CONE Midstream Partners LP (NYSE:CNNX)

Investment Synopsis:

CONE Midstream Partners is a natural gas gathering focused MLP formed by CONSOL Energy and Noble Energy and launched with a September 2014 IPO. The market has not seen any value in the MLP and along with the general energy sector sell-off, the CNNX unit price is now 58% below the IPO value. The management team has committed the assets to produce mid-teens or higher annual distribution growth, and with a 7% current yield, this MLP looks like a great value and longer term growth prospect.
• IPO Date: September 25, 2014
• Market Cap: $750 million
• Annual adjusted EBITDA: $68 million (Q2 2015 annualized)
• GP/Sponsors: Noble Energy Inc (NYSE:NBL) and CONSOL Energy Inc. (NYSE:CNX)

Distribution Facts
• Current yield: 7.0%
• TTM distribution growth: N/A
• Forecast annual distribution growth rate: 15%

Business Operations

CONE Midstream Partners was formed in 2014 out of the natural gas midstream assets of CONSOL Energy Inc. –$3 billion market cap– and Noble Energy, Inc. –$14 billion market cap. The two companies combined have the sixth largest amount of dedicated natural gas production acreage in the Marcellus play. In 2011, CNX and NBL formed a 50/50 midstream joint venture, CONE Gathering LLC, to service their rapidly growing production in the Marcellus Shale. The two companies initially dedicated 500,000 acres to the venture for a 20-year term.

The assets in CONE Gathering were divided into three separate development companies:

• The Anchor Systems hold the gathering assets that currently collect the majority of the two companies’ production volumes. The majority of current midstream cash flow comes from the Anchor Systems.
• Growth Systems include the areas where wells are currently being drilled and natural gas production is increasing, requiring a growing amount of gathering services. The majority of near term CONE Gathering cash flow growth will come out of these systems.
• Additional Systems are other assets that currently produce a modest amount of cash flow and have the potential to be developed for additional cash flow growth.

At its IPO, CONE Midstream Partners received a 75% share of the Anchor Systems and 5% each of the Growth and Additional Systems. With this arrangement, the sponsor companies will pay up to 95% of the capex required to increase gathering volumes and cash flow in the growth focused systems. As cash flow ramps up, portions of the systems can be transferred to CNNX using the typical MLP drop-down mechanism. The structure of CONE Gathering provided CONE Midstream Partners with an initial stable amount of revenue and good visibility to hit the growth targets set in the IPO road show.

The 2015 second quarter was the third full quarter for CNNX as a public MLP. Quarterly results included gathering volume up 11% compared to Q1. EBITDA and distributable cash flow were both up 5% over the first quarter results. The company announced its first distribution increase, a 3.5% bump over the minimum rate paid the first two quarters. During the second quarter conference call, management pointed out that both distribution cash flow and DCF coverage were well above the guidance provided at the time of the IPO.

Growth Prospects

In my mind CONE Midstream Partners is a “quote marks” MLP. At a current $12.50 per unit, CNNX is down 58% from the closing price on its IPO date in September. The units were initially priced to yield 2.8%, which was typical for high distribution growth rate MLPs at that time. Then management started the problems by refusing to define their understanding of “top tier” distribution growth. The Wall Street analysts were looking for 20%+ growth rate, and CNNX management wouldn’t touch that discussion. A quarter later, they committed to mid to high teens distribution growth, but by then the sell-off of the MLP units was well under way.

For 2015, the energy bear market has taken down all energy companies as crude oil prices have declined. It did not matter that an MLP like CNNX had nothing to do with crude and was operating in stable natural gas production in the Marcellus Shale. The MLP’s sponsor share prices have also crashed, probably adding to selling pressure on CNNX. The MLP’s unit price has recovered for a while after the last two good quarterly earnings reports, but then the general energy bear market pushed the unit value even further down. After another good earnings for Q2 and the very nice distribution increase, the market showed no interest and the value kept falling.

With its lack of exposure to crude prices and unique holding company structure to generate growth, CNNX “should” be priced to yield less than 5%, even in this market. That yield points to a $17.50 unit price, instead of the current $12.50 and a 7% yield. It seems that the bears have their teeth in CNNX and are not about to let go. In any rational market, a 7% yield on a midstream MLP with high visibility of 15% or greater annual distribution growth would be a no-brainer. The unit price was at $17.50 when I included CNNX as an initial holding for The Tax-Smart Income Hunter growth focused portfolio. It “should” be a much better value and growth prospect now at a significantly lower market price.

Recommendation: Buy and Accumulate as a part of the MLP Total Return portfolio. Spread an initial purchase over several months to average down if the energy sector keeps declining.