Energy

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.

Do me a favor: Read this excerpt from Genesis Energy LP's press release on Thursday and then answer a question:

As noted above, our legacy operations continue to perform in line with expectations and, importantly, our recently acquired soda ash business is performing better than expected.  As contributions from recently completed organic growth projects and acquisitions ramp, we expect to generate record net income, cash flows from operations, Adjusted EBITDA and Available Cash before Reserves in future quarters and fiscal years. 

Does that sound like a company that just slashed its dividend by almost a third?

To be fair, Genesis is hardly alone when it comes to serving up word-salad from the corporate buffet bar, especially at distressing times. Even so, as I've noted before, words matter, especially when spoken by master limited partnerships at this point. 

Genesis taking its quarterly distribution down from about 72 cents to 50 cents a unit next quarter will wipe out almost five years of steady growth:

Wipe Out
Genesis Energy's cut to payouts takes them back the level of early 2013
Source: Bloomberg, the company
Note: 3Q2017 as per latest company guidance

And the new guidance of growing those reset distributions by at least one cent a quarter implies it will take about another five years to get back to the current level.

This is by now a fairly well-worn path in this sector. Kinder Morgan Inc. kicked things off with a huge dividend cut back in December 2015, and other pipeline operators and MLPs, including Plains All American Pipeline LP and Energy Transfer Partners LP, have followed suit.

What unites all these examples with Genesis is that they expanded too quickly during the pre-2014 energy boom, issuing tons of new units and taking on too much debt and raising distributions too fast. Genesis made five acquisitions in as many years, according to data compiled by Bloomberg, adding up to $3.3 billion of cash paid out -- equivalent to more than half the company's current enterprise value. Leverage jumped, as the chart below shows:

The Legacy
Genesis Energy's leverage climbed through a combination of acquisitions and the energy downturn. While it has come down, it remains at a relatively high level
Source: Bloomberg
Note: This is not the "leverage ratio" as used in Genesis Energy's credit agreement.

As Hinds Howard, a portfolio manager focused on MLPs at CBRE Clarion Securities, puts it, the plan across the sector was to "grow into leverage" and then reach a point where profits would grow sustainably, underpinning higher distributions, without the need to keep issuing more debt and equity. That mindset ran into the energy crash. Today, as Howard says: "The way to get to a sustainable business model is to reduce cash going out the door.

Genesis's new distribution guidance implies it will retain roughly an extra $100 million of cash each year relative to the old payout. As management said on the call Thursday morning, it doesn't make sense to keep paying out a dividend yield north of 11 percent.

Up To 11
Genesis Energy's dividend yield had reached a level indicating expectations it would have to be cut
Source: Bloomberg

Yet the move comes barely a month after Genesis closed on another all-cash deal, this time a $1.33 billion acquisition of Tronox Ltd.'s alkali business. It was billed partly as a way of reducing the leverage ratio, as Genesis paid a relatively low multiple for the asset (by MLP standards, anyway.)

From a business perspective, though, adding soda-ash production to a portfolio that already encompasses onshore logistics, offshore pipelines, refinery services and marine transportation doesn't exactly make for the clearest of equity stories. Hence, the flip-side of that chart of dividend yields:

Deal Me Out
Genesis Energy's distribution cut follows hard on the heels of another big all-cash deal
Source: Bloomberg

Genesis's price is now not far off the trough reached in the blind panic of early 2016, which tells you exactly how enamored investors are with the company's strategy.

That the stock fell just 3 percent on Thursday despite the savage dividend cut signals sentiment may not have much further to fall. But to entertain that view, you would need to see evidence Genesis really gets that the world has changed.

And here is where those word-things matter. Because, while cutting the distribution is a necessary step, it beggars belief that in the same announcement Genesis also held out the promise of maybe doing a buyback "at some point in the future".

If the intention is to signal that Genesis is now too cheap, then it might be worth dwelling on how much support Kinder Morgan's $2 billion buyback promise made in July has provided to its stock:

After The Fall
Kinder Morgan's recovery has proven to be a long, hard slog and even the promise of a buyback hasn't revitalized its stock
Source: Bloomberg

Quite apart from the market's apparent disinterest in traditional goodies like Kinder Morgan's buyback, a sudden spate of deals involving asset managers specializing in the sector, such as Blackstone Group LP's acquisition of Harvest Fund Advisors and this week's buyout of Center Coast Capital Holdings LLC by Brookfield Asset management Inc., points to a fundamental turnover in the investor base for energy infrastructure. Just adding assets to a conglomerate of businesses using high-multiple MLP paper in order to fund ever-rising payouts just isn't going to cut it anymore.

The salad days are over.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

  1. Please note this chart shows net debt divided by trailing Ebitda and is different from the "leverage ratio" used in Genesis Energy's credit agreement.

To contact the author of this story:
Liam Denning in New York at ldenning1@bloomberg.net

To contact the editor responsible for this story:
Mark Gongloff at mgongloff1@bloomberg.net