One of the latest involves an MLP (master limited partnership), Targa Resources Partners (NGLS) that I hold in both the 12-18 month Jubak Picks portfolio and in my dividend income portfolio.
The general partner, Targa Resources (TRGP), has made an offer valued at $9 billion to buy the 91.2% of the master limited partnership that it doesn’t own. The deal, the general partner has said would give the master limited partnership greater access to capital at a lower cost since it would no longer have to pay distribution rights to the general partner. Investors in the master limited partnership would lose many of their tax benefits but, the general partner has argued, would be able to defer taxes over time by recapturing depreciation of the joint company’s pipelines and other system assets.
The move makes sense in the short term since it will get Targa through the current rough patch in the energy sector. It looks like Targa Resources Partners is coming close to the limits on its debt covenants. That would limit the master limited partnerships ability to borrow to fund new projects.
The deal isn’t bad deal—the price amounted to an 18% premium to Targa Resources Partners unit price at the time it was announced. And if projections are correct, the combined company will show 15% dividend growth in 2016.
But the deal isn’t a great deal. When, earlier, Kinder Morgan (KMI) announced a buyout of its master limited partnership it included cash in compensation for the capital gains taxes the investors in the master limited partnership would have to pay to step up units in the MLP to shares in the parent company. At the moment, there are no comparable funds in the Targa deal.
Kinder Morgan, with a project backlog of more than $20 billion, will also get more bang for the buck if it can, after the acquisition, raise more debt at a lower price. Targa has only $4 billion in potential projects so it will be able to put less capital to work.
Besides any disgruntlement with the lack of cash kicker to help pay investors’ taxes from the deal, there’s some bad feeling since the company turned down a $15 billion bid earlier, calling it inadequate. And now the deal is priced at $9 billion. It’s certainly possible to argue, and some investors are, that parent Targa is getting a bargain at the expense of holders of the master limited partnership.
I’m inclined to sell on the deal but I’d like to get a better exit price.
Units of Targa Resources Partners have rallied over the last few days, climbing 4.23% yesterday to $25.85 before declining in the oil sector sell off by 2.67% today. But the units still down significantly from the beginning of the month when they traded at $30.49 on November 2.
I think that drop is a result of the general sell off in oil shares and in other energy stocks. I’d be inclined to wait a few more days to see if today’s bounce gives you a more attractive exit point. The MLP has paid its quarterly 82.5 cent a unit quarterly dividend so all you’re waiting for is to see if the upward trend runs for a while.
If you’re looking for an alternative, I think Kinder Morgan (KMI) offers more leverage to the upside on its bigger portfolio of projects. Kinder Morgan pays a yield of 6.55% to a yield of 12.01 on Targa Resources Partners. Which, of course, does tell you what the market thinks of the relative risk in the two situations.
Not that nothing else matters—the price of natural gas and natural gas liquids is important—but my theory is that at the moment, in the current cheap money environment, the crucial thing that investors in energy MLPs (master limited partnerships) need to know is whether one of these dividend generating machines has enough new projects to keep distributions to investors climbing.
Since master limited partnerships by law must distribute all of their income to investors, the way one of these companies grows is by raising money in the financial markets and then investing it in new pipelines, distribution hubs, refineries, processing facilities, and the like. With money so cheap right now, thank you Ben Bernanke and Janet Yellen, it’s easy for a master limited partnership to profit from the spread between the cost of borrowing money and the returns that projects produce. The hard part right now—after so much money has gone into master limited partnerships to be put to work in the U.S. energy boom—is finding enough good projects to keep the cycle going.
From that perspective, the March 31 update from Targa Resources Partners (NGLS) was extremely good news. The MLP announced that because of an increase in exports of liquid petroleum gas first quarter EBITDA (earnings before interest, taxes, depreciation, and amortization) would be 60% higher than in the first quarter of 2013.
Liquid petroleum gas isn’t the same as liquefied natural gas. LPG is made from natural gas liquids and it is largely made up of propane and butane rather than the methane of natural gas. Exports of liquid petroleum gas fall under a completely different regulatory scheme than exports of liquefied natural gas. The United States became a net exporter of liquid petroleum gas for the first time ever in 2012 and exports are projected to grow until the United States becomes the world’s top exporter sometime around 2020. The biggest market is Asia where it’s used both for heating and increasingly as the feedstock for chemical production.
All those exports to Asia mean a lot of opportunity for investment in new infrastructure.
Which along with that increase in EBITDA was the big news from Targa on March 31. Targa’s liquid petroleum gas export capacity climbed to 3.5 to 4 million barrels a month by the end of 2013 and the company projects that it will reach 5.5 to 6 million barrels by then end of 2014.
In addition to the $650 million in previously projected capital spending to reach that goal, Targa will add another $50 million in capital spending in 2014 to build a plant to split liquids into butane, propane, and other components. (Total cost for the splitter will be $115 million with the splitter to go into service in 2016/2017.) The company also said it will build a new processing plant in the Bakken shale gas region.
Targa is a member of both my Jubak’s Picks portfolio and my Dividend Income portfolio. (The master limited partnership paid a 4.9% dividend as of closing price on April 4.)
As of April 4 I’m raising my target price on Targa to $60 a unit in both the Picks and Dividend Income portfolios. (Traditionally I haven’t put target prices on picks in the Dividend Income portfolio, but I’ve have decided to add them gradually as I update these picks.)
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/, I liquidated all my individual stock holdings and put the money into the fund. The fund did not own units of Targa Resources Partners as of the end of December. In preparation for closing the fund at the end of May, as of the end of March I had moved the fund’s holdings almost totally to cash.
Not surprisingly Targa Resources Partners (NGLS) has show a little weakness recently after the February 14 date (record date January 28) for paying the master limited partnership’s fourth quarter dividend.
What’s surprising is how small the retreat has been. I suspect that this strength in a dividend-paying stock after the dividend payout is a sign that investors are feeling a little less aggressive and a little more conservative at current high.
The retreat wasn’t very large—from $41.88 on February 14 to $41.04 on February 20—but decline pattern is normal for stocks and master limited partnerships (MLPs) that pay hefty dividends. (Targa showed a projected dividend yield of 6.5% at the February 14 price.) Some holders of the stock, having collected the quarterly dividend, sell with the idea of buying something else about to pay a dividend and maybe returning to hold Targa closer to its next dividend payout.
The dividend for the fourth quarter of 68 cents per unit ($2.72 per unit on an annual basis) is a 3% increase from the third quarter and a 13% increase from the dividend in the fourth quarter of 2011. The partnership continues to project a 10% to 12% increase in distributions for 2013.
If you believe those projections, and I think they’re reasonable, then that $2.72 in dividends turns into $2.99 to $3.05 a share at the end of 2013. And that would equate to a $45 a unit price and at a 6.8% yield at end of the year. (Which is–$45 by December 2013—what I’m going to set as my new target price for Targa in my Jubak’s Picks portfolio http://jubakpicks.com/the-jubak-picks/ .)
On February 14 Targa Resources Partners reported financial results for the fourth quarter of 2012 and for the full 2012 year. Read more
Quick, name the best performing sector for 2013 to date.
Did you say energy? The sector is up 8.6% for the year as hopes for global growth (or is that hopes of Chinese growth?) drive visions of growing global demand. West Texas Intermediate crude is up another 1% today and Brent crude is up 0.6%.
Shares of U.S. refiners with geographic exposure to the U.S. oil boom in regions such as North Dakota’s Bakken formation or Texas’ Permian Basin have done as well—HollyFrontier (HFC) is up 8.4% in 2013—or better—Marathon Petroleum (MPC) is up 13.9%.
And going forward I think refiners with U.S. oil boom exposure are likely to outperform in any dip in the sector created by worries that higher oil prices will put a damper on global growth. (Well, oil prices could at some point. At $97.40 a barrel for West Texas Intermediate and $114.16 for Brent, oil is near the point where its price does start to bite into growth.)
Why are U.S. refiners a good bet to keep climbing even in a dip for the rest of the sector? Read more
I added Targa Resources Partners (NGLS) to my Dividend Income portfolio http://jubakpicks.com/jubak-dividend-income-portfolio/ on January 11 because the units offer a really attractive potential for dividend growth and capital gains. The current dividend, at 6.81% on January 11, isn’t any too shabby either. (For the most recent update on that portfolio see my post http://jubakpicks.com/2013/01/11/reformatting-my-dividend-income-portfolio-for-a-period-when-dividend-investing-gets-more-important-and-tougher-too/
The big upside here comes from Targa’s acquisition of oil and natural gas pipelines from Saddle Butte Pipeline that for the first time moved Targa into the Bakken shale formation of North Dakota that is the heart of the U.S. oil boom. The deal also gave Targa its first oil pipelines—before that Targa had been a natural gas only pipeline play. The North Dakota oil boom is currently very underserved by pipelines, which gives pipeline companies with footholds in the area, and that now includes Targa, an opportunity to invest today’s cheap money in profitable new capital projects.
After the deal Targa reiterated its projections for 10% growth in distributions to holders of the MLP (master limited partnership) units in 2013 from 2012 levels. Read more