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Eagle Rock Energy Partners, L.P. Message Board

jgriffith111 13 posts  |  Last Activity: Jan 21, 2015 9:52 AM Member since: Apr 29, 2008
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  • jgriffith111 jgriffith111 Jan 21, 2015 9:52 AM Flag

    Right now I'm long 25,000 KMI warrants and almost no stock, so I can't really take advantage of the huge disparity in options premiums. If I had the ability to sell naked calls in my accounts I would consider selling a basket of call options on WMB and some other midstream companies and use the proceeds to hedge out my KMI position or to just buy more KMI warrants at a much cheaper price.

  • jgriffith111 jgriffith111 Jan 21, 2015 9:48 AM Flag

    So if you made that trade, here's how I would look at it.

    The $100k worth of KMI (2,391 shares) is projected to pay $4,782 in dividends in 2015 and $5,260 in 2016 for a total of $10,042 by the expiration of the WMB LEAPs.

    WMB has also given dividend guidance for 2015 and 2016 (and this may be a high guidance, but I think I'm providing enough variables to make a reasonable back of the envelope comparison) of $2.46 / $2.82. This would be $5,747 in 2015 and $6,697 in 2016 before expiration for a total of $12,444 in dividends.

    Selling 23 covered call contracts as described (at probably a lower price than could have been achieved at closing yesterday) would provide enough funds to buy 2,875 KMI warrants.

    So this seems like a great deal because you capture the (higher) dividend on WMB while keeping more than 100% exposure to any equity appreciation on KMI PLUS $3 equity appreciation potential on WMB, and your downside is EQUAL to just going long on WMB. So the only way this comes out behind is if WMB massively outperforms KMI, and then you still end up with a decent total return.

    Let's say WMB is at $55 in 1/17 (almost 50% up) and KMI hits $50.

    Long KMI - $119,550 + $10,042 dividends = $129,592 total value
    Long WMB - $130,625 + $12,444 = $143,069
    Long WMB, short the 1/17 $45 calls x23; long 2875 KMI warrants = $106,875(WMB stock called at 45), $12,444 dividends (this is an estimate depending on when the WMB stock got called), $28,750 for KMI warrants (assuming $0 value for the remaining 4 months of time value) = $148,069

    So this requires a whole lot of assumptions, but the point is that this trade seems to offer a similar downside with a higher upside, and the only way it underperforms is if WMB massively outperforms KMI on the upside or if WMB drops in price per share (more than whatever KMI drops - the extra dividend from WMB) over the next 2 years. If WMB does massively beat out KMI then it's still likely going to be a highly lucrative trade.

  • I've followed several of the larger players in the midstream space. If I owned KMI STOCK right now I would strongly consider switching a portion of that stock out for WMB right now.

    But I'm not long (very much) KMI STOCK. I'm long a lot of warrants, and currently the $40 strike price warrants which expire May 2017 only trade around $4 when the stock last closed at $41.82 (so $1.82 of intrinsic value and the remaining $2.18 is the cost to get access to all further upside on a nearly $42 stock all the way until May 2017).

    I look at WMB and the stock just closed at $42.09 so these stocks are practically the same price. Both have a similar yield (WMB has been a lower yield all year than KMI, and the recent crash just brought WMB to a higher yield and at least similar if not higher growth projections), and yet when I look at options for WMB they are FAR FAR more expensive than KMI options or warrants.

    To buy the $40 LEAPs on WMB which have 4 months LESS time available than the KMI warrants, there is a $7.05/$8.10 BID/ASK. I consider KMI and WMB to be similar companies with similar prospects in basically the same business and trade at almost the exact same dollar price. The dividend yields are even within 1% of each other.

    So WHY THE HELL do the WMB options trade at 75-100% higher than the longer dated KMI warrants? KMI warrants are mispriced and provide the cheapest upside leverage on any stable midstream play I've found.

    If I were long $100,000 of KMI (about 2,390 shares) in an account where taxes weren't an issue here's what I'd do.

    Sell 2,391 KMI
    Buy 2,375 WMB
    Sell the covered call on WMB at 1/17; $45 strike (I might not use this particular strike price, and there's a BIG bid/ask spread here, so you could probably get a little more for the covered calls, I'm being conservative) for $5.00 per contract x 23 contracts. - Proceeds of $11,500
    Buy 2,875 KMI warrants @ $4 (strike price $40 expiration 5/17)

  • jgriffith111 jgriffith111 Jan 21, 2015 8:49 AM Flag

    KMI demands such a high valuation because of a low exposure to the upstream business, but this could be the perfect time for KMI to take advantage of the equity markets to grow its upstream exposure.

    It seems like some of the bigger upstream MLPs like BBEP/LINE follow a similar strategy of purchasing low decline reserves that have already been largely depleted, but don't require exploration/drilling. Even with their large reductions in dividend these companies are yielding over 10% right now. KMI could acquire these types of MLPs or standalone E&Ps or assets from oil majors. KMI stock yields under 5% based on the forecasted $2 dividend in 2015, and while KMI still carries a lot of leverage, KMI's interest costs would be substantially lower than any E&P MLP and most E&P companies as well.

    It seems to me that aggressive acquisitions or asset purchases in the E&P business could be highly accretive to KMI so long as the company doesn't over leverage. Since the equity price is high compared to others in the sector it seems like borrowing costs could be kept at below average by issuing enough equity to keep the debt:equity/ debt:EBITDA ratios safe.

    I guess the downside to this is that in the SHORT TERM environment a move towards more volatile assets that are more exposed to the price of oil/NG/NGLs might cause the market to put a lower value on the KMI shares since KMI clearly gets a premium for its blue chip fee based asset base.

    My investment is mostly in KMI warrants, so I'm obviously hoping this situation works out by May 2017, and I still think it will.

    If I owned half this company and was deciding what direction to take it over the next 10 years I think I would be issuing stock hand over fist to buyout lower cost producers that had slow decline aging reserves, and over the next 10 years I think North American fossil fuels will sell for enough to make a profit overall. I would love to see KMI buyout BBEP/LINE or buy assets from an oil major!

    Sentiment: Buy

  • jgriffith111 jgriffith111 Jan 21, 2015 8:34 AM Flag

    Is KMI in the catbird seat to grow the Co2 business?

    Everyone has been worried about Co2 exposure, but in reality most of KMI's cash flows and almost all of KMI's backlog is in the midstream fee based space. In the short term this seems to insulate KMI's cash flows, and hopefully insulate KMI's expansion budget.

    KMI and its predecessors have created very stable cash flows with a higher than average return on invested capital, and a large degree of leverage through debt and equity raises (WACC) at a decent margin below its ROIC.

    KMI equity price has held up remarkably well, and actually INCREASED, during the current massacre in the oil and gas industry. So I see a catch 22...KMI has substantially outperformed (or underperformed far far less than other businesses in the sector) during the energy massacre we've seen over the last 6 months (or less). On the other hand, KMI has made fantastic cash-flow from its Co2 business and earned higher returns on invested capital in that business than its core fee based business.

    KMI has a huge competitive advantage and efficiency of scale in the Co2 business. KMI is the biggest Co2 midstream player PERIOD, and seems to perform well by injecting its own wells with Co2.

    My amateur opinion is that KMI could make a huge impact on its future by acquiring more low cost oil reserves in declining production fields while the price of oil and equity value of companies owning attractive reserves is very low. The fact that KMI's equity price has INCREASED while upstream names have been DESTROYED seems to set KMI up to buyout lots of low cost declining assets with stock at the bottom of the market. I believe KMI has a competitive advantage with its scale, dominant position in the Co2 market, supply chain, and successful experience operating a niche upstream business with high returns on capital. So I think KMI can issue equity yielding ~5%, and potentially earn 10%+ over a full business cycle BEFORE using debt.

  • I feel like KMI is possibly one of the best situated energy businesses around in a low price environment. In the long term, KMI would not see its optimal growth prospects pan out if there is not a large increase in production of oil, NG, NGL's over the longer term.

    In the medium to long run though, the question is whether there is enough oil production to set a price below the cost of production for shale producers. In my opinion this is likely given that the shale oil/gas revolution is really not the high cost oil producer. I believe shale production is going to be lower cost than deep sea oil, oil sands, etc.

    I'm certainly not an oil analyst, but it also seems like the shale wells have a much faster decline rate than conventional oil production. So with reduced CAPEX in the short term, I could easily see the market moving from oversupplied to undersupplied if shale production declines in the short term.

    If a credit worthy shale producer with good assets looks long term like 20 years, and believes that some years will be unprofitable, but on average the price of oil will exceed the cost of production (and possibly substantially over time), then it still makes sense to build out infrastructure and enter into long term contracts with companies like KMI.

    I've been following KMP/KMI for quite some time, but only became a shareholder (in KMI) in spring when the Barrons/Hedgeye short attack brought the shares to the $33 range. One of the big arguments against KMI was that one of its most profitable businesses was the Co2/upstream portion of the business. My (highly amateur) understanding is that KMI has a very efficient operation piping Co2 to old oil fields and injecting Co2 to increase production. This is a small part of the business currently, and a part of the business that I tolerated rather than booked on when it came to an investment in KMI. I'm beginning to change my mind and see this as a huge opportunity.

    Sentiment: Buy

  • Reply to

    Selling Pressure

    by rossrogers89 Dec 30, 2014 4:21 PM
    jgriffith111 jgriffith111 Dec 30, 2014 10:52 PM Flag

    Or want to show large positions of a winner in their portfolios without having to disclose cost basis.

  • Reply to

    Warrants are dirt cheap right now

    by jgriffith111 Dec 29, 2014 3:47 PM
    jgriffith111 jgriffith111 Dec 30, 2014 10:50 PM Flag

    I have the same objective, but I'm looking 2 years out instead of 1. I'm paying almost nothing for leverage here, and even counting the lost dividend I pay less than I would on margin with no chance for margin calls and the ability to leverage 10:1 instead of 2:1.

    I plan to convert half my position to shares at $50 which would give me the same number of shares I could have initially purchased with my original investment, and leave a huge amount of leveraged upside on the share price.

    I believe we hit $50 before warrant expiration, and with the market's cooperation I think we go higher than there.

    Sentiment: Strong Buy

  • Reply to

    Warrants are dirt cheap right now

    by jgriffith111 Dec 29, 2014 3:47 PM
    jgriffith111 jgriffith111 Dec 29, 2014 6:01 PM Flag

    Instead of selling why not sell some covered calls against them. You can sell the $55 1/17 warrants for $0.65 and bring your cost basis down to 3.20.

  • Reply to

    Warrants are dirt cheap right now

    by jgriffith111 Dec 29, 2014 3:47 PM
    jgriffith111 jgriffith111 Dec 29, 2014 3:59 PM Flag

    One last point. The warrants are now actually very slightly less expensive than the January 17 $40 calls even though they last 4 months longer and have certain anti-dilution privileges.

  • I'm long on the warrants with an avg. cost basis of 4.10 (could have done much better) as my largest position.

    Right now the warrants only trade at ~$1.40 above their intrinsic value. Including the projected dividends you lose out on about $6 between the warrant premium and lost dividends before warrant expiration. So you end up paying about 14% of the total return over 2.5 years by going long the warrants. Or about 5.5% per year in order to get 10 to 1 leverage.

    Whether you want to make a highly bullish bet on KMI over the next 2.5 years like me, or whether you want to keep your exposure to KMI while dramatically reducing your risked capital, the warrants are a great bet right now.

    As I post this the stock is $43.08 and the warrants are $4.50.

    Sentiment: Strong Buy

  • The Alerian indexes indicated they would be dropping KMI in exchange for actual MLPs if the deal went through. I'm sure some other MLP funds will do the same. For many others the funds are allowed to own MLPs and other companies investing in the midstream space. KMI is an obvious choice to keep in a fund investing in the midstream space. This selling pressure is just related to indexing nonsense.

    Now speaking of indexing nonsense, KMI is now going to be a MUCH larger position in the S&P500 and all other major indexes, so subsequent index rebalancing will cause substantial buying pressure from non MLP funds.

    So I think the share price drop is largely related to fund rebalancing and some people trying to run the gun for the short term.

    Those holders of KMP who now have a cost basis around $40 may sell in December for short term tax losses to offset the gains from the KMP deal if the share price stays below $40. So who knows, maybe we get another great buying opportunity in December, but I think we're going up substantially from here over the course of 2015. Who really cares what happens before then? And I'm mainly long the warrants which ARE time sensitive, but I've got til mid 2017 before expiration when I see KMI trading much higher than $44. If it trades to $50 before May 2017 then the warrants make 150%+ from here.

    Sentiment: Strong Buy

  • jgriffith111 jgriffith111 Nov 5, 2014 8:25 AM Flag

    It's going to be almost impossible to look 30-40 years in the future as posted by others here. However, I think if we had to make a guess now that KMI would likely result in above average returns for 30-40 years.

    First, it's already yielding more than 5% in 2015 and expected to grow at 10% a year for the next 5 years. Beyond 5 years, I have no idea what the growth rate will be. However, I see KMI as the leading player in one of the hugest growth sectors over the next 20 years. The EIA predicts something like $600b of infrastructure needed over the next 20 years. KMI has economies of scale, is the leading player in the pipeline world, should have a lower cost of capital than most competitors because there is no GP and it trades at a lower yield than many MLP peers.

    So if you had to make a guess, I'd say KMI was well positioned to potentially take great advantage of a decades long growth industry.

    Historically KMI has done well with acquisitions and created shareholder value, and there will continue to be ample opportunity for acquisitions over and above the potential for organic growth.

    If KMI can invest a lot,and also have a return on its internal investments that exceeds cost of capital by a wide
    margin, then it will likely provide a great absolute return.

    At some point, rising interest rates will both increase the cost of capital by raising interest on non-fixed borrowing costs, and making future growth more expensive, and thus slowing growth. To the extent that the stock trades based on yield, higher interest rates may also result in a higher market yield of the stock, and this would also increase cost of capital and slow down potential growth.

    While I see interest rates and availability of cheap credit as one of the largest risks with the growth story going forward, I also think KMI is better equipped to deal with these headwinds than most of its competitors because of its industry leader status.

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