In February 2016, utility holding company CenterPoint Energy (NYSE:CNP) announced that it was exploring strategic options to sell or spin off its interest in Enable Midstream Partners LP (NYSE:ENBL), a joint venture formed with OGE Energy Corp in 2013 to focus on midstream oil and gas development. The announcement was made not long after the master limited partnership’s abysmal performance resulted in a disastrous $1.6 billion equity loss for its majority owner. Therefore, jettisoning the investment would save the utility’s shareholders from the volatility inherent to a business based on volume-based sales of commodities.
But 18 months later, the context may have changed. Enable Midstream Partners LP has steadily improved its business in the first nine months of 2017, thanks to a strengthening market supporting its natural gas business and growth projects in promising regions. That has some openly questioning whether CenterPoint Energy should proceed with the strategic process to sell its stake. (The spin option has since been ruled out.)
While the midstream investment provides an important source of cash and accounted for roughly 28% of diluted EPS through the first nine months of 2017, a potential sale still has multiple attractive attributes that investors should consider.
What’s at stake
The midstream operator is jointly controlled by CenterPoint Energy and OGE Energy, which own stakes of 54.1% and 25.7%, respectively. Both companies own half of the management rights in the general partner of Enable Midstream Partners.
As noted, the midstream investment is an important income stream for the electric and gas utility. CenterPoint Energy sourced nearly 28% of its diluted EPS through the first three quarters of 2017 from cash distributions paid on Enable’s common stock and Series A preferred units.
That contribution would be difficult to replace, especially for a slow-growing utility company. Management expects 2018 EPS growth of 4% to 6% compared to this year — and that presumably includes increasing contributions from the midstream investment.
However, management has also laid out criteria that must be met for it to follow through with a potential sale of the midstream investment. The simple list provides insight to the opportunity at hand that CenterPoint Energy bears should consider. A potential sale must create sustainable value for long-term shareholders by:
- Maintaining current credit ratings of the company.
- Improving visibility of future earnings.
- Providing comparable EPS and dividends.
Management was able to rule out the spin option after determining that such a transaction would not maintain the company’s current credit ratings.
The second criterion would be met almost by default in the event of a sale. The company’s primary business — regulated utilities — comes with a relatively high degree of predictability. The midstream investment, which depends on more volatile volume-based commodities business, introduces uncertainty to the company’s projections. While volatility means risk, and risk means there’s a possibility for greater returns compared to the boring business of utilities, it wasn’t that long ago that investors were reminded of the downside of that risk.
The third criterion figures to be the most difficult to meet — and may hinge on the interpretation of “comparable” — but there’s reason for optimism. CenterPoint Energy reported a payout ratio of 70% through the first nine months of 2017. That leaves room to maintain the current dividend even without contributions from the midstream investment, albeit with a payout ratio approaching 100% in that scenario.
Plus, a potential sale would net shareholders a major cash windfall: The utility’s stake in Enable Midstream Partners is valued at about $3.5 billion at current market prices — and that doesn’t include the Series A preferred shares or its general partner stake. A cash injection of that magnitude would allow CenterPoint Energy to invest in growth opportunities within its core competency of electric and gas utilities and distribution, strategically payoff certain liabilities to save on interest expenses, and open several other opportunities to create shareholder value both immediately and in the long term.
What does it mean for investors?
There’s definitely an argument to be made for having CenterPoint Energy retain its ownership stake in Enable Midstream Partners. The energy markets of today are different than they were in the disastrous year of 2015. The midstream operator is going full steam ahead on multiple growth investments, which figure to both increase the distributions in the near future and make shares more valuable over time. Selling now could be a regrettable move.
Then again, hindsight is always 20/20. In the event CenterPoint Energy management decides to sell part or all of its equity stake in the midstream operator, the decision would still have the potential to serve as an important opportunity to create value for long-term shareholders.
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