I am submitting the following article to Seeking Alpha. It is possible that it will be up on the SA website in just a few hours. As is my practice, 30 Day Dividends subscribers get a first look at anything I plan to publish on any current holdings in the newsletter portfolio list.
Midcoast Energy Partners: Speculative Turnaround With an 9% Yield
I was in a bit of shock when I realized that I have not yet written about Midcoast Energy Partners LP (NYSE: MEP) for Seeking Alpha. I wrote the headline back in January with the 11% yield that was in effect at that time. The MEP unit price has come up quite a bit since the first of the year, but if this midstream MLP can start to hit its distribution growth guidance, the unit price is going to go a lot higher.
Background
Midcoast Energy Partners was spun-off by Enbridge Energy Partners LP (NYSE: EEP) in November 2013. Enbridge had accumulated a portfolio of natural gas/NGL gathering and processing assets that did not fit in well with Enbridge’s core business of FERC regulated crude interstate pipelines. Enbridge’s natural gas assets were transferred to a wholly owned holding company, Midcoast Operating. At the IPO, 39% of Midcoast Operating was transferred to the new MLP. The plan was for the rest of the assets to be transferred/sold (drop downs in MLP jargon) to Midcoast Energy Partners over the next five years.
At the time of the IPO and into early 2014, Midcoast was providing guidance of mid-teens distribution growth through at least 2017. MEP hit the market during a period when new spin-off MLPs were hot and this new partnership had the backing of a large cap MLP and Enbridge, Inc (NYSE: ENB), a $50 billion pipeline company. It appeared that Midcoast was a no-lose MLP growth prospect.
Results Don’t Work Out as Planned
As Midcoast moved through 2014, actual financial results for the second and third quarters came up short of guidance. For the 2014 third quarter, distributable cash flow coverage had dropped to 0.79 times the distributions paid, down from 1.0 times in Q2 and the guidance target of 1.1 times. The market had become aware that Midcoast was not living up to the growth expectations. From a peak unit value of $25 in early September, the MEP price dropped to under $15 two months later. Then the energy sector year end sell-off due to low commodity prices and the unit price bottomed at about $11.75 in late January. At that point MEP was sporting a yield of about 11%.
Enbridge and Midcoast started making changes midway through Q4 2014. In early December, there was a shakeup at the top levels of partnership management and the company announced a revised business plan and guidance for 2015. The biggest change was to reduce overhead costs including workforce and contractor reductions, consolidate or idle underutilized assets, and eliminate discretionary expenditures. The reductions totaled $50 million for the year, or a 12% reduction in planned expenses. Put another way, the $50 million in spending reduction is comparable to the $59.6 million that was paid as unit holder distributions in 2014.
The 2014 Q4 distribution declared in late January had a 1.5% increase compared to the 4% growth rate of the previous two quarterly distributions. When the fourth quarter results were announced, DCF was back up to 1.08 times the distributions paid for the quarter. Midcoast management had pulled back the growth rate to gets its cash flow vs. distributions house in order.
Tremendous Prospects for 2015
In December, I named Midcoast Energy Partners as one of my top picks for 2015 in several private reports and issued a Buy recommendation to my 30 Day Dividends newsletter subscribers. The position is up 12% since the end of December, but there is plenty of gain yet to be made in MEP.
A combination of continued revenue ramp up from current projects and additional asset drop downs from Enbridge Energy Partners should allow Midcoast handily meet its reduced distribution growth guidance of about 10% for 2015. Distribution growth guidance remains in the high teens starting in 2016. When Midcoast hits its distribution growth targets with greater than 1.0 times DCF coverage over the next couple of quarters, I expect the market to push the yield down below 7%, possibly to the low 6%’s. This would put the unit price in the low $20’s, up 50% from where MEP currently trades. Midcoast will announce 2015 first quarter results on April 30.