Leveled with downward leverage

Summary

  • With free cash flow generation becoming more significant since 2020, many companies have used excess cash flow to reduce leverage, while EBITDA growth has also contributed to lower debt ratios.
  • With improved balance sheets, midstream companies were able to proceed with dividend increases and buyouts, as strong free cash flow generation provided increased financial flexibility.
  • Lower leverage speaks to the improving overall financial health of the space and builds confidence that companies will be able to continue to maintain and grow their dividends.

Debt reduction and balance sheet improvement have been key themes in energy infrastructure for years. For many names, deleveraging was a prerequisite before deploying excess cash flow to boost dividends and buyouts. Others are still working to reduce their leverage before pursuing these shareholder-friendly initiatives. Today’s note examines leverage improvements from 2016 to 2022 for MLPs and broader intermediaries using Alerian MLP Infrastructure Index and Alerian Midstream Energy Index, respectively, and explains why these improvements matter.

Average leverage at the index level reflects broad improvements for intermediaries/MLPs.

With free cash flow generation becoming more significant since 2020, several companies have used excess cash flow to reduce leverage, while EBITDA growth has also contributed to lower debt ratios. The graph below shows the average leverage for the current constituents of the AMZI and NAMA for 2016, 2019 and from 2Q22. Average leverage for AMZI and NAMA constituents has fallen from over 4.2x in 2016 to less than 3.9x today. Leverage was calculated using long-term debt and corporate EBITDA. Note that leverage calculations may vary. Net debt is often used and banks/creditors can make other adjustments.

The average leverage is trending down at the moment NAMA and AMZI Constituents

The charts show notable improvement over time, with 2016 and 2019 providing useful benchmarks. Remind that WTI oil prices fell to a multi-year low of $26 per barrel in February 2016, also before the significant adoption of equity self-financing, which began to gain traction in late 2017. Data from 2019 provides a pre-pandemic measure and coincides with a period when capital spending in space was still high. Finally, data for 2Q22 and the last 12 months EBITDA reflects improvements from the shift to strong free cash flow generation as spending moderated, supporting debt reduction. With improved balance sheets, midstream companies have been able to execute buyouts of dividend increases. Strong free cash flow generation provided increased financial flexibility.

Enterprise-level data gives more color to improvements.

Examining debt ratios at the constituent level provides useful context regarding company-specific improvements and the various factors that may affect debt trends over time. The chart below shows the leverage ratios, sector classifications and weightings for the ten main components of NAMA (please see the appendix to reference the same table for the AMZI). All ten names are less leveraged today than in 2016. Seven of the ten are less than 4.0x leveraged today, compared to Pembina Pipeline (BVG CN) with a leverage effect of less than 4.0x in 2016.

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Medium and MLP: leveled up with leverage down

Digging into the constituent data provides several observations. Some companies had debt ratios at or below 4.0x in each period, including Enterprise Products Partners (DEP), Magellan Midstream Partners (MMP), and MPLX (MPLX). These names have been able to maintain or grow their distros in harsh macro environments. Cheniere (LNG) and Cheniere Energy Partners (CQP) have seen notable improvements in leverage since 2016 due to their high capital intensity LNG projects have entered into service. Since announcing its long-term capital allocation in September 2021, Cheniere (LNG) paid off $3.1 billion in debt in 2Q22. For large Canadian companies Enbridge (IN B CN) and TC Energy (TRP CN), leverage has tended to decline from 2016 levels, but remains elevated relative to other names as both companies are working on a large project backlog, unlike many peers .

Why is lower leverage important?

Massive construction of energy infrastructure in the 2010s and financing difficulties in 2014-2016, when oil prices were falling, left an imprint on the balance sheets of many midstream companies. Several names took steps to improve their balance sheets and were better positioned financially when the pandemic rocked energy markets. For some companies that were financially strained, dividend cuts were essential to shore up the balance sheet during these tough times, and those cuts have been painful for investors. The macro volatility of recent years adds important context to why companies have prioritized debt reduction and why companies that were perhaps comfortable with leverage of 4.5 to 5x in the past adopted more conservative goals today. Lower leverage speaks to the improving overall financial health of the space and builds confidence that companies will be able to continue to maintain and grow their dividends.

Conclusion :

With stronger balance sheets and increased financial flexibility supported by strong free cash flow generation, midstream companies execute shareholder-friendly returns in the form of dividends and buybacks and are better equipped to weather potential periods of market volatility. .

Annex:

Medium and MLP: leveled up with leverage down

AMZI is the underlying index of the Alerian MLP ETFs (AMLP) and the ETRACS Alien MLP Infrastructure index AND N B-series (MLPB). NAMA is the underlying index of the ETRACS Alerian Midstream Energy Index AND N (NAMA).

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