Contest:
Thanks Bearcatbob for the contest and Bocor for proofing.
My selection is Atlas Energy LP (ATLS) stock price about $33 as of this writing.
Normally, I do not write much on the Big Dog’s board. This particular post has taken me well over 8 hours to write and hundreds of hours of research in the company and its pieces.
I have been reading this board for well over a decade and have learned a lot. I hope some of you make money off of this or other picks on this stock contest. This is an effort to say, thank you, and to contribute where I can write a more complete thought than I would normally have time, and answer questions preemptively that might be generated as this is a fairly complex structure.
My explanation is much longer than 10 words so skip if you do not play with Master Limited Partnerships (MLP’s) although you might find this investing style useful in adding to your current methods.
Short version, I expect capital gains from ATLS of 30% to over 100% in next 16 months with a purchase price of $34. The timeframe I am allowing for the market to fully value this entity is between now and 2017 or 2018 with above market returns over the duration and the potential for a sharply higher revaluation. Variables involve the value chain on oil and gas exploration, production, transportation, taxes, etc and which gate-keeper has the ability to maintain or improve margins in the next cycle. ATLS has exposure to oil and gas drilling like Linn Energy not just through its own account, but also through a partnership business. ATLS also has exposure to natural gas gathering and processing, transport of NGL’s, fee contracts as well as commodity exposure contracts (natural gas, NGL’s and condensate).
Since 2008/2009 I have modified my investment style to one of purchasing securities which I can understand with a future yield or a current book value I can calculate. This is for wealth accumulation not preservation and it does take a bit of work.
I try to look ahead at least 2 years account most analyst seem to not want to stick their necks out beyond about 18 months so I have a chance to be ahead of the crowd .
With ATLS is it just a matter of calculating likely distribution increases in a security that is not well understood or followed and the likely stock price increases that will follow the increase in distribution.
I think ATLS has a very good risk reward profile but do not consider it a no brainer pick.
Understanding ATLS:
ATLS is a General Partner (GP) MLP with equity stakes, a 2% General Partner (GP) interest and Incentive Distribution Rights (IDR’s) in 3 MLP’s.
The business model of the GP is to grow the limited partners (LP) MLP’s and in doing so earn larger and larger cash flows from the LP. GP’s are valued at lower yields than LP’s so through the alchemy of modern finance, a dollar of cash flow in the LP might be valued as low as $10 in stock price; when washed through the GP it is magically transformed into $20 to $30 in stock price. IDR’s are not indexed to inflation and over time even small increases in distributions at the LP level will amount to significant increases at the GP level.
The business plan has negatives in that the GP has an interest in sometimes marginal projects for the LP account the project may push the LP into the higher IDR splits. Also the GP has an interest in avoiding diluting its own shares but there is an incentive for the GP to use the shares of the LP as a form of currency to increase the asset base while potentially diluting the LP shareholders.
The high split (50% and 50%) IDR’s also increase the hurdle on what projects are economic account the GP ATLS will not have to contribute much capital (2%) while taking up to ½ of the profit that the mix of LP capital and debt will support.
I will stay away from detailed explanations of the 2 LP businesses and instead provide web links to more info if you wish to look and instead give numbers on some of the expected increases using today’s commodity prices.
The above business model is a restatement of the opaque business model presented by the company ATLS. It is a great model as long as there are opportunities for growth at the LP level of over 20% IRR projects. I see those opportunities in the basins that APL services and the very high returns that the ARP oil and gas partnership business model allows for at least the next 3 years. Beyond that excessive returns will be made when the natural gas market has a shift in price beyond $4.50 per million btu’s and/or the light end of the NGL value chain (ethane and propane) is pushed higher in the 2017ish time frame when the chemical industry is expected to catch up with growth in supply.
Corporate presentation link for ATLS provided.
phx.corporate-ir.net
ATLS has about 52 million shares outstanding and the following assets:
A small MLP Lightfoot Capital which my memory has generating about $2 million a year in cash flow and is not included in the estimates.
General Partner interest in Atlas Pipeline (APL) and 5.75 million limited partner shares in APL.
General Partner interest in Atlas Resource Partners (ARP) and about 21 million limited partner shares in ARP.
Incentive Distribution rights and 2% GP interest
ATLS is entitled to Incentive Distribution Rights (IDR’s) and a 2% GP interest which entitles ATLS from both APL and ARP as follows:
2% of cash distributed between .00 and .42 per share
15% of cash distributed between .42 and .52 per share.
25% of cash distributed between .52 and .60 per share.
50% of cash distributed higher than .60 cents per share aka high IDR’s.
Multiplier in high IDR’s using current share count is about 125% of growth rate of both. So if APL and ARP both increase distributions by 10 cents per Q then ATLS will have a 25 cent increase. The high IDR split should be reached with APL late 2013 and ARP 2014.
Distribution policy of the 3 companies:
ATLS distributes near 100% of the cash received from APL and ARP as there is already distribution coverage at the MLP level. Coverage ratio of 110% to 120% of distributable cash flow is normal at the LP level.
ATLS distributes the cash from the previous Q so is always a Q late in matching increases.
Explanation of estimates:
The growth of APL is much easier to analyze than that of ARP. ARP has been on an acquisition led growth path while APL has an organic growth trajectory.
I have estimates for end of year 2013 distributions and how they affect ATLS. These estimates were derived from company provided information reflecting the effect of continued organic expansion in a couple of areas and how these expansions contribute to capital gains for ATLS beyond 2013 from the APL portion of cash flows.
I have not added any growth in ARP for beyond 2013 company provided guidance in my estimates even though I believe the business model will provide significant growth.
APL estimates:
There will be significant increases in distributions at APL in the 3rd Q of 2013 and beyond so ATLS will have very large increases in distributable cash flow starting in 4th Q of 2013. Corporate presentation link provided.
phx.corporate-ir.net
APL has not given a distribution estimate but has given EBITDA estimate of $310 to $360 million with a large portion 2nd Q and later account NGL takeaway restrictions (pipelines are being built) and natural gas processing plant startup inefficiencies.
My estimate based on management comments is .75 to .80 cents per Q rate by the 3rd or 4th Q of 2013 with significant increases still to come in 2014.
APL Pioneer driven Spraberry field growth:
APL is active and partnered with Pioneer Resources stock symbol PXD in the Spraberry field in Texas. Pioneer has a 27% ownership in the natural gas processing plants and gathering system and currently supplies greater than 40% of plant intake.
If you are not familiar with the growth of the Permian basin oil production or natural gas processing margins, this field is APL’s most profitable gathering and processing area. I should say this several times account this is by far APL’s most lucrative area even with the partial ownership of the plants and gathering system. Without this growth I would not have the confidence that current projections are simply too low.
Current capacity is fully utilized at 255 million cubic feet a day in the Spraberry field. Another 100 million feet a day plant will be on line 1st Q 2013. An expansion of this plant will be on line in 2013 which will increase the capacity to 200 million feet a day capacity.
Another 200 million feet a day processing plant is planned for 2014 per Pioneer web cast dated 12/4/12. APL has not announced this 2014 expansion or the earlier date for the expansion to 200 million feet on the 2013 plant. Link provided to webcast.
investors.pxd.com
Skip to bold if you do not like word problems, I do not like how I wrote it.
Economics on these plants is average POP (Percent of Proceeds) of about 16%, ownership 73%, plant operating cost about 25 cents per 1000 cubic feet of gas. Gathered gas with liquids upgrade = $8.50 per 1000 cubic feet at $3 gas and $0.85 per gallon NGLs per company presentation. When plants are running well and full it works out at current prices to about $0.80 cents per 1000 cubic feet of gas processed margin for APL or $56 million a year per 200 million capacity plant utilized in the Permian basin. These last 2 plants will be in the high split IDR’s (50% APL and 50% ATLS).
Math is (16% POP (times tailgate value $8.50) less 25 cents plant operating)) times 73% plant ownership=(80 cents per 1000 cubic feet gross margin) times 365 days times 200,000 less maintenance capex of $2 million and when fully utilized I have $56 million per year margin. (((.16x8.5)-.25) x .73 x 365 x 200,000)-2
This does not include gathering fees which in the past covered interest debt service cost but not sure if they will in this basin.
At 115% distribution coverage it is 56/115 times 100= $48 million per year in distributable cash flow.
10% cushion for me just being wrong somewhere so use $44 million for distributable cash flow.
At high IDR splits $22 of the $44 million for APL and $22 million for ATLS plus $2 million for ATLS added for the equity stake of 5.75 million shares.
ATLS has 52 million shares outstanding so each plant could be worth fully utilized $0.46 per year in additional ATLS distributions. ATLS will yield between 4 and 5 percent IMO account the growth multiplier of 2 cash flow streams although the market could push the yield as low as 3%. Current yield is 3.3%. The 0.46 cents per year should equate to between $9 and $11 capital gain per plant potential per ATLS share using 4 to 5 percent stock price yield.
I do not believe APL has publicly modeled the rapid increase in production in the Permian basin account the ramp up is partly dependent on Pioneer’s joint venture that should close in the first Q 2013. When it does close the amount of money dedicated to high volume rich gas horizontal wolf camp shale will be very significant in addition to other producers also increasing drilling. The 75 cent distribution estimate for 4th Q 2013 that the company APL has indicated in past calls does not include significant contribution from this soon to be completed plant. APL has been conservative in its expansion and the play has been developing rapidly.
APL Sandridge and Mississippi oil play driven growth:
I know Sandridge SD with the Mississippi oil play has been well discussed on this board and for APL I expect that a 100 million a day per year in additional plant capacity will be needed each year for the next few years. Margins, even at 100% plant ownership, are much less per thousand cubic feet account much lower NGL yield. It is much leaner (less NGL’s) gas in Oklahoma than in the Permian field Texas.
Current contract with SD is Keep Whole and when renegotiated will likely be POP. This will be much less profitable than the current contract but margins on both contract types are down account of ethane rejection. I am estimating margin will be closer to $0.45 or $0.50 per thousand feet of gas processed when ethane is not rejected and NGL takeaway capacity improves mid-2013. Tailgate value $4.64 per 1000 cubic feet. I expect gathering fees to cover debt servicing on plant additions. 100 million per year in plant additions would be close to $0.14 cents per year in additional ATLS distribution or $3 to $4 in potential capital gains per year for several years at the high IDR split.
APL Velma area and Woodford shale driven growth:
APL Velma area has a new 60 million a day plant that is fully contracted for XTO on a fee base in addition to a 100 million plant that is POP and some Keep Whole contracts. Velma plants have richer gas then the Mississippi oil play with plant tailgate value of $6 per 1000 cubic feet and economics should be better but I have no knowledge of when there will be another plant. I do expect another plant eventually as the gathering system is right over the southern part of the SCOOP oil play. This play has been compared to the Eagle Ford Shale. It may be a tremendous growth driver in a year or 2. Scoop play presentation link:
media.corporate-ir.net
Most recent acquisition for APL is fee based and has expected additional cash flow growth of $10 million for 2014 and 2015 fee based. Possible $2 per year additional capital gains for ATLS in 2014 and 2015. Acquisition news release link:
finance.yahoo.com
Math for the IDR’s from APL at 75 cents per Q APL distribution
APL has about 62 million shares outstanding compared to 52 million ATLS.
ATLS holds about 5.75 million shares in APL
By 4th Q APL estimated distribution of $60 million or 0.75 cents per share split as follows:
Zero to 42 cents per share per Q $26.5 million for APL $0.5 million for ATLS
42 to 52 cents…. $6.3 APL and $1.1 for ATLS
52 to 60 cents….$5.04 APL and $1.76 ATLS
60 to 70 cents….$9.45 APL and $9.45 ATLS
5.75 million shares equity stake at $0.75 per share $4.3 million to ATLS
ATLS also will give back to APL $3.75 million per Q after receiving $7 million per Q in IDR’s as part of the GP agreement associated with the purchase of a large gathering system some years ago. This was to overcome the IRR hurdle mentioned in the business model.
I have not added this give back to the next Q distribution but in theory ATLS would get ½ of this back the next Q for a 3.5 cent distribution bump per share worth $3 per share capital gain potential beyond estimates. It has not been paid in so long and there has been no discussion on what APL will do with the cash on any of the recent conference calls. Current share count has this occurring somewhere between 67 and 73 cents a share per Q distribution from APL.
Total IDR’s with equity position about $13 million per Q or $0.25 per ATLS share 4th Q 2013 or 1st Q 2014 from APL.
Atlas Resource Partners (ARP) estimates:
(Atlas Resource Partners) website presentation link :
phx.corporate-ir.net
Link to last company press release with distribution estimate:
finance.yahoo.com
ARP distributions $39 million a quarter per company current estimate using $2.50 per share or $0.625 per Q. I am using the higher company provided $2.50 estimate is ARP has kept quiet about partnership capital raising and the recent $255 million acquisition still leave another acquisition of a similar size to be announced likely before the end of the year per 3rd Q conference call. Search seeking alpha using acquisitions key word in link below to go straight to information.
seekingalpha.com
ARP’s partnership business is a very valuable franchise. A business plan that inside an MLP and coupled with the higher grade drilling locations that ARP has been accumulating is a competitive advantage. If there are no significant changes in taxes with regards to oil and gas drilling or the MLP model then I expect this advantage will be recognized and ATLS stock valuation will be higher than my current guesses. This is already too long so check out the ARP 10k or annual report page 10 (competitive strengths) if you want more info.
ARP IDR calculations at 62.5 cents per Q ARP distribution:
ARP has 49 million shares outstanding compared to 52 million for ATLS.
ATLS holds 21 million shares of ARP.
Zero to 42 cents per share $20.58 million for ARP and $0.4 million for ATLS
42 to 52 cents …..$4.9 ARP and $0.86 ATLS
52 to 60 cents …..$3.92 ARP and $1.30 ATLS
Above 60 cents ….$1.22 ARP and $1.22 ATLS
21 million ARP shares at 62.5 cents $13.12 ATLS
ATLS G&A expense of $2 million per Q.
Total IDR’s with equity position from ARP $16.9 million per Q less G&A expense of $2 million per Q we have $0.29 per Q 4th Q 2013 to ATLS from ARP
Combined IDR’s and equity income:
Total ATLS IDR’s of $0.54 per Q or $2.16 per year compared to current $0.27 Q or $1.08 per year likely by 1st Q 2014. I did not aim for a 100% increases but it is a nice number.
Yield expected to be 4% to 5% gives a first Q 2014 ATLS stock price of $43 to $54 with likely expected increase of another $20 to $25 in 2014 to 2015. I own it for the capital gains low estimate of 30% over the next 16 months.
Optimistic estimate
I think the company may hit a little bit higher numbers and expect $0.80 per share per Q APL and $0.75 per share possible for ARP late 2013 or early 2014. Using the same metrics I get $0.78 per share per Q for ATLS or $3.12 yearly rate and a price target of $62 to $77. This is about a 190% increase compared to current distribution.
Why not to invest:
Risks include changes to oil and gas drilling deductions that will affect the partnership business and or a decline in NGL and oil prices. Both entities hedge very well but distribution coverage will be higher if product prices decline to avoid lowering distribution in future periods.
I do not like filing state income taxes so I hold ATLS only in my IRA even with the UBTI (Unearned Business Taxable Income) issues and in non-retirement account long dated options only. APL price discussed later is also good and if you own APL you may have to file tax returns in OK and KS. Those two states are not too bad to deal with. I have filed there the last 2 years.
If you do not understand MLPs or have a competent tax person then I suggest you do not invest in any of the mentioned companies. Operations in several states have state income tax filing requirements and there is not much tax shield at the ATLS GP level. All of the information here is publicly available. It just takes a lot of digging and estimates are just that and I tried to be conservative in my price targets with safety of capital primary goal.
These companies should update their own estimates in February for the next calendar year and I will adjust accordingly.
APL price target since I already have a distribution estimate:
My price target for APL end of year 2013 is $41 to $47 to yield 7.3% to 6.3% with potential capital gains of 30% to 50% based on a buy price of $31. APL is a Lower risk stock than ATLS in the short term as the higher yield keeps a higher floor under the stock.
Why not also an ARP price target?
My price target for ARP end of year 2013 is $26 to $29 to yield 9.5% to 8.6%. I do not know when ARP will slow down the acquisition spree so cannot speculate on any additions next year. Any additions will flow through to ATLS so there is little incentive to buy ARP. I would speculate that acquisitions will keep occurring while natural gas is historically cheap and the futures curve allows profitable hedging. ARP should not stop until they have 10 or more years of high quality drilling locations for the partnership program IMO.
My exposure:
Options are a bit rich and very thinly traded but I am using both options and the stock as my method of exposure. I plan on buying some 2015 calls next year and am currently long APL and ATLS stock in my IRA and 2014 calls for both strikes $25, $30, $40, and $45.
Jim
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