Summit Midstream Partners: The Prospects Of A Lost Decade Even If They Survive (NYSE:SMLP)


Introduction

The Master Limited Partnership area of the market has seen a great deal of pain throughout 2020 as the COVID-19 pandemic inflicted immense broad-ranging damage. This has left Summit Midstream Partners (SMLP) fighting for survival, and if you are interested in their prospects to survive, I would recommend reading this article by a fellow author who provided an excellent analysis. Suffice it to say that their situation is not looking promising, and sadly for their unitholders, they could still face a lost decade before they finally get back on track even if they survive.

Executive Summary & Ratings

Since many readers are likely short on time, the table below provides a very brief executive summary and ratings for the primary criteria that were assessed. This Google Document provides a list of all my equivalent ratings as well as more information regarding my rating system. The following section provides a detailed analysis for those readers who are wishing to dig deeper into their situation.

Image Source: Author

*There are significant short and medium-term uncertainties for the broader oil and gas industry. However, in the long term, they will certainly face a decline as the world moves away from fossil fuels.

**While the oil and gas industry to which they service has high economic sensitivity, given the more stable nature of the midstream sub-industry, this was deemed to be average.

Ratings Summaries & System

Summit Midstream Partners cash flows

Summit Midstream Partners notes 1

Image Source: Author

Instead of simply assessing distribution coverage through distributable cash flow, I prefer to utilize free cash flow since it provides the toughest criteria and best captures the true impact to their financial position. The main difference between the two is that the former ignores the capital expenditure that relates to growth projects, which, given the very high capital intensity of their industry, can create a material difference.

Their historical cash flow performance clearly shows their very weak distribution coverage with an average of negative 2.95% during 2017-2019. Since their distributions are now suspended, and they are fighting for their life, their distribution coverage is not the primary issue. The bigger topic right now is their ability to survive and, if possible, their ability to deleverage since the majority of their solvency issues relate to excessive leverage.

When looking towards the future, they have provided guidance for total capital expenditure during 2020 of $40m at the midpoint, as per slide four of their 2020 Citi One-on-One Midstream Conference presentation. Despite them using the word “total”, this seems to still ignore their investments in equity method investees, which I believe should be included as they are alike to capital expenditure and obviously impact their ability to deleverage. Once these are included, it can be seen that their capital expenditure for 2020 was already $107m during the first half of 2020 alone, which, for the sole purpose of this analysis, will be referred to as their “real” capital expenditure.

Given this rather opaque situation, it makes judgments less than ideal, but given their history, it seems reasonable to assume that their real capital expenditure will sit around $100m in a middle of the road scenario for the long term, which represents a 50% decrease versus 2019. Once again, to stay broadly down the middle of the road, assuming their operating cash flow averages $200m seems suitable as it equals the average of 2018-2019 and the annualized equivalent from the first half of 2020. The final moving part is their miscellaneous cash expenses that are listed beneath the graph included above, the most important ones being their preferred distributions that normally total $29m per annum, along with their distributions from equity method investees that were $7m during 2019.

After combining all of these three main moving parts together, it indicates that they should have approximately $80m on average available to deleverage going forward. Admittedly, this is only an estimate, but it nonetheless provides a suitable baseline to estimate their ability to deleverage and begin rewarding unitholders.

Summit Midstream Partners capital structure

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When looking at their capital structure, it can be observed that their situation has deteriorated over the years as their net debt increased, and their equity decreased simultaneously. Since the focus of this analysis is their ability to deleverage, the most important number here is their net debt of $1.509b.

Summit Midstream Partners leverage ratios

Summit Midstream Partners notes 2

Image Source: Author

When looking at these financial metrics, it naturally is no surprise that their leverage is very high, as primarily evidenced by their net debt-to-EBITDA of 6.54 and low interest coverage of only 1.22. This means that, to sufficiently deleverage, they would have to reduce their net debt by $701m, which would bring their net debt-to-EBITDA down to the bottom range of the high territory at 3.50. If they were only to generate the $80m of free cash flow as previously discussed, this would take slightly under nine years. Needless to say, this is a very long length of time to wait, and thus, it appears that, even if they survive the short term, their prospects to ever materially reward their unitholders are very limited.

Summit Midstream Partners liquidity ratios

Image Source: Author

When seeing current and cash ratios of 1.09 and 0.32, respectively, it normally indicates at least adequate liquidity, but this is not the situation in this instance, given their upcoming debt maturities and very high leverage. They face $309m of debt maturities within the next two years, even if their credit facility is ignored, as the table included below displays. Since they are unlikely to produce $309m of free cash flow during the next two years, it seems highly unlikely that these can be repaid, and as the analysis from Michael Boyd highlighted, refinancing could prove quite problematic, and thus, their risk of bankruptcy is very realistic.

Summit Midstream Partners debt maturities

Image Source: Summit Midstream Partners’ Q2 2020 10-Q

Conclusion

At the end of the day, they are a prime example of why analyzing financial positions still matters even for organizations that boast about their stable cash flows, as too much leverage can destroy any organization. Since they could still go either way, I believe that a neutral rating is appropriate as sitting on the fence and watching feels suitable for all but investors with the highest possible risk tolerance.

Notes: Unless specified otherwise, all figures in this article were taken from Summit Midstream Partners’ Q2 2020 10-Q (previously linked), 2019 10-K and 2017 10-K SEC Filings, all calculated figures were performed by the author.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.





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4 reasons this investment could be ‘one of the best-performing asset classes’ over the next decade


As the adage goes, “Don’t wait to buy real estate. Buy real estate and wait.”

If you follow advice in the current climate, you could be in store for a nice windfall over the next 10 years, according to Ritholtz Wealth Management’s Ben Carlson.

And, as you can see, there is a clear uptick in homeownership happening at the moment:

“There is a real possibility real estate could be one of the dominant assets of the 2020s,” Carlson wrote in a post on his “Wealth of Common Sense” blog.

To many, that might sound rather obvious. But Carlson pointed out that, historically, real estate isn’t all it is cracked up to be compared with other assets in terms of performance.

He cited Shiller real home price data showing that the annualized gain of U.S. housing over the rate of inflation comes to a paltry 0.1% from 1900 to 1996. From there, it performed much better, but over the past century, it clearly lags behind many other asset classes.

“Some would say the takeaway here is that housing makes for a lousy long-term investment,” Carlson explained in his post. “There’s certainly an argument to be made for that claim when you consider all of the ancillary costs associated with homeownership — property taxes, upkeep, maintenance, insurance, renovations, landscaping, closing costs, etc. Owning a home involves more consumption than almost any investment on the planet.”

Now, however, he gave four reasons housing prices should catch fire in the coming years.

1. Millennials — This generation has resisted taking the plunge, but now, with the pandemic shifting the landscape, could be the time for this group to do adult things, like buy that first home. “Young people are settling down later in life because they are going to school for longer, had to deal with a housing bust, and graduated in and around the Great Financial Crisis,” Carlson said.

2. Interest rates — It’s hard to resist the historically low cost of borrowing money.

“Even if housing prices have risen in this time, lower borrowing rates have kept things more affordable than most people realize,” Carlson wrote in his blog post. “If the Fed has their way it sounds like rates are going to stay low for a number of years.

3. Supply — Are there enough houses to meet demand?

“The hangover from the bursting of the 2000s housing bubble is still being felt when it comes to the supply of homes in this country,” Carlson said. “My guess is a combination of retiring baby boomers who need to tap their biggest asset (their house) for retirement funds and millennials who need a home will help these numbers rise in the coming years.”

4. Work from home — Carlson, unlike many others, isn’t calling for the virtual death of big cities, but he’s also not denying the change that seems to be here to stay.

“There could still be a nasty transition period as employers and employees alike realize they don’t all need to live and work in big cities to be productive,” he said. “Untethering employees from a specific location will allow them to move to more cost-effective areas and potentially change the housing dynamics for a large group of people.”

Meanwhile, the stock market continues to flex its muscle, with the Dow Jones Industrial Average
DJIA,
+0.32%

up nicely Tuesday. The S&P 500
SPX,
+0.11%

and Nasdaq Composite
COMP,
+0.07%

were fighting to gain traction higher in choppy trade.



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Valuation of Asian shares rises to decade high on stimulus support By Reuters


© Reuters. An investor looks at his mobile phone in front of a board showing stock information at a brokerage office in Beijing

(Reuters) – The valuation of Asian shares surged to a more than 10-1/2-year high in July, Refinitiv data showed, as record-low interest rates and abundant government stimulus helped offset worries over the economic impact of the COVID-19 pandemic.

MSCI’s broadest index of Asia-Pacific shares rose 4.29% last month, recording its fourth straight monthly gain. The index’s 12-month forward price-to-earnings (P/E) ratio was at 16.15, the highest since December 2009, the data showed.

Meanwhile, MSCI’s gauge of stocks across the globe climbed 5.14% in July, lifting its P/E ratio to 19.65, the highest since at least June 2003.

Lower interest rates, stimulus support from regional governments and retail investors’ increased participation in stock markets have bolstered the valuation of regional indexes this year, analysts said.

Hopes that vaccines against the COVID-19 disease might be ready by the end of the year also supported the risk-on trade in regional markets.

China’s benchmark stock index surged 10.9% in July, recording its best monthly rise since February 2019, and topped regional gains.

Simona Gambarini, markets economist at Capital Economics, said the higher P/E ratios of mainland China equities, which have been driven higher by a government-sanctioned wave of retail speculation, do not yet suggest signs of trouble.

“One reason why we wouldn’t put too much emphasis on high P/E ratios in general is that earnings are distorted by the impact of the pandemic, which has been very large but will probably also prove short lived,” Gambarini said.

New Zealand, India and Malaysia shares were the most expensive in the region, with P/E ratios of 32.93, 20.36 and 18.11, respectively.

(GRAPHIC – Asia-Pacific equities performance in July 2020: https://fingfx.thomsonreuters.com/gfx/mkt/azgvokzkzvd/Asia-Pacific%20equities%20performance%20in%20July%202020.jpg)

(GRAPHIC – Asia-Pacific equities performance in 2020: https://fingfx.thomsonreuters.com/gfx/mkt/oakpemxmjpr/Asia-Pacific%20equities%20performance%20in%202020.jpg)

Taiwan equities hit a record high of 13,031.7 in July and gained about 9% last month, the biggest monthly rise after China.

(GRAPHIC – MSCI Asia and World index PE: https://fingfx.thomsonreuters.com/gfx/mkt/xlbpgbzbdvq/MSCI%20Asia%20and%20World%20index%20PE.jpg)

(GRAPHIC – Valuation of Asia-Pacific equities: https://fingfx.thomsonreuters.com/gfx/mkt/jbyprkeknve/Valuation%20of%20Asia-Pacific%20equities.jpg)

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Vanguard comes to defense of the 60/40 portfolio as it forecasts stock market returns for the next decade


The 60/40 portfolio has come in for its share of criticism recently, with Bank of America proclaiming its death last year.

A 60/40 portfolio has 60% invested in stocks, and 40% in bonds or other safe asset classes. In a new note to clients, index fund powerhouse Vanguard Group points out how well the portfolio did in weathering the storm caused by the coronavirus pandemic.

A 60/40 portfolio — with 60% in the MSCI All Country World index
892400,
+0.14%
,
and 40% in a dollar-hedged Bloomberg Barclays Global Aggregate Bond index — weakened just 1.5% over the first half of the year.

“It is true that over a few days, the correlation between the global equity and bond markets was positive and that they moved relatively in tandem, but for the first half of 2020, a globally diversified bond exposure acted as ballast, helping to counter the riskier stock component of the portfolio,” says Joe Davis, global chief economist at Vanguard.

Vanguard is forecasting average annual U.S. stock-market returns between 4% and 6% over the next year, which isn’t dissimilar from a recent projection from Goldman Sachs. Vanguard says global stocks, to U.S. investors, will return between 7% and 9% a year. But despite Vanguard’s low return outlook for bonds — 0% to 2% for both U.S. and non-U.S. bonds — Davis says globally diversified fixed income will continue to play the important role of a risk diversifier in a multiasset portfolio.

Peter Dixon, senior economist at Commerzbank in London, is another who has come to the defense of the 60/40 portfolio. He points out that, over 20 years, it has generated higher returns than hedge funds once fees are taken into account.

“The current low rate environment means the returns from bonds are likely to look very poor for years to come. But investors tempted to overweight equities, which are likely to benefit as a consequence, run the risk of getting caught out by volatility as markets continue to question whether current price valuations are justified (we can expect quite a lot of that in the months ahead),” says Dixon. “Since the intention of 60/40 is to offset the extreme highs and lows of equities, it may be worthwhile sticking with it for a bit longer. It is, after all, a tried and trusted method and that is not a bad thing in our new, uncertain investment world.”

Strategists at Goldman Sachs disagree. In a note to clients this week, they acknowledge that over the last 30 years, there has been little benefit from diversification within equities or bonds, while diversification across assets was very effective.

But with bond yields closer to the effective lower bound, potential for further declines is limited, they say. As for stocks, equities are likely to be stuck in a “fat and flat” range, that is, below average returns with above average volatility.

They suggest an 80/20 portfolio with put protection, which they say outperformed a 60/40 portfolio significantly this year. Convertible bonds also look more attractive, they add.

The S&P 500
SPX,
+0.57%

has rallied 46% this year from its March lows, and has gained a little over 1% this year. The yield on the benchmark 10-year Treasury
TMUBMUSD10Y,
0.588%

has fallen below 0.60%, falling 1.3 percentage points on the year. Yields move in the opposite direction to prices. 



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Philip Morris says cigarette sales in many places could end in a decade and they’ve got a ‘safer’ product to replace them


Philip Morris International Inc. thinks the sale of cigarettes could come to an end in countries around the world in the coming years, but have no fear, because they’ve got another product ready to sell that offers a “safer” nicotine fix.

Philip Morris
PM,
+4.02%

and the Food and Drug Administration announced this week that the company’s IQOS “electrically heated tobacco system” has been given the green light to market as a safer alternative to cigarettes.

Now designated as a “modified risk” product, the company can promote these items “as containing a reduced level of or presenting a reduced exposure to a substance,” according to the FDA statement.

Philip Morris, the company behind Marlboro cigarettes, describes these alternative products as heating rather than burning tobacco, which a cigarette does. Burning tobacco, which reaches 600 degrees Celsius, “contains high levels of harmful chemicals,” according to the company’s website. The tobacco heating system (THS) heats tobacco to 350 degrees Celsius.

Read: After his latest firing, this cannabis entrepreneur raised $150 million, for a hemp venture — during a pandemic

“However, THS is not risk-free and delivers nicotine which is addictive,” the site says. Philip Morris has turned its focus to the IQOS product, with Philip Morris’ Chief Operating Officer Jacek Olczak saying at the Deutsche Bank dbAccess Global Consumer Conference last month that the company is committed to “working towards realizing [the] potential of this opportunity,” according to a FactSet transcript.

The development comes at a time when Philip Morris is preparing for the end of cigarette sales.

“I am convinced that it is possible to completely end cigarette sales in many countries within 10 to 15 years, but for that to happen, manufacturers and governments need to work in the same direction,” said André Calantzopoulos, chief executive of Philip Morris, in a letter to stakeholders published with the company’s report on its environmental, social and governance (ESG) efforts.

Calantzopoulos notes the “skeptical stakeholders” like international organizations and the media that “doubt that harm reduction through smoke-free alternatives is sound public health policy or argue that our purpose-driven strategy is nothing more than window dressing.”

He highlights other areas where advice to reduce a hazardous activity is accepted, such as lowering sugar intake for better health.

“I feel strongly that people who smoke cigarettes, the most harmful nicotine-containing product, should not be denied the opportunity to switch to better alternatives,” Calantzopoulos wrote.

In 2019, Philip Morris sold 706.7 billion cigarettes, down 4.5% from 2018, according to a June CFRA report. Over the next few years, CFRA forecasts that cigarette consumption will fall 3% each year.

Shipments of heated tobacco products, on the other hand, soared 44.2% to 59.7 billion units in 2019.

Watch:How to keep emotions out of your portfolio with systematic investing

There had been discussions about merging Philip Morris and Altria Group Inc.
MO,
+4.32%

, however those talks ended without a deal. This is a good thing for Philip Morris “given heightened regulatory and legal headwinds surrounding e-cigarettes in the U.S., as Philip Morris’ IQOS product underwent a lengthy FDA review process before getting the green light for sale in the U.S. in April 2019,” CFRA said.

CFRA rates Philip Morris stock buy with a 12-month price target of $95.

“Despite declining cigarette consumption in developed markets, we look for pricing gains and growth in emerging markets to support revenues,” CFRA said. “We think the launch of Philip Morris’ heated tobacco product, IQOS, will lead to market share gains and help offset cigarette volume weakness.”

The company reported earnings and revenue that beat expectations in the most recent quarter. The stock is down 15.1% for the year to date while the Dow Jones Industrial Average
DJIA,
+1.43%

has fallen 9.3% for the period.

See:This California legislator is taking on SmileDirectClub

While the cigarette business was hurt by restrictions imposed by coronavirus-related lockdowns and plummeting duty-free demand at global travel hubs, Olczak said on the April earnings call that device and heated tobacco sales were showing the potential to regain pre-COVID momentum.

Philip Morris’ goal now is to move into a “smoke-free future,” said Huub Savelkouls, the company’s chief sustainability officer, in a post on LinkedIn. Philip Morris has cut its cigarette portfolio by more than 700 SKUs (stock-keeping units) over the last four years and aims to move 40 million smokers of its cigarettes over to smoke-free products.

Savelkouls says engagement, including between the company and the investment community, is needed to achieve change.

“Making cigarettes obsolete can be achieved much more rapidly through inclusivity and openness,” Savelkouls wrote. “Our goals are really not that different and that is where the potential for creating impactful change lies: working together towards making the world smoke-free.”



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