Have you heard the old joke about the efficient market professor who walks down the street with a student who bends down to pick up a $100 bill? The professor tells her not to bother, because if the $100 bill were real, it wouldn’t be there. Well Sanchez Production Partners (SPP) kind of looks a little like that $100 bill. I’m not sure it’s real either, but I think it’s at least worth bending over to check it out.
SPP is a small, 33 million market cap, formerly busted MLP, originally known as Constellation Energy Partners. It was picked up by the owners of Sanchez Energy (SN) last year to provide a GP/LP financing structure for funding SN via drop-downs to SPP. SPP’s assets are 60% midstream assets and 40% oil and gas production by EBITDA contribution. With the recently acquired midstream assets financed by the selling of 350 million in preferred shares to Stonebridge partners.
First the stunningly good news, on Nov 13, Sanchez initiated a forty cent quarterly distribution along with a plan for 15% distribution growth through 2019. At its current share price of $11, this is a 14.5% yield backed by 1.8x coverage for 2016. If the yield re-rates to 10%, the unis would trade for $16/share. And to top that, they also announced a 10 million dollar buyback on a stock that’s 1/3 the public float.
So is there a catch? Well if oil prices jump back up before 2017, not really, because production is fully hedged at $74/bbl and $4.17/mcf through 2016. But… SPP is only partially hedged and at lower prices for 2017-19. If oil bounces back to $65 before the hedges run out, life is good. Otherwise, challenges will loom.
First, lower oil prices will drop the coverage ratio. For example, the current $74 hedges and $24 operating expense leave a $50 spread, but $35 oil provides only a $10 spread. The current 1.8x coverage ratio is only possible because of the $74 hedges. Without higher prices, the distribution will funded only by the fee based mid-stream assets and the coverage ratio will drop to 1 at best. Furthermore, at low oil prices, SN won’t drill as many wells in the Eagle Ford which will result in less gas to process. Yes, there are minimum commitment numbers that help provide a foundation to the distribution, but the 15% distribution growth doesn’t occur unless the Catarina plant gets fully loaded, and that requires SN to drills more wells. The IR materials claim a 35% IRR on $60 oil, but no one is getting $60 anymore… Do they get 25% IRR on $50?
So is SPP a $100 bill lying on the ground? Yes, if oil goes back to $60/barrel in 2017, but it’s a mirage if oil drops to $35/barrel for an extended period. In between those prices it can still work, but maybe only turns out to be a $20 dollar bill and I think still worth bending over to pick up. With the hedges solid for 2016, I’m long SPP, but I am keeping it on a short leash.
For more information:
- Read about the 350 million infusion by Stonebridge partners. This provided the capital for the Catarina purchase and improved SN’s liquidity. Read the nitty-gritty in the full 8-k.
- Nov 12 News Release announcing the distribution and announcing buy back.
- Nov 12 Q3 2015 Conference Call. My favorite part is describing that the limiting factor to the buyback is effectively the low trading volume. Management basically states that they will be buying 25% of the daily volume.
There are also other moving parts in play, such as the planned sale of the legacy mid-continent producing assets, the health of Sanchez Energy, the appropriateness of holding production assets in a MLP, etc. But if I wait to write those down, I will never finish the post.