In 2008, before Lehman, before Freddie Mac and AIG, there was SemGroup. One of the largest closely held companies in the US, the midstream giant filed for bankruptcy in July of that year after losing $2.4 billion on bets that crude would drop from triple-digits-per-barrel amid a gathering global recession.

As usual with such “no-brainers,” the bettor — in this case a trade-addled CEO — wasn’t wrong, just slightly (and terminally) early. Just after SemGroup went belly up, crude began the precipitous decline that would take it as low as $35 per barrel the next year. Subsequently, allegations surfaced that SemGroup’s trading partners, notably Goldman Sachs, had worked to bankrupt it.

In any case, a messy struggle for control of SemGroup’s far-flung assets ensued, before the much slimmed-down company owned largely by its predecessor’s creditors emerged from Chapter 11 in December 2009, and went public in November 2010.

The new SemGroup (NYSE: SEMG) is a midsize midstream operator specializing in crude gathering, transport and storage and the processing of natural gas from some of the fastest-growing shale plays in North America.

Assets include the general partner and majority of limited-partner interests for Rose Rock Midstream (NYSE: RRMS), the rapidly expanding master limited partnership gathering crude in the Bakken, Denver-Julesburg, Niobrara, Mississippi Lime, San Juan, Granite Wash, Permian and Eagle Ford plays and shipping some of it to Cushing, Oklahoma, where it owns oil tanks with the storage capacity of 7.6 million barrels, almost all of it leased through 2016.

Together with Rose Rock, SemGroup owns 51 percent of the White Cliffs Pipeline running crude from Colorado down to Cushing, which will more than double its capacity to 150,000 barrels per day (bpd) by August in response to growing shipper demand. Rose Rock is projecting growth of 12 to 20 percent in shipping volumes for the year.

It also owns a 50 percent stake in the Glass Mountain pipeline transporting crude from the Granite Wash and the Mississippi Line in Western Oklahoma to Cushing. This pipeline, completed in February, is now operating at 44 percent of its 140,000 bpd capacity.

In addition, SemGroup has gas gathering and processing assets in western Alberta in Canada as well as northern Oklahoma and southern Kansas. The US segment operates 1,200 miles of gathering lines and four processing plants with a combined capacity of 363 million cubic feet per day (mmcf/d), currently processing about 65 percent of that maximum. SemGroup’s Canada segment has 600 miles of pipes and four plants with a capacity of 694 mmcf/d, recently running at 68 percent of that number.

Source: company presentation

Other crumbs from the empire gambled away in 2008 include a significant minority stake in NGL Energy Partners (NYSE: NGL) (as well as that master limited partnership’s general partner), gained in exchange for the SemStream natural gas liquids logistics assets; a major oil (and more recently gasoline) tank storage farm on the UK’s Welch coast capable of storing 8.7 million barrels, and a Mexican asphalt business whose 15 plants sold 103,000 metric tons of the stuff in the most recent quarter.

The crude segment made up of Rose Rock and pipeline interests that haven’t yet been dropped down is the main attraction, accounting for just over half of the adjusted corporate EBITDA in the first quarter and growing revenue 71 percent year-over-year. Impressively, gas gathering and processing has grown even faster, and accounted for 36 percent of adjusted corporate EBITDA in the last quarter. Year-over-year, the Canadian segment’s EBITDA better than doubled, while that of the Oklahoma gas processing complex tripled.

The rapid growth is driving big increases in distributions. Rose Rock is aiming to hike its payout 15 percent this year with a 1.1x-1.2x coverage ratio, with SemGroup getting a 51 percent (and growing) cut. SemGroup, in turn, expects to improve its modest 1.5 percent yield by raising the dividend 25 to 30 percent year-over-year.  

The debt-to-capitalization ratio is a modest 36 percent and net debt is a reasonable 2.7 times the adjusted EBITDA. That EBITDA is forecast to increase 35 percent this year at the midpoint of the company’s guidance range (which might be a bit low given the excellent quarterly results SemGroup has recently reported.)


_{¹Consolidated with Rose Rock Midstream}

Source: company presentation

The current enterprise value works out to about 13 times this year’s expected EBITDA, inexpensive given the growth trajectory.

SemGroup is a corporation paying qualifying dividends, and its shares are suitable for IRAs.

In addition to all the tangible assets on its books SemGroup has two more that can’t be quantified but should prove very valuable nevertheless.

One is the recently installed CEO Carlin Conner, replacing Norm Szydlowski, who capably led SemGroup out of bankruptcy to renewed prosperity. Conner, 45, oversaw the Oiltanking Partners (NYSE: OILT) IPO and then presided over that partnership’s industry-leading growth as chairman of the general partner. He then returned for a second work stint at the parent company’s Hamburg, Germany headquarters as managing director of Oiltanking GmbH and member of the executive board of its parent, Marquard & Bahls AG.

And though management and ownership have turned over completely since 2008, the other asset is the notorious name and the institutional memory of market risk and its consequences. Conner, steeped in Germany’s conservative business culture, should help reinforce that theme. Fixed-fee contracts account for 86 percent of margin, with processed Oklahoma gas contributing 9 percent and 5 percent from Rose Rock’s crude marketing.

In sum, SemGroup offers fast growth, strong leadership and margins, and exposure to midstream operations in some of the fastest growing shale plays, at a reasonable price. We’re adding it to the Growth Portfolio. Buy SEMG below $82.

A Wallflower at an Orgy

Though oil’s dear at more than $100 a barrel, these are in many ways the best of times for US refiners.

The glut of crude from booming domestic shale plays has given the refiners more sourcing options than ever before, often at significant discounts. Their suppliers are barred by law from selling their output to most foreign competitors. US refiners, on the other hand, have turned exports into a major source of profits as they squeeze out inefficient European rivals and cater to growing Latin American and African demand that hasn’t been met internally.

The only group faring even better than the refiners in this environment are the investors in the midstream logistics MLPs they have spun off.  Phillips 66 Partners (NYSE: PSXP) has nearly tripled in price since its initial public offering less than 11 months ago. Valero Energy Partners (NYSE: VLP) has almost doubled in the six months since its own market debut. Western Refining Logistics (NYSE: WNRL) is up 60 percent in its eight months as a publicly traded partnership. Tesoro Logistics Partners (NYSE: TLLP) has gained 60 percent from its December low. MPLX (NYSE: MPLX) is up 50 percent in six months.

None of these refining logistics plays yield more than WNRL’s 3.6 percent, and PSXP’s limited partners are settling for a 1.6 percent yield, presumably in hopes that dropdowns and capital appreciation will continue to provide the bulk of the return on their investment.

And then there’s Holly Energy Partners (NYSE: HEP), still yielding 5.6 percent after a 9 percent decline in the unit price over the last year.

HEP beat all of its refining logistics rivals to the punch with an IPO back in 2004. Since then, revenue and cash earnings have compounded at an 18 percent annual rate and the distribution per unit has nearly doubled, not quite keeping pace with a unit price that’s almost tripled. The problem is that the recent increases in the payouts per unit, now growing at a staid 6.3 percent annual rate, pale next what a PSXP or VLP can promise based on a seemingly never-ending stream of dropdowns from their much larger parents.

Other than that, Holly Energy Partners is thriving, as Robert Rapier describes in a recent MLP Investing Insider profile. All of its revenue comes from long-term contracts with escalator clauses and minimum volume commitments, and is growing faster than the distribution as the partnership expands its crude gathering operations and ownership of the enlarged pipeline funneling the output of HollyFrontier’s Salt Lake City refinery to Las Vegas.

A recent prepayment of $150 million in expensive debt has chopped debt service costs nearly in half. And the partnership continues to eye organic growth in crude gathering, notably in New Mexico and the Rockies, as well as third-party acquisitions. Yet analysts remain largely skeptical that growth will accelerate, and see no scarcity value to HEP’s superior yield, which would be larger than PSXP’s or VLP’s even if the price of those investments were to get cut half.

This is the sort of doubt that leaves plenty of room for an upside surprise, were HEP to find a new growth avenue or dance partner. It does have a strategic presence in some of the most promising mid-Continent crude plays. And in the meantime the above-average midstream yield backed by secure contracts should limit the downside.

Source: partnership presentation

One thing to keep in mind as others announce rapid distribution gains is that all revenue growth is not the same, and the organic sort Holly is pursuing deserves to be more highly valued than the gains from dropdowns.

Every dropdown is a one-time event reducing the seller’s stock of future assets to transfer, so that growth based on dropdowns, no matter how long-lasting, is never indefinite. And these asset transfers are as a rule dictated by the general partner, typically allowing the seller to effectively name its own price. And to the degree that such deals are financed with equity they can also slow the growth in distributions per unit.

That’s not to say that dropdowns can’t be hugely lucrative for the acquiring MLP — one need only look at the trajectory of EQT Midstream (NYSE: EQM) to know that they can be. But a high rate of growth based on asset purchases is far less sustainable than a modest one dependent mainly on predictable fee increases and returns from smaller growth initiatives.

The time will come when HEP’s steady but gradual improvement is rewarded again. Until then, its decent and secure yield should do just fine. We’re adding HEP to our Growth Portfolio. Buy below $40.