Summary
- CorEnergy is mispriced on a variety of misconceptions and temporary issues.
- CORR is fundamentally worth about $11.00 per share.
- 75% upside and an 8.5% dividend while we wait.
The Buy Thesis
CorEnergy Infrastructure Trust (NYSE:CORR) has become unusually cheap as a combination of misconceptions and temporary issues have dragged its market price below reasonable levels. CORR is currently trading at $6.30 or roughly 8.2X FactSet's consensus 2016 FFO/share estimate of $0.77. We believe CORR should trade at $11.00 (75% higher) or roughly 14.25X the 2016 FFO/share estimate based on our analysis of its quality of earnings as well as a relative valuation to its peers. This article will detail why CORR could reasonably trade at $11.00, but first let us examine how such extreme mispricing came about.
A history of misunderstanding and mispricing
Back in 2012, CORR (with the approval of its shareholders) abandoned its place as a BDC and began the transition to becoming the first energy infrastructure REIT. In doing so, CORR had to issue a very large amount of equity relative to their size which dropped the market price by roughly 50% shown below as the straight downward line at the end of 2012.
(click to enlarge)
As the first of its kind, the business model was regarded as unproven and the market demanded a substantial risk premium which forced CORR to issue the new equity at $6.00/share. The capital was immediately put to work through the purchase of the liquids gathering system (or LGS) from Ultra Petroleum (NYSE:UPL). The deal was accretive to stabilized cash flows, allowing CORR to raise its dividend to $0.50 annually starting in 2013.
While the stock price rose steadily in 2013 to the mid-$7 range, forward multiples remained relatively low due to concerns that the business model was not viable. The LGS was CORR's only major REIT asset and many quarters had passed since the acquisition. Some market participants began to think the energy infrastructure REIT business model which CORR's CEO Dave Schulte had largely pioneered was a niche space with few assets that would fit well in the model.
Given the concerns for future growth, it could be argued that the low-teens forward multiple CORR traded at through most of 2013 was about right. Since this time, very clear mispricing has emerged as CORR's fundamentals have improved substantially while its market price sank.
Improved fundamentals
CORR has made a series of acquisitions in 2014.
- In January, CORR acquired the Portland Terminal Facility for $40mm
- In July, it financed Black Bison's acquisition of salt water disposal properties for $15mm
- In November, CORR bought MoGas Pipeline, LLC for $125mm.
I have already analyzed the LGS and Portland Terminal Facility in previous articles linked here and here, so I will not go into detail. The MoGas Pipeline acquisition, however, has been largely ignored in all forms of media so we will take a look.
MoGas owns a 263-mile natural gas pipeline involved in the delivery of natural gas to end consumers.
(click to enlarge)
source: CORR presentation
This asset seems to be low risk and helps diversify CORR's portfolio. Transmission fees for interstate natural gas pipelines are federally regulated, so there is little variance in profitability. Further, the primary customers of the pipeline are Laclede Gas Company (NYSE:LG) and Ameren Corporation (NYSE:AEE), both of which have reasonably healthy balance sheets and are publicly-traded companies that have been performing well.
Since the pipeline is largely used in the process of supplying natural gas to people's homes, its demand should remain healthy for the foreseeable future. In fact, the low energy prices may cause people to buy more gas to heat their homes.
The underlying business of MoGas seems rock solid, but the valuation is unclear. The press release did not reveal information on operating income or anything else that would allow us to ascertain a cap rate. Accretion is hinted at by the simultaneously announced dividend raise to $0.54 annually, but we cannot know for sure.
Overall, the acquisitions have 3 main effects:
- Increased FFO/share from the original ~$0.55 with just the LGS to the now FactSet estimated $0.77 for 2016.
- Diversified revenue streams in terms of both tenant mix and functionality.
- Proof of business model
The third is a big one. It is now excessively clear that the energy infrastructure REIT space is economically viable with many companies slated to enter the space in 2015. CORR has a competitive first mover advantage as well as the skill and knowledge to acquire the right properties at the right time. This brings me to the next element of mispricing: management.
Management
A likely reason for CORR's discounted market price is a misunderstanding of their management. Among REITs, external management is widely regarded as riskier and less aligned. Nearly all externally-managed REITs trade at substantial discounts to peers. A close inspection of CORR's management, however, reveals that it should actually warrant a premium.
Let us first note that running CORR is an exceedingly difficult task. Management needs to be well versed in financial matters such that it can create mutually beneficial deals with energy asset operators, while remaining in compliance with REIT regulations. Further, management needs to have extensive experience in energy assets which can be difficult to value. A sufficient level of expertise and skill in these areas is generally too expensive for a $287mm company to afford internally. Thus, the use of external management is inevitable until CORR grows much larger.
CORR is externally managed by Corridor Infratrust Management LLC. It maintains a rather frugal contract in which management fees equal 1% of assets annually. Certain members of management get bonus compensation for sustainable dividend per share increases. This aligns management with shareholders in that the only way to achieve sustainable dividend growth is to actually grow earnings per share. This end cannot be achieved by growing the company for the sake of growth. It must actually be accretive growth.
If we add up the G&A and other fees, we can see total expenses related to management were only $1.48mm in 3Q14.
(click to enlarge)
Data from SNL Financial
Data from SNL Financial
In contrast, another REIT of similar size, Whitestone (NYSE:WSR) had 3Q14 G&A of $3.84mm.
CORR's officers seem to have high conviction that the stock is substantially undervalued with 19 insider buys and 0 sales in the last 6 months.
(click to enlarge)
Data from SNL Financial
Data from SNL Financial
If we expand the time horizon to 18 months, CORR's directors and officers have executed 36 buys and 0 sales.
CORR's management offers a very high ratio of expertise and alignment to cost to shareholders. Such a ratio warrants a premium to peers, not a discount.
A 3rd factor has also contributed to CORR's mispricing: oil prices.
An odd correlation
As oil prices have plummeted over the past 6 months, CorEnergy stopped trading like a REIT and fell almost in lock-step with oil.
(click to enlarge)
While it is true that a majority of CORR's assets are energy related, oil prices have little impact on its cashflows. We do not know which of CORR's assets the market is worried about, but our analysis suggests that each major property is likely to weather the low oil price environment without a scratch.
The LGS:
It has long-term contracted triple net cashflows. Thus, the only way CORR would lose its revenue would be if the tenant, Ultra Petroleum, defaulted. Although UPL is highly levered, we view default as unlikely for the following reasons.
- UPL's production is primarily natural gas (>70%).
- The LGS is a natural gas asset in the Pinedale field in Wyoming. UPL seems to really like the high margin operations of the Pinedale field as it recently traded its Marcellus Shale assets to Shell in exchange for Shell's Pinedale assets. UPL is now the dominant player in the Pinedale field.
- UPL has been increasing their utilization of the LGS which remains a profit-generating asset for them.
- Even if UPL were to declare bankruptcy (which I view as highly unlikely) continued operations of the LGS would require them to remain current on the rent payments which would functionally place their contract with CORR senior to the senior debt.
Thus, we anticipate cashflows from the LGS will grow over time due to contracted annual rent escalations.
The Portland Terminal Facility:
While the Portland Terminal Facility is an oil asset, it is not all that sensitive to the price of oil because it is an intermodal transportation terminal. As such, it does not care how much oil is selling for, but rather how many barrels are selling. Theoretically, the absolute volume of demand should actually be higher when oil prices are low, so the operator, ARC Terminal Holdings, may actually be fundamentally benefiting from the dip in oil. This asset is also on a 15-year triple net lease, so we anticipate that it too will slowly grow cashflows over time with escalators.
The MoGas pipeline:
As previously detailed, this asset's cashflows look quite secure.
Overall, we do not see oil prices having an adverse impact on CORR's earnings which suggests the substantial drop in its market price is misguided and represents a buying opportunity. In fact, the environment may actually stimulate CORR's acquisition pipeline.
Energy companies are having a difficult time raising capital as yields have substantially widened which makes raising debt less desirable or even not viable. Additionally, the low market prices make equity issuance undesirable. The alternative to debt or equity financing is to raise capital through selling an asset to CorEnergy. This allows the energy company to maintain operations of the asset which would not be possible through a traditional disposition.
Summary of origin of mispricing
We believe CORR's cheap market price is primarily the result of 3 things:
- High equity issuance volume relative to size of security flooded the market.
- Misunderstanding of the value of CORR's management.
- Misconceptions that falling oil prices will hurt CORR's business
If CORR is so mispriced, what is it actually worth?
Valuation
Both an NAV valuation and a relative valuation suggest CORR should trade around $11.00 per share.
Looking at the NAV, we can see a range of values for CORR's shares depending on what cap rate we apply. Its current ~$6.30 price suggests a cap rate of greater than 13%, but this is well outside the spectrum of reasonable cap rates for the types of properties CORR owns.
Generally speaking, properties with unstable or short-term cashflows would be valued at a high cap rate, while those with more stable and longer-term cashflows would be valued at a low cap rate to reflect the desirability of that payout structure.
CORR's assets produce cashflows that are both long term and stable, so it could be valued at a reasonably low cap rate. Many long-term triple net lease properties are selling for cap rates as low as 6%. Thus, we believe an 8% cap rate is quite appropriate for CORR which puts them at an NAV of $10.93. The table below shows a spectrum of NAVs for various cap rates over recent periods.
(click to enlarge)
Data from SNL Financial
Data from SNL Financial
A relative valuation reveals that CORR trades substantially cheaper than peers.
CORR's FFO/share as estimated by FactSet consensus and provided by SNL Financial is shown below.
Note that 27% growth is abnormally high so the $0.61 figure for 2015 is not yet stabilized. We regard the $0.77 of 2016 to be CORR's stabilized FFO/share, so we will use this year as the basis for comparison with peers. The peers have been selected for possessing similar qualities to CORR: strong management and long-term contracted triple net lease cashflows.
Company (ticker)
|
2016 FFO/share*
|
Market price $
|
Multiple
|
FFO Growth in 2016 %
|
CORR
|
$0.77
|
$6.30
|
8.18X
|
27.15%
|
Realty Income (NYSE:O)
|
$2.80
|
$48.52
|
17.32X
|
2.9%
|
National Retail Properties (NYSE:NNN)
|
$2.29
|
$40.00
|
17.47X
|
5.0%
|
Ventas (NYSE:VTR)
|
$4.87
|
$72.43
|
14.87X
|
4.51%
|
Average
|
n/a
|
n/a
|
16.55X
|
4.14%
|
*As estimated by FactSet consensus and provided by SNL Financial
The average multiple among peers is 16.55X 2016 FFO/share, and that is with an average peer growth rate of 4.14%. We believe that CORR should trade around 14.25X with the discount to the peer multiple based on its substantially smaller size at $280mm market cap vs the peers at ~$5B-$20B.
CORR simply has too fast of a growth rate and too stable of cashflows to trade at only 8.18X 2016 FFO.
Return Catalyst
In CORR's brief history as a REIT, it already has an excellent dividend history.
(click to enlarge)
As of late, the market has been witness to energy stocks with big yields and strong dividend histories cutting or even eliminating their dividends. We believe the market is anticipating the same from CorEnergy.
However, in conjunction with the closing of the MoGas acquisition CORR is about to raise its dividend to $0.135 quarterly or $0.54 annually beginning in the first quarter of 2015.
Continuing to raise its dividend in the face of perceived hardship will force the market to take another look at CORR. In doing so, we think its likely that many will see the deep value and CORR will trade closer to its intrinsic value.
While I am long CORR and quite bullish on its prospects, I feel obliged to also cover some of the associated risks to investment.
Risks and concerns
As a young company with a small asset base, CORR lacks diversification. If one of its properties fails for whatever reason, it would have an enormous impact on earnings. As a measure to combat these risks, I recommend studying anything that could cause fundamental harm to one of CORR's main properties or one of CORR's main tenants. To date, I have not seen anything that is particularly concerning, but risk could manifest quite quickly.
New York has banned fracking which has no direct impact on CORR given the locations of its assets, but there is some concern that other states may follow suit. Bans by other states could potentially reduce the value of CORR's assets or, at a minimum, reduce the total addressable market for future acquisitions.
The Bottom Line
CORR has become deeply undervalued on a variety of misconceptions and temporary events. It is growing rapidly, has stable cashflows and a large and growing dividend. We believe it is fundamentally worth $11.00/share and those who get in now have the potential to gain 75% as the market realizes its true value in addition to the 8.5% dividend while we wait.
Disclosure: 2nd Market Capital and its affiliated accounts are long CORR. This article is for informational purposes only. It is not a recommendation to buy or sell any security and is strictly the opinion of the writer.
Source>http://seekingalpha.com/article/2771535-corenergy-is-substantially-undervalued-with-upside-of-75-percent-and-an-8_5-percent-yield
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