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Dilantha De Silva
Dilantha De Silva
Articles (103)  | Author's Website |

One Unique Energy Company to Consider

CorEnergy Infrastructure Trust has a business model that enables it to earn profits even during an oil market downturn

February 04, 2020 | About:

Peter Lynch doesn’t need an introduction. Undoubtedly, he is one of the greatest stock pickers of all time. His uncanny ability to identify companies that are not loved by Wall Street but have tremendous growth potential is the one characteristic that led him to generate an annualized return of 29.6% during his tenor at the Fidelity Magellan fund. This stellar performance has earned him fame around the world, so when he has something to say about markets and potential returns, investors should listen.

In an interview with Barron’s in December, Lynch confirmed that he is bullish on the energy sector, but investors are yet to realize the lucrative opportunities that can be found in these stocks.

“You wouldn’t know it from the stocks, but oil is 25% higher than a year ago. Why have these stocks gone down? Everybody’s assuming the world’s not going to use oil for the next 20 years, or five years, or next year. The private-equity money wants out. The banks want to cut back their lending. They can’t do an initial public offering. I’m buying companies that I don’t think will go bankrupt.”

Commenting further, he said that three-baggers (stocks that are expected to triple) can be found in small-cap oil and natural gas companies.

In an article published on Dec. 18, I concluded that oil prices will likely be stable in 2020, providing ample growth opportunities for companies with healthy balance sheets. In this analysis, an energy company with a unique business model; CorEnergy Infrastructure Trust Inc. (NYSE:CORR), will be analyzed in depth.

Company profile and business strategy

CorEnergy is a real estate investment trust that specializes in acquiring and financing real assets in the U.S. energy sector. With a market capitalization of about $613 million as of Feb. 4, it is one of the smallest energy-focused listed companies in the United States. The company owns a few properties covering upstream, midstream and downstream energy operations.

Type

Asset

Upstream

Pinedale Liquid Gathering System

Midstream

Grand Isle Gathering System

Midstream

MoGas Pipeline

Downstream

Omega Pipeline

Source: Company presentation.

The business model is what stands out. CorEnergy acquires properties that are critical to an energy company’s earnings and establishes sale and leaseback agreements with these companies or enter into lease terms spanning many years. In summary, CorEnergy buys an asset from an energy company and then rents it back to the seller under a long-term lease that requires the tenant to pay operating expenses.

In earnings calls throughout the last couple of years, management outlined that the strategy is to buy one or two assets per year, each with a value between $50 million to $250 million.

Stable revenue in all market conditions

When evaluating investment opportunities in energy stocks, one of the primary risks that needs to be considered is the loss of revenue and earnings when oil prices plunge. This is true for companies of all sizes. However, the unique business structure of CorEnergy enables it to bring in a regular stream of income no matter what the macroeconomic conditions are.

For instance, following the oil price crash, two of its major tenants; Ultra Petroleum (UPLC) and Energy XXI (NASDAQ:EGC), declared bankruptcy in 2016. These companies accounted for 30% and 38% of total revenue, respectively. However, both these companies continued to honor lease and rent payments to CorEnergy as the assets were critical to the survival of both entities. CorEnergy collected all dues and paid quarterly dividends, while many pure-play oil companies were struggling to make ends meet.

Even though the result might have been different if oil prices remained under pressure for a prolonged time and tenants decided to abandon business operations, CorEnergy stands out as a company that can survive unfavorable market conditions for a longer period than traditional energy companies.

Investors get it wrong most of the time

Even though fluctuating oil prices have little to do with company revenue and earnings, investors tend to look at CorEnergy as they do other companies operating in this sector. For instance, in January 2020, the correlation between its shares and WTI crude oil reached 0.8, which is significantly high for a company that doesn’t entirely depend on energy prices. When there’s volatility driven by geopolitical or macroeconomic conditions, prudent investors can unlock lucrative opportunities with CorEnergy shares.

Outlook

Oil prices are expected to remain stable in 2020, save for a few spikes or declines resulting from adverse or favorable geopolitical developments. According to the lease terms agreed with tenants, CorEnergy will continue to collect rent payments through 2023. Even if the company fails to find new properties to acquire, the revenue coming in from existing investments will likely be sufficient to grow earnings in this period.

Source: Company filings.

At the end of the third quarter, CorEnergy had $120 million in cash and equivalents, which management expects to deploy as investments in the next few quarters. Notably, the company has not rushed into acquiring properties with below-average yields even though there was sufficient liquidity throughout the last 12 months, which is admirable and goes to show the due diligence applied before reaching investment decisions.

There’s another way the company can benefit from a drastic decline in oil prices. Throughout history, when energy prices declined, banks and other reputed lending institutions have become hesitant to approve new credit facilities to oil companies. For instance, in 2016, BNP Paribas (XPAR:BNP) announced it would not provide any such facilities to U.S. energy companies that were struggling to generate significant profits. If such a situation prevails in the future, CorEnergy would be the go-to solution for small-scale companies in this sector. This would unlock many attractive opportunities for the company to secure lucrative deals, the same way it did in 2016.

A healthy streak of dividends

REITs are highly preferred by income investors as the tax structure forces these companies to distribute at least 90% of their annual earnings to shareholders. Since 2015, CorEnergy has paid a dividend of 75 cents per share each quarter.

Source: GuruFocus.

In each of the last five years, CorEnergy has covered its dividend distributions with adjusted funds from operations, according to data from Reuters. This cash flow coverage is a sign of safety for investors and the stability in revenue makes it easier for the company to honor its shareholder commitments.

Shares yield 6.6% at the market price of around $45.47 on Tuesday, which is significantly higher than the sector average of 4.5%.

Takeaway

Lynch is bullish on small-cap energy stocks, and CorEnergy Infrastructure is a unique company in this space. As evident from its past performance, the company has what it takes to generate stable income even during adverse macroeconomic conditions. Shares are trading at a price-to-adjusted funds from operations ratio of 11.6, in comparison to the five-year average multiple of 20.68. With the outbreak of the coronavirus, shares declined along with other major oil companies. However, this is unwarranted as CorEnergy’s business model is a complete contrast to that of a traditional oil company. As markets realize this, shares will likely head higher. Shares are also tailor-made for income investors who seek to invest in businesses that show non-cyclical characteristics.

Disclosure: I do not own any stocks mentioned in this article.

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About the author:

Dilantha De Silva
I am an investment professional with 5-years of experience in financial markets. I specialize in U.S. equities and incorporate a top-down approach to identify developing macro-level trends and the companies that would benefit from such trends. I am a strong believer that the best investment opportunities could be found in under-covered equities.

I currently work with leading financial publications including Refinitiv, Seeking Alpha, ValueWalk, GuruFocus, and TradeGrill to produce investment-related content.

I'm a CFA level 2 candidate and an Associate Member of the Chartered Institute for Securities and Investment (CISI, UK). During my free time, I enjoy reading.

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