We have downgraded pipeline operator MarkWest Energy Partners L.P. to Neutral from Outperform purely on valuation grounds, as we see limited near term price upside.
Denver, Colorado-based MarkWest Energy is a master limited partnership ("MLP") engaged in the gathering, processing and transmission of natural gas, transportation, fractionation and storage of natural gas liquids (NGLs), and the gathering and transportation of crude oil.
MarkWest owns a high-quality and diverse portfolio of midstream assets that generate stable and recurring revenues based on long-term fee-based contracts. Over the last few years, the partnership has consolidated its position in the midstream business, achieved through a combination of organic efforts and accretive acquisitions.
With its proven track record of supporting producers in the development of shale plays, MarkWest is in a great position to participate in the development of infrastructure that will be required for the development of the leaseholds.
Last year, MarkWest teamed up with another MLP, Sunoco Logistics Partners L.P. (SXL - Analyst Report), to build a distribution system to transport ethane produced in the Marcellus Shale Basin (in north eastern U.S.) to markets along the Gulf Coast. We believe that the initiative, known as the ‘Mariner Project,’ offers several benefits.
Not only will the project help MarkWest to profit from the direct opportunity of capturing demand for ethane takeaway capacity at Marcellus, but it will also support higher gathering system volumes and higher ethane production.
We also appreciate MarkWest’s steady improvement in its liquidity/cash flow position and its track record of consistent distribution growth.
However, we think the current valuation is fair and adequately reflects the partnership’s future growth prospects.
First of all, gathering and processing MLPs, like MarkWest, are more sensitive to commodity prices compared to other MLP subgroups. As a result, collapsing energy prices adversely affect their cash flow stability.
MarkWest’s non-fee-based keep-whole and percentage-of-liquids basis contracts for its midstream assets – which make up more than 60% of its net operating margin – also expose the partnership to commodity price risk. This is expected to further limit its ability to generate positive earnings surprises.
As a result, our long-term total return expectation for MarkWest remains rather muted. We do not see any significant price upside for the units in the next few quarters and expect the partnership to grow at a somewhat more conservative and sustainable pace.