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Some thoughts on the CNX Midstream guide down

So this isn’t a stock that I own right now.  I have owned it though.  I’ve been following it and some other midstream plays fairly closely since early December.

Up until recently these midstream stocks weren’t performing all that well.  They were getting beaten up with oil even though some of these companies have absolutely nothing to do with crude.

CNX Midstream for example.  100% natural gas and liquids.  They are the child of the old Consol – basically a situation where the E&P assets went into one company (now called CNX Resources) and the midstream assets, so pipelines, compressors, and facilities, went into another.

CNX Resources is a fairly large Marcellus/Utica producer, wet/dry natural gas, 1.4 bcf/d.

CNX Midstream operates all the pipelines for them.  They basically handle gas for CNX Resources and one other customer (HG Energy, which is private) so they are very concentrated.

Most importantly, CNX Resources owns 33% of CNX Midstream.  They are also the general partner, which means they manage and operate CNX Midstream.

On their fourth quarter call CNX Midstream surprised the market.  EBITDA guidance was $200 million to $220 million.  Distributable cash flow guidance was from $150 million to $170 million.

Up until that point analysts had been expecting an EBITDA guide of around $245 million and the floor on DCF was thought to be $170 million.  So this was a significant guide down.  Below is from their analyst day forecast back in March of last year:

So what happened?

Well part of it was that their E&P partner CNX Resources reduced their activity in 2019.  They phrased it as “minimum activity levels” and stressed that they would be “flexible” and add capital depending on prices and returns, but bottom line is that they are budgeting less than was anticipated.

So there’s that.  What can you do – your customer is worried about prices or returns or whatever else and they decide to reduce activity.   That means reduced through-put for CNX Midstream, or at least less growth than the analyst community was expecting.

But that’s only part of the story.  One analyst, I believe his name was Matt Niblack (?) pointed out that there was still something that didn’t quite compute:

…the minimum [DCF] has been adjusted down from $170 million to kind of $150 million to $170 million due to timing and other factors. But there’s still upside to that, and we just have to see how that goes. I guess my only other question here then is, in the minimum guidance range, if that seems — and also, I think implied in CNX’s production growth range, you’re looking at kind of roughly flat economics relative to Q4, right? And I’m just taking your EBITDA in Q4 and multiplying it by 4. I realize there will be some seasonality associated with that, so that will vary quarter to quarter. But for the full year, that’s what you’re looking at. And yet, there’s significant growth CapEx…

So the question is, why are you spending the same amount of growth capital if you aren’t growing as much?

I read the transcripts a couple times and while the company is a bit vague about it I think the hint they give is when they start talking about de-bottlenecking:

“So a significant portion of the capital that we’re spending in 2019 is associated with de-bottlenecking projects”

So CNX Midstream spends money de-bottlenecking.  That’s either compression, looping, twinning… it’s something that is going to lower pressure in an existing line.  Lower pressure of course means more gas.

But it’s more gas on the back of Midstream’s capital.

This brings up the point about the competing interests of the E&P and midstream.  Particularly when the midstream is controlled by the E&P.  Whose best interests is the de-bottlenecking in?

I would argue that the E&P, so CNX Resources, benefits more from de-bottlenecking.   If it was all one company the capital decision would be based on whether we get more bang (ie production/NAV/cash flow per dollar spent) from drilling a new well or from adding compression/looping an existing line and getting uplift from existing wells.

In this case it’s not all one company.  CNX Midstream pays for the de-bottlenecking.  So its a bit of a free-bee for CNX Resources.

Yes, CNX Midstream gets the volumes as well.  But they just get a toll, and they could have gotten those volumes anyway if the E&P had used its own capital and drilled some more wells.  Now I realize that drilling more wells in an area that could use some de-bottlenecking is likely going to back out other production.  Sure. So drill them somewhere else, where there is capacity.  Volumes are volumes for the midstream.  My point here is that the uplift is paid for by the midstream but they aren’t getting the full benefit.

Of course CNX Midstream says that its a good rate of return. From the call: “I mean, we could follow up with those specifics. I mean, those are good rate of return projects. Otherwise, we wouldn’t do those on a standalone basis. It’s sort of like core, like baseload, sort of like easy low-hanging fruit stuff to do.”  And it does give CNX Resources the ability to ramp production more at some point, now that pressures are lower.  So there’s that.

One thing de-bottlenecking definitely does is it helps an asset look better, at least for a while.  Not saying that’s the case here, I really don’t know.  But type curves never talk about pressure.  It’s rate vs. time.  Nevertheless, you lower the pressure and rates go up.  There is a reason engineers do a bunch of crazy math on their wells and introduce concepts like material balance time and pseudo-time.  Its because its pretty easy to get the wrong impression from a rate vs. time graph.

It all just makes you wonder if CNX Midstream might be taking one for the team here?  CNX Midstream spends some money on de-bottlenecking.  It’s not really a big deal in the grand scheme of things, the stock takes a bit of a hit but it bounces because it doesn’t affect the dividend or anything.  CNX Resources gets some free uplift from it.  That helps their guidance.  Everything looks a bit better. No one gets hurt.

Who knows!  Maybe it’s all just efficient capital allocation.  Nevertheless I think the thought exercise is worthy of contemplation: that there is at least the potential of misalignment with these E&P-midstream separations in the United States.

16 Comments Post a comment
  1. Aurelien Windenberger #

    Hey thanks for taking the time to spell this out today! I’ve gotten very interested in the big US gas E&Ps, but still trying to wrap my head around the different arrangements they have for offtake.

    I find myself impressed with CNX Resources management over the last year+, as they do seem focused on value creation, whether through the drill-bit, or via share-repurchases. Its nice to see yet another way that might be happening, at the expense of the mid-stream in the short run.

    February 14, 2019
  2. Jack #

    Hey, interesting incentive structure for sure. I know you have been in shipping in the past, and I was just wondering if you have a take on shipping leading into the IMO 2020 regulations. Any thoughts on how the product tanker market might unfold as a result of the regulations? I despise the sector, but so does everyone else, which makes me think there might be opportunity if the market tightens up in Q3 through 2020.

    February 16, 2019
    • I’ve looked a this a few times, i even owned ASC for a short time, and I probably need to revisit again now that these companies have announced their quarters. ASC has said on a few occasions that it is a real boon for the product tankers, I believe a 6% equivalent uptake in demand? It’s on their calls. So it should be a good idea here shortly I think.

      February 16, 2019
  3. German reader #

    Found a nice pitch here for Ring Energy:

    Any thoughts?

    February 21, 2019
  4. arf #

    Take a look at Evolving systems. Trading at only 0.5x revenue, and 3.5x 2017 earnings. Their tech stack looks a bit outdated though. But they booted out the old CEO who was a bit of an idiot in 2018. And ramped up development. It seems to me 1x revenue is a fairer price for a company like this.

    February 22, 2019
  5. arf #

    Interesting write up on Tourmaline:

    February 23, 2019
    • Thanks that’s interesting to, but I don’t know, I don’t think I’ll be adding natgas in Canada, LNG Canada in itself just doesn’t seem like enough to swing the needle does it?

      February 25, 2019
  6. arf #

    What do you think about Zinc? stocks are really low:

    I mean at some point something has got to give? Or are there huge stocks of Zinc hidden away somewhere in Asia?

    Thinking of going back in ASND.

    February 24, 2019
    • Wow those are interesting numbers. I haven’t been following zinc for a long time. Maybe ASND? If I remember right though they weren’t terribly cheap at under $1.30 zinc. How about TV?

      February 25, 2019
    • Looking at BMO’s forecast significant zinc surpluses are expected for the next few years.

      February 26, 2019
      • arf #

        Hmm ok. I guess there are large stockpiles in Shanghai or something.

        February 28, 2019
      • I dont know about that. These are stockpiles to come that they are talking about. 2019 and 2020 S/D is going to see large oversupply according to their tables. If you email me I can send you the report.

        February 28, 2019
  7. arf #

    Nah I am fine thanks.

    What you think about GCM shenanigans? They will release updated Segovia reserves later this week. It seems to me that if Segovia can expand reserves significantly, the shares could easily double. As that is pretty much what has kept shares down. If they got 10+ years of production from Segovia, it would increase NAV a lot.

    But that share offering was really dodgy. Could be several things,

    -Things aren’t as rosy as they seemed, and management thinks shares were more than fairly valued, so why not issue some shares?
    -There is some politics happening behind the scenes and this is their way of making some people happy that need to be made happy by giving them some shares cheaply
    -They really do have ambitious plans and are impatient, ramp up reserves and then sell the company
    -Insiders just want to increase their stake cheaply

    What weirds me out is that apparently they could not see the share price drop coming? And they cancelled it right after? I don’t buy that they are that naive.

    March 5, 2019
    • Yeah I sold on the news. I tweeted at the time how it made no sense to me. I guess the debt pay down, that they have to spend $20mm or so on principle repayments, and so they need extra cash beyond that, makes some sense but still seems odd to me if they are expecting to be as profitable as we think they should be. I had been slowly selling it down over the last month or so but that news kind of precipitated me to just get rid of the rest.

      March 5, 2019
  8. arf #

    If you are willing to venture out to Australia, check out Reckon. Accounting and legal software company, trading at little over 1x recurring rev multiple and 8.5x earnings. They got a load of new services that are released this year. Failed to sell about half their revenue to a competitor for $180m (vs current market cap of $75m) in announced sale in 2017 due to a regulator blocking it.

    Got a new CEO and he has been buying shares as well at current price. They say that they still have interested parties to sell their accountant practice division and are still reviewing a sale.

    Seems like a valuation of $75m with $45m in debt is too cheap? And you get paid a 7.5% dividend while you wait. If they return to growth or get a sale done at $100m+ shares are probably worth double at least.

    March 6, 2019

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