This article is excerpted from Tom Yeung’s Moonshot Investor newsletter. To make sure you don’t miss any of Tom’s potential 100x picks, subscribe to his mailing list here.
Did the Government Just Solve the Gas Crisis?
In 2008, the characters in It’s Always Sunny in Philadelphia attempted to solve high gas prices by pumping gasoline into plastic trash cans, then selling the fuel at a roadside stand.
Fourteen years later, the White House seems to have landed on a similar solution — minus the plastic cans.
By releasing 1 million barrels from the strategic oil reserves per day, the administration has managed to put a cap on gas prices, even though the world consumes almost 100 million barrels every day. WTI crude prices have fallen 6% over the past four weeks.
But these measures are only a temporary stopgap. The EIA still estimates that prices at the pump this summer will be the highest since 2014. And Henry Hub natural gas will average well above $5 this year — for the first time since the gas price episode of It’s Always Sunny aired on TV.
That’s providing room for second-order energy firms to thrive. These are the companies that serve as the real world version of plastic trash cans — the movers, storers and distributors of the millions of the new oil flowing through the supply chain.
As American drillers continue to ramp up production in the near-term, it’s these firms that stand to benefit. And today, I’ll going to take a closer look at one of these companies.
So… who wants some gasoline out of this plastic can?
The Second-Order Winners of the American Oil Boom
Last month, I wrote about five cheap energy stocks riding oil higher.
“Investors will immediately notice that none of these companies actively drill for oil. Instead, these companies are a combination of services, refining and transportation.”
That was on March 23. Since then, this ragtag group has gained an average of 13.5% — a handsome return for four short weeks of investing.
- Martin Midstream Partners (NASDAQ:MMLP). +30%
- PBF Energy (NYSE:PBF). +29%
- Summit Midstream Partners (NYSE:SMLP). +12%
- Forum Energy Technologies (NYSE:FET). +0%
- Nine Energy Service (NYSE:NINE). -5%
Meanwhile, low-quality “meme” stocks have gone the other direction. Indonesia Energy (NYSEAMERICAN:INDO) is down -14% while Houston American Energy (NYSEAMERICAN:HUSA) has fallen a stark -32% as oil prices have retreated.
Oil Economics 101
INDO and HUSA have underperformed because these popular oil stocks are upstream producers.
Common wisdom dictates that if oil prices double, the value of their oil reserves should also double. And if oil prices fall -6%, as they have in the last four weeks, so does the value of the company).
But the truth is even more extreme. If a low quality oilfield such as INDO’s Kruh Block has an all-in production cost of $60, for instance, the field becomes basically worthless if oil drops even a single cent below that figure.
And few investors are particularly successful at predicting long-term oil prices.
On the other hand, midstream companies are driven by supply volume. These figures are far easier to predict than prices, and that opens up an entire world of “safer” Moonshot bets on the energy boom (Risk-seeking investors might alternately consider options plays on these stocks to increase leverage without sacrificing visibility).
Martin Midstream Partners (MMLP)
Chief among these supply volume winners is Martin Midstream Partners, a company I recommended in a March eletter. Though prices are already up 30%, there’s still potential for even more gains.
MMLP is one of my favorite kinds of deep value Moonshot investments: cheaply priced, plenty of hidden assets and with the potential for a massive rerating.
The company operates an understated billion dollar network of 31 terminals, natural gas liquid storage, sulfur processing and transportation services. It’s a humdrum business that I wouldn’t even glance at in ordinary times.
But these days are anything but ordinary.
Instead, growing energy nationalism has put a spotlight on America’s existing energy assets. Decades old liquified natural gas (LNG) plants are suddenly our star fighters in the battle against Russia’s so-called “pipeline diplomacy.” In fact, President Joe Biden just greenlit new drilling on federal lands this past weekend — the same president who vowed to make America carbon-neutral when he first took office.
For better or worse, this has given MMLP’s aging assets a new lease on life.
Moonshot Assets Hiding in Plain Sight
Anyone who owns a backyard swimming pool in my home state of Massachusetts will know it’s hard to store the water over winter. Never mind several gallons of gasoline.
No matter how many plastic garbage cans you own, it’s hard to hide all that pool water when temperatures go sub-zero.
Now imagine that problem, multiplied by several million. That’s the problem that energy producers are now facing.
And not only only are more hydrocarbons flowing through the refining system. Their byproducts — ethane, propane, butane, isobutane, pentane and so on — are also quickly accumulating.
Unsurprisingly, storage is quickly becoming an issue. Martin Midstream’s 2.1 million-barrel storage facility for butane and propane has already earned $12.2 million in operating income for the firm in Q4 2021. More gains could be on the way next year as inventories start to rebuild over the summer.
Firing on All Cylinders
MMLP’s benefits go beyond these gas byproducts.
In its sulfur segment, adjusted EBITDA has already risen 56% in Q4, driven by rising fertilizer prices. Meanwhile, hee tight supply of truck transportation has now spilled over into marine transportation as well: the company’s full-year 2021 adjusted EBITDA came in at $114.5 million, a 20% improvement over the prior year.
Rarely in any diversified business does everything go right all at once.
The cumulative windfall allowed MMLP to eliminate some of its most expensive debt, creating a magnifying effect for its share price. Yields on its 2025 bonds have fallen from a junk-bond level 15% in 2020 to an investment-grade 4% today. As the company’s default risk falls to near-zero, equity investors are the first in line to reap any additional benefit.
A reasonable 10x EV/EBITDA multiple would now give the company a $15-per-share value, or 2.5x upside. A more speculative market environment could send shares up even higher.
The Risks of Moonshot Energy Investing
Of course, an investment in MMLP does come with risks. Today’s “backwardation” of the forward price curve is a disincentive for energy storage — why store oil if you can find a willing high-price buyer today?
Martin Midstream also has negative book value — a natural outcome for any firm with aged assets, but likewise a hindrance for making any asset-based valuation call.
Finally, the firm has sold at a historical discount for good reason. Like many Moonshot investments, MMLP is a leveraged company that will face extreme boom-bust cycles until it can reduce more debt. Ask any experienced junk bond trader, and they’ll have dozens of horror stories to tell about healthy-looking companies that have gone bankrupt almost overnight.
Yet I’ve chosen companies like MMLP… Forum Energy… Nine Energy Services… and so on, because these are higher-quality choices that still sell for cheaper than you expect. And though nothing can prevent any stock from going to zero, it’s these companies with hidden assets with best standing to survive any eventual shakeout.
My Secret to Energy Investing
At first glance, investing in oil companies seems straightforward. High oil prices should mean high prices for energy stocks. Right?
But the truth is far more nuanced. There are blue-chip oil bosses buying up assets that can stand the test of time…
Private equity barons snapping up aged fields at a discount…
Wildcatters and speculators…
But everyone is looking for the same thing: assets that are selling below market value.
If you’re good at the business, you can spot these deals a mile away. The history of Texan oil drilling is full of stories of eagle-eyed wildcatters who became multi-millionaires.
Other times, these deals are more obvious to political watchers. Any LNG terminal selling for less than 8x EV/EBITDA should have prospective buyers lining out the door, based on prospective European gas demand.
Either way, my secret to energy investing is the same: Find hidden assets that other energy investors have somehow missed. Martin Midstream Partners fits that bill.
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On the date of publication, Tom Yeung did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Tom Yeung, CFA, is a registered investment advisor on a mission to bring simplicity to the world of investing.