First Portfolio Position — SMLP

Undervalued natural gas gathering MLP with several potential near-term catalysts

This post marks the start of a new initiative at Idea Hive: a curated portfolio of value/special situation investment ideas. The newsletter will include summaries of highly attractive investment ideas sourced from the Value Investors Club and incorporated into my personal portfolio. These summaries will be complemented by regular updates on key developments impacting investment theses. My aim with Idea Hive is to document my own portfolio management process while also enabling readers to quickly grasp and follow attractive investment opportunities.

I am excited to share the first portfolio idea, Summit Midstream Partners (SMLP). The idea was pitched on Value Investors Club in February. While SMLP's share price has jumped substantially since the write-up due to several positive developments, the setup now seems to be even more attractive. You can read the full write-up and the comments section here.

One note before diving into SMLP: I have identified several other starting positions for the Idea Hive portfolio, so you can expect frequent posts over the coming days.

Now, onto the investment idea.

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Summit Midstream Partners (SMLP)

• Elevator Pitch: Undervalued natural gas gathering MLP with several potential near-term catalysts.

• Current Price: $35.10

• Target Price: $60+

Summit Midstream Partners is a $366m market cap MLP that owns several natural gas gathering, processing, and transmission assets in the US (see slide below).

SMLP Investor Presentation, December 2023.

SMLP has historically been an over-leveraged company. To address this, company’s management has implemented several positive changes since 2019, including internalizing its general partner, cleaning up the cap structure, and swapping some of the non-core assets for better-fitting ones (see slide below). More recently, in Oct’23, the company announced a strategic review, with options including “sale of assets” and “sale of the Partnership by merger or cash”.

SMLP Investor Presentation, December 2023.

The strategic review came to an end in March, with the company announcing the sale of its Utica assets for cash proceeds of $625m. Subsequently, last week SMLP announced the sale of its assets in West Virginia (Marcellus Shale) for $75m, allowing the company to fully exit the lower-quality Northeast segment.

While SMLP's share price is up 80% since the Utica divestiture announcement, the RemainCo is still cheap. Here’s where the company’s EV stands pro-forma for these divestitures:

• $733m in net debt as of Mar’23. This includes 1) debt repayment with proceeds from Utica asset sale and 2) cash proceeds from West Virginia asset divestiture.

• Plus $366m current market cap.

• This results in pro-forma RemainCo EV of $1099m.

Management expects the RemainCo to generate $170m-$200m in 2024E pro-forma EBITDA. This would imply a 5.9x EBITDA multiple at the mid-point.

Several points indicate that there is substantial headroom for a share price re-rating above the current levels:

• SMLP’s comps AM, CEQP, OKE, DTM, ENLC, and ETRN are currently trading at significantly higher 8-11x forward EBITDA multiples. SMLP’s management also highlighted the valuation discrepancy in the Dec’23 investor presentation, showing that the company’s peers were trading at an average 9.4x EV/2023E EBITDA multiple (see slide below).

SMLP Investor Presentation, December 2023.

• As illustrated in the slide above, comparable industry transactions have been completed at substantially higher 10x+ multiples, including DTE Midstream acquiring a gathering system/pipeline in the Haynesville shale formation in Oct’19 at 11x EV/EBITDA.

• Utica assets were divested at approximately 7.8x 2024E EBITDA. Meanwhile, West Virginia assets were sold at approximately 4x 2024E EBITDA, however, management has highlighted that a substantial portion of the asset’s EBITDA (around $7m out of the $17.5m midpoint of 2024E guidance) was comprised of shortfall payments (i.e. minimum volume commitments) that are set to expire in 2025-2026. Adjusting for these payments, the recent divestiture valued the asset at approximately 7.5x normalized EBITDA. Given that both assets were on the lower end in terms of quality in SMLP’s portfolio, the remaining business might conservatively be valued at a similar multiple.

• At the current prices, a substantial part of SMLP’s current market cap might be covered by its crown jewel asset Double E. It’s a gas transportation asset that boasts long-term contracts and a super investment-grade anchor customer, Exxon Mobil. Management expects Double E’s EBITDA to increase significantly in the coming years (see slide above) as SMLP continues to connect the asset with additional plants/wells. While there are few publicly-listed comps/similar transactions, one reference point for Double E’s potential valuation is Kinder Morgan’s acquisition of NEP’s Texas natural gas pipeline portfolio in Nov’23, valuing the assets at 10x 2023E EBITDA. Assuming SMLP can increase natural gas transportation capacity to the high-end of management’s target and applying a 10.5x EBITDA multiple, the value of Double E might alone nearly cover the company’s entire market cap. This would leave any upside from SMLP’s remaining assets for free.

Given SMLP’s high leverage, potential multiple expansion would have a disproportionate impact on the market cap. A potential stock re-rating to an 8x EBITDA multiple (i.e., in line with where Utica assets were sold) would imply a share price target of c. $63/share or an 80% upside.

There are several potential near-term catalysts that could help unlock the valuation discount:

• Concurrently with the divestiture announcement, SMLP’s management revealed plans to convert the company from an MLP to a C-Corp. Management will seek unitholder approval for the conversion during a shareholder meeting to be held later this year. Given that the current MLP structure limits the pool of potential investors and liquidity, the planned conversion could catalyze a significant share price re-rating.

• The recent asset divestitures have allowed SMLP to significantly reduce its debt burden. This, coupled with potentially inflecting earnings, might put the company in a position to reinstate a dividend (suspended since 2020), helping lure in dividend-focused investors.