Could CORR Soar, Again?
Back in December 2016 I wrote that my “best REIT in 2016 was up over 150% on a
year-to-date basis, CORR has been on fire.”
Of course I’m referring to the energy infrastructure-focused CorEnergy (CORR), a
former BDC that restructured as a REIT. By restructuring as a REIT CORR started
acquiring real property (to qualify as a REIT) while still focusing on energy
infrastructure.
Although the company does not have a private ruling letter from the IRS (a
moderate risk) the company does have a legal opinion, and the energy
infrastructure sector is comparable to other real estate asset classes (cash flow is
a high component of total return). In the 2016 Annual Report, the company said,
“In September, the Internal Revenue Service and Treasury Department released
final regulations on the Definition of Real Estate Investment Trust Real Property.
We welcome this clarification of qualifying assets in our tax-efficient structure. As
a pioneer of the energy infrastructure REIT, we believe the certainty provided by
regulation versus the private ruling process confirms our strategy, and will
increase confidence with potential operating partners, as well as potential
investors.”
The highly fragmented energy sector enjoys a resilient inflation hedge - the
distribution that you get with CORR includes underlying contractual features that
give visibility over the long run to inflation-based returns (1% to 3% is a
reasonable expectation).
As I said, CORR was a BDC in a previous life, but the company smells more like an
MLP. Also, the accounting nuances (MLPs distribute K1s), MLPs are volume based,
so the actual pipelines and operational acumen are joined at the hip.
Keep in mind, CORR is NOT involved in the operation of energy-related assets. The
company is simply a landlord that primarily owns midstream and downstream
U.S. energy infrastructure assets subject to long-term triple net participating
leases with energy companies.
Commodity prices has stabilized and CORR should become less volatile as a result:
CORR’s assets include pipelines, storage tanks, transmission lines and gathering
systems. The company invests in a variety of infrastructure-related assets across
the energy value chain, and since commodity prices have stabilized the frequency
and magnitude of energy bankruptcies have decreased.
A few months ago I decided it was time to cash in a few chips, and I explained my
trimming event as follows,
“We think the multiple could expand further, but unless CORR purchases
additional assets, we do not see an increase in FFO. As a result, we believe there
might be 10% upside from here, but with the risk of potentially greater
downside.”
As you can see, CORR shares took a nose drive on Friday, falling over 6%...
I could not discern the reason for the pullback, the Q1-17 earnings were sound.
Let’s take a closer look…
The Latest Earnings
CORR’s assets are necessary for tenants to produce economic value for their debt
and equity holders, and that was demonstrated despite the bankruptcy of the
tenants. As David Schulte (CEO of CORR) explained on the recent earnings call,
“All these payments are operating expenses; they are not financing expenses for
those companies. Operating leases have priority in payment and bankruptcy. The
CORR revenue stream therefore is resilient and protected even during
bankruptcy. Therefore, our stock price moved with commodity prices in this cycle,
our revenues and AFFO did not, demonstrating the benefit of our business model
for investors seeking infrastructure assets in their portfolio.”
In Q1-17 CORR’s AFFO was $1.00 per common diluted share quarter. With the
current asset mix CORR targets a coverage ratio of 1.5x AFFO to dividends. The
company believes that amount of excess coverage is a prudent level enabling it to
reinvest for dividend stability and growth over the long term.
CORR’s AFFO to dividend coverage ratio for the first quarter was 1.49x and in the
seven quarters since the Grand Isle acquisition (on June 30, 201) the coverage
ratio has ranged from 1.43 to 1.53x.
On April 18th CORR closed on the $70 million offering to the issuance of an
additional 2.8 million depository shares which resulted in net proceeds of
approximately $67.6 million. The company immediately utilized $44 million of the
proceeds to pay down the outstanding balance on its revolver as a near term use.
These actions promote CORR’s conservative leverage profile, by enhancing
liquidity and positioning the company well as it moves from a defensive position
in 2016 to growth mode. As illustrated below, CORR is in a good position to grow
by funding new drilling plans:
\
“Which one or two options do you think will be the most likely path that lenders
& borrowers will take if faced with a borrowing base deficiency in spring 2017?”
As referenced in a recent article, CORR’s preferred stock provides investors with a
stable and safe dividend. The issuance of the additional shares brings the total
outstanding Series A preferred to over $125 million which provides enhanced
liquidity in the market and promotes broader participation in ownership.
CORR has a policy of employing moderate leverage supplemented with equity
issuances the company believes that “maintaining a conservative leverage policy
serves the expectations of investors and the infrastructure asset class.”
Time To Get Back In The Game?
The pullback on Friday is intriguing, recognizing the pullback could have simply
been a block-sale trade. On the recent earnings call, David Schulte explains,
“The energy markets seem to be adjusting to a new normal of $50 crude,
bankruptcies have decreased in size and frequency and companies are emerging
from restructuring processes which renewed growth expectations, announcing
increases in capital expenditure budgets and resumption of drilling plans.”
As illustrated in a slide (above) rigs are coming back online in the United States.
However, energy companies are still wary of the downturn they just experienced
as are their lenders and equity investors, and this is where the opportunity lies for
CORR. As David Schulte explains,
“In a recent survey, energy company said they're more likely to sell non-core
assets if they're faced with bond-based efficiencies still in 2017.”
CORR is well-positioned to acquire what Upstream companies might consider to
be non-core, but which are essential to their overall operations such as Energy
XX1 and UPL (two of CORR’s tenants).
The sale of an asset to CORR provides an alternative to issuing new equity or
increasing debt for companies where capital project opportunities exceed
internally generated cash flow, particularly at these commodity price levels.
Based on the outlook below, CORR appears to be going back to work:
CORR has successfully navigated volatility, as David Schulte explains in the 2016
Annual Report,
“To paraphrase Warren Buffet: When the tide goes out, you get to see who is
wearing their bathing suit. The onslaught of bankruptcies in the energy sector,
including the parent companies of two of our tenants, felt like a reverse tidal
wave.
With full exposure to all elements of challenge, CorEnergy demonstrated success
on both pillars of our thesis, suffering no economic changes to either lease.
CorEnergy also demonstrated its adaptability to changing market conditions by
extending the service agreement between our subsidiary, MoGas Pipeline LLC,
and its largest customer to 13 years.
We believe 2016 proved to be a year of validation for CorEnergy and for the real
estate investment trust structure as a way for investors to access the benefits of
the infrastructure asset class.”
As noted above, CORR acquires many of the same types of assets as MLPs,
however the structure as a REIT enables access to a much larger pool of capital
through a broader institutional investor base. CORR views its risk profile as more
similar to that of the REIT and utility sectors.
I am upgrading CORR from a HOLD to a BUY, and increasing my Target Price to
$31.00 per share. The pullback on Friday was intriguing, and I would like to know
what sparked it (the pullback) before I get back in the game. Also, keep in mind
that CORR has a market cap of around $400 million, and this means that I am not
recommending an equal or over-weight allocation, I propose modest limits. The
8.9% dividend yield is attractive, but the preferred looks like a safer play for
income.
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