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Energy & Income Advisor Live Chat October 2020
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AvatarRoger Conrad
1:54
Hello everyone, and thanks so much for joining us at our members only Energy and Income Advisory monthly webchat for October.

There is no audio. Please type in your questions and Elliott and I will answer them as soon as we can concisely and comprehensively. We will remain on the chat so long as there are questions in the queue. And we will email all EIA members a link to the complete transcript of the Q&A shortly after we sign off.

Before we begin, I want to call everyone’s attention to the new issue of EIA that just posted this morning. Highlights include Q3 results and guidance updates from the first Portfolio companies to report, and what they mean for our outlook for the sector. We also discuss implications from the upcoming US elections, which will no doubt be a subject of interest during this chat.
1:55
As usual, we’re going to start by answering questions we received via email. Thanks again for joining us.

Q. Good afternoon, Folks, in its recent conference call, Valero Energy (NYSE: VLO) management said it intended to defend its dividend even if it meant dipping into its cash reserves to do so. The stock is crashing to March levels, with 10% yield. I suspect Covid may push back the gasoline price recovery, but do you think the stock now presents a buying opportunity? 

Also, I would appreciate your thoughts about Occidental Petroleum (NYSE: OXY). Are you still hanging in there? Many thanks!—Jeffrey H.
A. There’s no change in our advice for either company and both remain in our Model Portfolio. Occidental won’t announce its Q3 results until November 9, so recent downside is probably more related to negative investor perceptions about where oil prices are going, than actual company developments.

Earlier this month, CEO Vicki Hollub told the virtual Energy Intelligence Forum that she expects global oil supply and demand to “rebalance” by the end of 2021. She also expressed the view that there would be a “moderate restoration of production” over “the next three to four years.” We’ll see next month what that rather dour view means for the company’s plans.
But I think it’s a good bet management is going to talk a lot more about cutting operating costs and debt, as well as asset sales like the $825 million divestiture of onshore Colombian assets to the Carlyle Group. Hollub also affirmed the company is ahead of plan on debt reduction. 

Back in April, we highlighted Occidental’s 2.7 percent senior unsecured bonds maturing August 15, 2022 as a buy with a yield to maturity north of 18 percent. The price of those bonds has since increased by more than 30 percent and they yield less than 7.5 percent to maturity. That’s great for those who bought them. But it’s also the best possible sign this company is recovering its financial strength. And it’s only a matter of time before that shows up in the share price of this deeply discounted, asset rich producer.
1:56
Valero has announced Q3 results, and I doubt it surprised anyone that year-over-year comparisons were affected by the pandemic’s impact on demand for refined products. Throughputs overall were lower by -14.6 percent from the same quarter in 2019.

The company also took a hit at the ethanol segment, with throughput lower by about -5 percent though operating income swung positive from last year’s loss. Renewable Diesel operating income nearly tripled on a 36.4 percent boost in throughput.

The company posted a net loss including one-time items. On an adjusted basis, however, earnings per share still covered the quarterly dividend by a 1.18-to 1 margin, despite dropping -25.2 percent from year ago levels.
1:57
Management also affirmed its ability and intention to continue paying dividends at the current rate. That’s despite a year-to-date payout ratio of 165 percent, based on adjusted net cash provided by operating activities, which compares to a target ratio of 40 to 50 percent.

Closing the gap will depend to a large extent on continuing recovery in demand for refined products from spring lows, as well as management’s ability to execute new projects and expand in growing markets like renewable diesel. That’s what we continue to expect. And in the meantime, the company’s finances remain very strong with no maturing debt until 2022.
Bottom line is Valero’s Q3 results show it can afford to maintain its dividend, fund its CAPEX and keep its balance sheet strong. That’s what we were looking for this quarter and we weren’t disappointed.

 
Q. Roger and Elliott:

1. If Biden is elected, he is clearly anti-energy industry. Assuming he also takes the Senate, to what extent will he be able to do much damage? Is your long-term thesis that major declines in capital spending must inevitably result in supply constrictions still valid?
 
2. I have read that major pipeline companies are offering 50% discounts on new contracts in the Permian. If true, how sustainable are dividends?
 
3. ET slashed its dividend this week. How safe are EPD's and KMI's? Do you expect KMI to pay the deferred portion of its commitment to go to $1.25 in January?
 
4. Are you changing buy/hold/sell ratings or dream prices on EPD, KMI, MMP, and PBA?
 
5. Although talk of an end to "shareholder capitalism" is campaign talk, there is also a fair chance that the Green New Deal wing of the Democratic Party could emerge with what they will call a mandate of change. In that case, are you still bullish on the overall Market?
 
6. Please comment on the feasibility of California's call for an end to gas powered cars. Can the infrastructure be put in place, in what time frame, and at what cost?
1:58
Thanks in advance. Thursday's chat may be a long one!—Ken V.
 
Thanks for those questions Ken. I’ll take them one at a time.
 
First, in the Energy and Income Advisor issue that posted this morning, I highlighted a matrix constructed by Bloomberg Intelligence, which gave odds on nine potential actions a prospective Biden Administration could take regards the oil and gas sector.
 
Details are in my answer to the last question in the Feature article Q&A. But the big takeaway is most of the issues investors seem to be concerned about now—a full ban on hydraulic fracturing for example—are extremely low probability events even if Democrats control the US Senate next year. And the measures that look like they’d be near certainties really aren’t going to make much difference, including greater regulation on methane emissions, which the industry is already addressing to improve efficiency.
I realize BI’s analysis is at odds with some of the doomsday predictions we’re hearing now. But consider this also. President Trump did his level best to revive the US coal industry the past four years. Instead, coal’s share of US electricity generation fell from over 30 percent to probably less than 20 percent this year. Bottom line is there are real limits on what a president can do, and keep in mind the road to a Democrat-led US Senate runs through a lot of states that support the US oil and gas business.
 
Regards pipeline discounts, this does not appear to be a real issue with the midstream energy companies reporting their earnings so far, notably Enterprise Products Partners (NYSE: EPD), Kinder Morgan Inc (NYSE: KMI) and ONEOK Inc (NYSE: OKE).
There are obviously a large number of companies yet to report and the issue in the Permian could be important particularly for NuStar Energy LP (NYSE: NS) and Plains All American Pipeline (NYSE: PAA). But so far it looks like the business model of large, diversified and financially strong energy midstream is weathering this latest—and frankly quite predictable—phase of the energy cycle as producers focus on cutting costs.
 
Third, Energy Transfer LP’s (NYSE: ET) situation has been far different from that of either Enterprise or Kinder for quite a while, due to much higher debt leverage and more exposure to cyclical elements of the energy sector. With retrospect, Kelcy Warren stepping down as CEO to become full-time chairman also gave the company an opportunity to make a move to hold in more cash.
1:59
We’ll know more when ET announces results on November 4. But at this point, my guess is the new management felt shares weren’t being valued for the higher payout—a reasonable assumption for any company yielding 20 percent plus. And they decided that though the company was generating more than enough cash to cover, it would be better off long-term by cutting debt faster.
 
We’ve had Energy Transfer on our Endangered Dividends List for quite a while. But we’ve also recommended shares for aggressive investors as a bet on eventual business recovery. This dividend cut does nothing to change that outlook. A hard look at Q3 results next month might.
In any case, it doesn’t follow from ET’s cut that dividends at EPD or KMI are at greater risk—far from it. As for the $1.25 per share annual dividend Kinder once talked about, I think it’s more likely we’ll see a mid-single digit payout boost when the company releases its capital budget later this year than an immediate rise to that level.
 
Regarding changes to buy targets, we’re keeping the current ones in place for Enterprise and Kinder after their Q3 earnings and guidance updates. I don’t anticipate changes for Magellan, while reports tomorrow. The same holds for Pembina, which reports November 5. But as always we’ll be keeping an open mind depending on what we hear and see.
Regarding question five, any comments we could make about what politics are ascendant would be just conjecture until we know results of next week’s election. I won’t argue there aren’t major issues in play here that are of great interest to investors. But it is worth pointing out two things. Bernie Sanders lost big in the Democratic Party primaries and the road to a Democrat-led Senate always runs through a lot of moderate and conservative states. To me that means moderate/incremental policies are a lot more likely than radical ones, especially when a prospective Biden administration’s first priority is going to be the economy.
2:00
Finally, California is talking about becoming “CO2 neutral” by 2050. The first part of that goal is to switch to 100 percent renewable energy and the current target date is 2035. The falling price of solar panels has helped that goal. The state’s increasingly extreme weather has not. And in fact, the Independent System Operator has already had to extend lives of natural gas power plants already to keep the lights on.
 
The second piece is to electrify transportation—cars, trucks, buses, maybe even airplanes—within 30 years. That will also involve an enormous infrastructure build, particularly charging stations. It will also require major improvements in range, efficiency and cost for batteries—also an essential element of providing storage for renewable energy. And as Elliott has pointed out, it means producing vehicles consumers actually want to buy.
At Edison International’s Q3 conference call yesterday, CEO Pedro Pizzaro talked a great deal about California’s energy plans, and the $21 billion investment his company will add to rate base under regulator-approved plants for 2021-2023. And if the state sticks to its current plan, that investment and its positive impact on earnings will eventually be many times that.
 
But it’s important to remember that even under the most aggressive assumptions for spending and technology adoption, California will still be driving gasoline-powered cars in the mid-21st century. Phasing out oil and gas if and when it happens will be an incremental business. And that leaves a lot of room for well-run energy companies produce solid returns for investors.
Eric
2:12
Obviously ET is going to be a big topic today, and I have a question about their preferred C stock. I was reading an article that recommended buying the preferred stock as a way to play the dividend cut. Citing the perceived security that will be restored in the preferreds once the common div is cut, causing it to rise back to par value. Do you see this happen when common divs get cut?
AvatarRoger Conrad
2:12
Hi Eric. We've had Energy Transfer on our Endangered Dividends List for some time. And given it was priced to yield roughly 20% before the cut, we find it pretty hard to believe this move was really much of a surprise. The challenge hasn't really been at operations, though we'll get a better idea of how they're faring when they announce Q3 results November 4. Rather, it's been the need to reduce debt, and it looks like the new management that replaced Kelcy Warren at CEO saw little use in maintaining such a high payout in this environment when it could make a bigger dent in borrowing costs. I think all else equal does enhance safety of the fixed income including preferreds. But the best way to play a recovery in ET is still with the common--preferreds and common are for more aggressive investors only.
Michael L.
2:14
I'm sure there will be plenty of questions about this MLP, but I think it all comes down to this: was this cut enough to hold the investment grade rating and get leverage to around 4.5. Any context you can put on this would be appreciated.

 Thanks
AvatarRoger Conrad
2:14
Based on what we now know, the answer should be yes. But we're going to know a lot more about how things are going at Energy Transfer when they announce Q3 results and update their guidance on November 4. As I said answering the previous question, this dividend cut really should not have surprised anyone.
Michael L.
2:16
XOM reports tomorrow, so we don't have anything definitive, but wondering if you still feel good about the sustainability of the dividend.
AvatarElliott Gue
2:16
There's no question in my mind that XOM's dividend is sustainable from a financial perspective. The only risk I see for the payout is that management decides XOM isn't getting credit from the market for paying the dividend and could, therefore, be rewarded by using the cash flow to pay for planned CAPEX. I still think that's unlikely as I think management is pretty committed to the payout. Also, I don't think anyone is really concerned about XOM's finances  since the yields on their debt are still ultra low.
Fred W
2:20
Hi Guys,
Thanks for your continuing great advice, especially for giving us a thorough understanding behind the why’s and wherefore’s of your thinking.

A few questions about NextEra’s recent interest in Duke Energy:

-Do you think a merger will happen, and, if so, in what timeframe?
-Do you think it would be positive for DUK shareholders and, at what price?

-Considering investments in a current Retiree’s IRA (where emphasis is on yield as well as safety), would you suggest being more heavily weighted towards DUK,KMI,EPD,MPLX,&WMB or all  five?
AvatarRoger Conrad
2:20
I think if there were a merger between Duke and NextEra it would be beneficial for shareholders of both companies. I wrote about the economics of a prospective merger in my October 2 Income Insights article "Duke/NextEra and Another Wave of Utility M&A." Since then, NextEra has reported its Q3 results and guidance and management clearly expressed interest in buying more regulated assets. Duke won't report until November 5 and faces a key decision in North Carolina on coal ash remediation costs. But is otherwise very attractive as a potential target for its regulated assets and huge investment opportunity from moving off coal. If there is a deal here, it will have to be a friendly one and I believe somewhere north of $100 for the offer.
AvatarRoger Conrad
2:22
Regarding the second half of Fred's question, as I noted in answering one of the pre-chat questions, Kinder and Enterprise have both reported Q3 results and guidance that affirm they're navigating this environment by protecting dividends and the balance sheet while keeping investment plans on track. Duke, MPLX and Williams all report next week but I'm pretty confident they'll all affirm the same thing. And all else equal I prefer being diversified and balanced in an income portfolio.
David O.
2:28
Gentlemen,

Positioned my retirement portfolio as you advised. Let’s hope the world doesn’t end! I do think I need to face the reality that “electrification” will be a real trend for the rest of my life. Worrisome for me is that the wackos may well toss out natural gas with the bath water! The likes of TOT, BP. VLO, do seem to be getting more into “green.” Should I put my “green” money into our integrated names, assuming they will transition better, or rather should I go with my smaller positions in AQN, EIX, BEP, DUK, D.

Thanks
AvatarRoger Conrad
2:28
BP has a potential challenge with funding pensions in a zero interest rate environment--not alone in that by any means but that is a risk to future growth. I think Total SA so far has done a much better job of integrating more steady cash flows from contracted renewables, LNG and utilities into its business mix without disrupting earnings, dividends and the balance sheet. And at its current price it's not getting any credit for doing so from investors--which to me means more upside. Total reports tomorrow. Valero already has, and as I pointed out answering an earlier question we're still positive on the company. As for the electric companies, they're all on track for strong growth the next several years and a great balance to the oils.
Alan R.
2:35
I am a little confused with something in today’s publication “In Energy It’s Economics over Politics”: “In fact, the only dividend cut announced in more than a month now in our coverage universe is not yet official: A tacit reduction of -19 percent at TC Pipelines that’s embedded in the current share offering from parent TC Energy, which has a better than even chance of narrowing substantially in a final offer.” ET just cut its dividend for Q3 by 50%. What am I missing? ET is currently trading just above $5.00 with a dividend yield of 11.6%. This seems to make sense when comparing it to an EPD with a 10.5% yield. Thoughts on ET down here?  Thanks.
AvatarRoger Conrad
2:35
The explanation is Energy Transfer announced its payout cut while the issue was in production stage. But our advice on the company hasn't changed as I've indicated in earlier answers in this chat. It's still a buy for more aggressive investors. We'll know more about operations when the company reports results on November 4. But the dividend cut was not unexpected--we had the company on the Endangered Dividends List for some time. It's off the EDL now as the cut has freed up cash. But it's also worth pointing out that ET still has a lot more debt leverage than Enterprise and its operations are also at greater exposure to cyclical and regulatory/legal pressures--so it's still a riskier investment than EPD in our view despite paying a similar yield.
Eric
2:44
This question is about IEP, it's still income and does own some oil assets. Is it wise to put some money here? The div is quite high which surprised me. Is it because he's risky himself, or do investors fear the holdings maybe?
AvatarRoger Conrad
2:44
Icahn Enterprises hasn't been one we've tracked historically. They've basically frozen their payout at $2 per quarter since April 2019. They'll declare another quarterly payout and announce earnings on November 6, which should give us a good idea of how cash flows at its 9 "primary" business segments are holding up. I think there are basically two reasons the current yield is this high. First, all of the business segments are quite cyclical, which of course includes energy, and dividend coverage has slipped this year in the face of pandemic pressures--payout ratio in Q2 was 146%. Second, this MLP carries a lot of debt--$7.2 bil though they have apparently made their obligation for this year. This vehicle sinks or swims based on Carl Icahn's skill navigating the market and economy--that may be worth a bet. But I would not consider this an investment to rely on for income.
ron
2:49
I'm concerned about OXY. Could the company be a merger target because of its oil assets? May its large debt would prevent it but it certainly is a very cheap buy.
AvatarElliott Gue
2:49
I don't think OXY will be acquired near term due to the debt load coupled with the fact that given the current depressed price of the stock, I just don't think OXY's management could, agree on a takeover price with any company large enough to buy them. I think the story here for the next 12 to 18 months is one of self-help -- OXY has a breakeven price in the low $30s and generates copious cash flows at $40 to $45 or higher. I think we'll see $50 oil in 2021 and, at that price, OXY will be in a position to quickly pay down debt. I expect that to lead to a major rerating of the stock.
JT
2:50
Roger torn between holding, buying, selling PAGP and PEYUF.  What are your current evaluations.
AvatarRoger Conrad
2:50
Plains reports on November 3. Coverage has been very good fo the dividend and they maintained the 18 cents per share rate for payment this month. At this point, we expect Q3 results to be pretty closely in line with guidance issued at the end of Q2, which would be enough for us to continue holding it for recovery. And that would be our advice until we see those numbers. As for Peyto, it's rough to be a natural gas producer in Alberta and I expect another quarter of weaker year over year comparisons when it releases Q3 numbers on November 11. it's still one of the world's lowest cost producers and I think it's protected its balance sheet and productive capacity very well in this environment. I believe that ensures survival and shares have actually been pretty flat this year, which would confirm that view. But at this point, that may be about all you can expect from the shares for a while.
herm
2:51
The recent merger of severial of our companies are with little premium so recovery in their price is not as hoped for. Would you hold on to COP and DVN for that recovery?
AvatarElliott Gue
2:51
Yes, you're not going to see large premiums in energy takeovers in this environment. That's because acquisitions aren't driven by a desire to buy new acreage or gain access to new plays, they're all about cutting costs and boosting efficiency. Thus the value creation isn't immediate (an overnight premium on a takeover) but comes more gradually in the form of higher free cash flow and higher variable dividends over the next few years. That applies to both COP and DVN.
Kathy
3:00
Do you consider Suncor Energy (SU) a good company in a bad environment that will eventually recover - both the environment and the company - or is this long slide in the stock unrecoverable?  Is it worth showing more patience and holding through this slump?
AvatarRoger Conrad
3:00
Suncor's dividend cut last spring did in retrospect undermine investor confidence. But looking at the Q3 results announced today, the company is faring as well as could be expected in this environment. Funds from operations per share more than doubled from Q2 levels for one thing, and covered the dividend by a 3.6-to-1 margin. Upstream output was lower by about -19% and refinery utilization fell to 87%, though by the end of the quarter it was back up at 97%. The company is on track to cut CAD1 bil from annual operating costs this year, as well to generate CAD2 bil in incremental free cash flow. Those are all pretty clear signs this company is weathering this environment and that the next move for the reduced dividend should be an increase. And it looks like its oil sands output is gaining a new market in China, should Keystone XL to the US not get built. I think all of that is worthy of investors' patience, though the company is not currently in the Model Portfolio.
Mack
3:22
You still have CEQP as a 'hold." I thought the recent earnings report was solid: Maintained payout with 1.9x coverage.  Leverage 4.1 but with positive fcf after capex and distrib's. Began buying back bonds and paying down revolver.  The market has yawned and yield is still 17.4 today.  What say you?  What will it take for you to move it off hold to buy?  Thanks.
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