Adversity Is Bitter, But Its Uses May Be Sweet

I first recommended shares in CorEnergy (CORR) in January 2015 and I even titled my article, My REIT Underdog Pick For 2015, and then in November 2015, I wrote another article explaining that CORR was My Worst REIT Pick For 2015. I keep riding the bull hoping that CORR would eventually bounce back, and boy did it bounce.

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Over a year ago, I wrote an article titled, Could CORR Soar, Again?, in which I explained that:

“CorEnergy demonstrated success on both pillars of our thesis, suffering no economic changes to either lease…2016 proved to be a year of validation for CorEnergy and for the real estate investment trust structure as a way for investors to access the benefits of the infrastructure asset class.”

At the time I wrote the article (May 2017), I decided to upgrade CORR from a HOLD to a BUY and increased my target price to $31.00 per share. Since that time, CORR shares have increased by ~7% (closing at $36.17).

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Given the strong growth potential for “dedicated infrastructure” assets — mostly pipelines and storage assets — CORR offers a compelling value proposition driven by stable, high-cash-generating business models in the midstream that provide very desirable investment characteristics.

CORR owns assets that are critical to upstream counter-parties, that are located in desirable fields that are integral to their overall operations. CORR has proven that the revenue stream is reliable, even in periods of distress, as long as the assets are critical to the upstream operators. Having come out of the energy crisis with its strategy validated, CORR has become a battle-tested REIT that is now better prepared to scale into a safer investment platform. As Benjamin Graham famously said:

“Adversity is bitter, but its uses may be sweet. Our loss was great, but in the end we could count great compensations.”

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Photo Credit

What Are The Risks?

CORR is a guinea pig of sorts – the Kansas City-based REIT is the first Infrastructure REIT so there is somewhat of an acceptance risk. Although I now cover a number of other infrastructure companies like Hannon Armstrong (NYSE:HASI), Landmark Infrastructure (NASDAQ:LMRK), and InfraREIT (NYSE:HIFR), CORR is a unique player in the energy space. In other words, many investors don’t really understand what the company does and there are certainly no true peers to compare.

However, there’s also an opportunity: CORR can build a foothold – as the premier partner of choice in energy infrastructure sale/leaseback transactions. Instead of competing for deals in the open market, CORR can source off-market deals and essentially be the “go to” landlord of choice.

Because the leases are net lease structured (tenants pay for taxes, insurance, and maintenance), the only way the company would lose revenue is if the tenant defaulted under its lease contract. However, if one of its properties fails for whatever reason, it would have an enormous impact on earnings and dividends.

As a measure to combat these risks, CORR is continuing to grow in size such that it can mitigate tenant concentration.

CORR owns mission-critical assets and lease payments are “operating” expenses, not “financing” expenses. It’s important to note that in bankruptcy, real property operating leases are subject to special provisions.

Operating leases have priority in payment and bankruptcy. The CORR revenue stream, therefore, is resilient and protected even during bankruptcy. Therefore, the stock price moved with commodity prices in this cycle, while revenues and AFFO did not, demonstrating the benefit of CORR’s business model for investors seeking infrastructure assets in their portfolio.

The Portfolio

With commodity prices seeming to have firmed up, energy companies want to get back to production stability and growth, making them hungry for lower-cost capital. CORR can provide a source of funds from something that already exists on their balance sheet. They can sell relatively low-returning, critical assets and then redeploy those dollars into higher-return opportunities, thereby enhancing the value of their enterprise.

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Grand Isle: The GIGS includes 153 miles of undersea pipeline that transports oil and water from six Energy XXI fields and one field operated by Exxon Mobil (NYSE:XOM) in the Gulf of Mexico. The 16-acre terminal includes four storage tanks, a saltwater disposal facility with three injection wells, and associated pipelines, land, buildings and facilities. At the time of acquisition, the GIGS system transports approximately 60,000 barrels/day (18,000 oil and 42,000 water) and has a total capacity of 120,000 barrels/day.

The Grand Isle Gathering System is CorEnergy’s largest asset and is leased to Energy XXI Gulf Coast (NASDAQ:EGC) (continues to serve production from the Gulf of Mexico). Energy XXI announced that they will continue as a standalone company following their strategic analysis by Morgan Stanley, and they recently released their 2018 capital budget.

They anticipate drilling six new wells in 2018, which is the most robust drilling plan for that company in the last four years. Drilling will be focused in the West Delta and South Timbalier fields, both of which are located in what Energy XXI deems its core properties and each field is partially served by CorEnergy’s Liquids Gathering System in the Gulf of Mexico.

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Grand Isle Photo

The Pinedale Liquids Gathering System (LGS) consists of more than 150 miles of pipeline, with 107 receipt points and four central storage facilities located in the Pinedale Anticline in Wyoming. The system was acquired in 2012 and leased to a subsidiary of Ultra Petroleum (NASDAQ:UPL) (guaranteed by the parent company) under a triple-net participating lease with a 15-year initial term.

Ultra Petroleum has had much success in the Pinedale field this past year, particularly with its horizontal drilling test announced recently. In 2017, CorEnergy received approximately $0.5 million of participating rents from UPL based on higher levels of production.

Given CorEnergy’s conviction in the reserve profile of this field and demonstrated level of utilization, the company purchased a minority equity interest in the Pinedale LGS, which was previously held by CORR’s partner for initial capital of $32.9 million. Pru also was going to remain involved in the asset and provided CORR with $41 million of asset level debt, which was utilized for the equity buyout.

CorEnergy has been evaluating the purchase of the remaining interest in the Pinedale LGS as if it were a new asset, subject to the same level of diligence, processes and procedures as any other unrelated asset.

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Pinedale Photo

Acquired in January 2014, the Portland Terminal Facility is a 39-acre rail and marine transloading terminal on the Willamette River in Portland, Oregon. The site has 84 tanks with a total storage capacity of approximately 1.5 million barrels and is capable of receiving, storing and delivering crude oil and refined petroleum products. The property is leased to Arc Terminals (guaranteed by Arc Logistics) under a triple-net lease with a 15-year initial term.

At the Portland Terminal, Zenith Energy (OTC:CANIF) completed its acquisition of Arc Logistics in December. This provided Zenith with options including an option to buy the terminal from CorEnergy, which remains live through the end of the lease as well as early termination options at the 5th and 10th anniversary of the lease.

In January, CorEnergy agreed to extend that first notification period from February 1 to August 1 due to the recent fee of the acquisition by Zenith and the ongoing discussions with their new management team around long-term plans for the terminal. CorEnergy believes the Portland Terminal’s strategic location at the Pacific Northwest as well as the versatility of that terminal make it a valuable asset, and CORR is not anticipating that Zenith will exercise their termination option.

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Portland Terminal Photo

Omega Pipeline Company owns and operates a natural gas distribution system primarily serving the U.S. Army’s Fort Leonard Wood in south-Central Missouri. In addition, Omega provides natural gas marketing services to several customers in the surrounding area. Omega has a long-term contract with the Department of Defense. CorEnergy provides REIT-qualifying intercompany mortgage financing to MoWood, a taxable REIT subsidiary of CorEnergy that owns Omega, secured by the 70-mile pipeline system.

Also with regard to the Omega Pipeline, CorEnergy received a private letter ruling from the IRS which enabled the company to designate the income from its contract with Ford Leonard Wood as REIT qualifying income. CORR subsequently converted Omega into a REIT subsidiary from a taxable REIT subsidiary. As the energy infrastructure real estate world continues to take shape, this PLR helps to solidify CorEnergy’s position as a pioneer in this front.

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Omega Pipeline Photo

The MoGas Pipeline System is an approximately 263-mile interstate natural gas pipeline system which originates in northeast Missouri and extends into Western Illinois and Central Missouri. The pipeline maintains receipt points with Mississippi River Transmission Corporation in Eastern St. Louis and with Panhandle Eastern Pipe Line Company and Rockies Express Pipeline on the northern end of the system.

With regard to the MoGas Pipeline, CORR continues to look at options available to offset the impact of the upcoming decline in rates and the new Spire contract, which is effective in November of this year. CORR anticipates filing a rate case in the second quarter of 2018.

Despite the upcoming decrease in rates charged to Spire for usage of CORR’s MoGas pipeline, CORR expects the decreased revenues to be adequately mitigated by the accretion from the increased ownership interest in the Pinedale LGS, the results of deferred rate case for MoGas, and growth from existing contracts through CPI based escalators as well as participating rents.

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MoGas Photo

The Balance Sheet

CORR’s capital structure remains largely unchanged from year-end, with total debt to total capitalization ratio at the low-end of the target range at 25%. Also, there remains some capacity to issue additional preferred shares as the company is under its target of 33% preferred to total equity.

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CORR has around $142 million of availability at quarter-end, as the company continues to prudently manage its utilization, considering the status of the borrowing base assets and potential uses for growth. CORR has access to diversified pools of capital, using its existing financial tools as well as potential for co-investors and project level debt.

In a recent interview, CORR’s CEO, David Schulte, said:

“We expect to transact on one or two acquisitions per year. Although we didn’t acquire a new third-party asset in 2017, we feel we have gotten back on stable footing after the recent energy crisis. We had five significant investigations of assets, one of which is still ongoing. The others were at various stages of due diligence or documentation, but we decided to not proceed due to our strict underwriting criteria.”

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He went on to say that “the $50 million-$250 million size range is suitable for our capacity to transact by ourselves. If it’s much smaller, the documentation and process may not be worth it. For larger transactions, we have developed many promising relationships with well-known infrastructure investors who have expressed interest in co-investing with CorEnergy”

CORR has broad access to capital and appeal to investors that have low risk, long-term horizons for their investment capital. As Schulte explained:

“Investors that buy utilities and REITs generally want to sleep at night. They don’t need high growth, but they want limited risk. We acquire critical assets that have long-duration, contracted cash flows that will enable our investors to have peace of mind, while we selectively provide much-needed capital to energy companies as they return to growth.”

Its Uses May Be Sweet…

As viewed below, CORR’s diluted net income, NAREIT FFO and FFO adjusted for securities are higher sequentially, largely due to the increased income tax expense back in the fourth quarter associated with the impacts of tax reform.

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Each of these earnings metrics displayed, including AFFO, was impacted in the first quarter by adoption of the new revenue recognition accounting standard.

While the majority of CORR’s revenue was not impacted under the new guidance, revenue from MoGas’ long-term contract with Spire, which has the downward revision in rates starting in November of this year, is required to be recorded ratably over the contract’s 13-year term on a straight line basis. Previously, CORR had recognized revenue from this contract as it was invoiced.

As a result, the AFFO coverage ratio to dividends for the quarter declined to 1.35x, which after adjusting for the prior target coverage ratio of 1.5x for the nearly $1 million impact of the straight line revenue change, it is approximately in line. Also, CORR recently declared its 11th consecutive $0.75 common dividend for Q1-18.

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Although CORR does not have the diversification of the peers, we like the company’s conservative capitalization strategy, and modest payout ratio (also CORR continues to receive participating rents, which contribute to increase the dividend coverage). While CORR has capacity to grow the dividend, the company recognizes the dividend is already attractive, as viewed below:

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Over the last few years, we have learned a lot about CORR and the company’s ability to manage and control risk. While we were skeptical of the REIT during the energy cycle, we remain bullish in regard to the company’s business model and specifically the diligence in sourcing critical mission assets.

In 2018, CORR expects to generate $61.4 million of rental income and that could jump about 25% by 2021. FAST Graphs estimates similar growth potential, as viewed below:

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Keep in mind, this estimate is just an analyst scorecard and there are only 4 analysts referenced in the estimate, but the potential for growth cannot be underestimated. Fellow Seeking Alpha writer, Kevin Cavanagh, has a 12-month price target pegged at $40.00. I’m going to be a tad more aggressive based on the estimates above and forecast the company to hit $40 year-end.

The primary catalyst is tax reform, as I believe we will continue to see growth in corporate spending and CORR’s sale/leaseback platform is perfectly aligned for companies to lease back the critical real estate to generate higher ROE. While the retail REIT market is continuing to understand the implications for a dark Sears or Toys-r-Us store, there is little doubt that CORR’s assets are critical and the potential for vacancies is extremely low. Besides, I like to see a company that can weather a storm and is battle-tested. “Adversity Is Bitter, But Its Uses May Be Sweet”.

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All Strong Buy picks can be viewed in my Marketplace service (The Intelligent REIT Investor).

Note: Brad Thomas is a Wall Street writer, and that means he is not always right with his predictions or recommendations. That also applies to his grammar. Please excuse any typos, and be assured that he will do his best to correct any errors, if they are overlooked.

Finally, this article is free, and the sole purpose for writing it is to assist with research, while also providing a forum for second-level thinking. If you have not followed him, please take five seconds and click his name above (top of the page).

Source: F.A.S.T. Graphs and CORR Investor Presentation.

Other REITs mentioned: (AMT), (CCI), (HASI), (LMRK), and (UNIT).


I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.