EROC - Eagle Rock Energy Partners

[Fat Pitch]

Eagle Rock Energy Partners

[NASDAQ:HNRG]

 

Link to NASDAQ:EROC article

 

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In this edition Fat Pitch will be reviewing Eagle Rock Energy Partners- NASDAQ:EROC . A Master Limited Partnership that has an unsustainable business practice, unless management changes their financial policies soon.

 

Master Limited Partnership’s (MLP’s) in the energy sector have become increasingly popular with retail investors. Their main attraction is their perceived riskless investment that pays a yearly distribution of 6%. Now a truly riskless investment yielding 6% per annum is quite lucrative considering we are currently in a near zero interest rate environment. However, caveat emptor, many retail investors have no idea what they are getting themselves into!

 

The sales team pushing this product hide behind the shroud of the minor, yet true, benefits of MLP’s: the tax benefit of a limited partnership and the liquidity of a publicly traded equity. However, don’t be sidetracked when they call and tout these insignificant benefits! Be sure to do your research and check out the financials. Lastly, when the sales-rep starts chit-chatting about how you will spend your easily earned earnings on a family vacation in the Bahama’s, hang up the phone!

 

Just to clarify, it is not that Fat Pitch thinks all MLP’s are bad, it is just that most are! We see no point in explaining the background of the Eagle Rock Energy Partners – NASDAQ:EROC business since it is a horrible investment! Let us move on to the important part: the financials, focusing on a 3 year history of cash-flows statement.

 

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Right off the bat a keen investor will realize that the 2013 cash flows from operating activities (line B) is $300,000 less than depreciation (line A). In other words, the company is barely earning enough from their operations to replace what is consumed just to maintain the status quo of business operations. Also consider that Eagle Rock obtains positive cash flows from a depleting asset (oil & gas reserves) and their gas compressing and processing plants will need replacing every so often. Replacement costs have been reviewed and we agree that this yearly depreciation figure very accurate.

 

Next, lets look at lines C and D: sections from the cash flow from financing activities. Notice how unsustainable this investment is!? Line C shows 2013 dividend distributions equal to 70% of its yearly cash flows from operations. You read that right! 70% went straight to investors via the dividend! And to think that this company cannot even earn enough to pay for its own replacement cost. Our calculations reflect Eagle Rock having a yearly shortfall of $118 million.

 

So how to they stay in business!? Lets take a look at Line D. Thank goodness they have hard-nosed investment bankers to push new stock on the market to unsuspecting retail investors! And every time Eagle Rock Energy Partners – NASDAQ:EROC raises capital by selling equity, these investment bankers collect a pound of flesh, typically 5-7% of the total amount of capital raised, in 2013 that total amount of new equity sold to the market was $96 million. Investment bankers probably walked away with $6 million at the end of the transaction.

 

Seems pretty reasonable to say that the only persons making any return on investment are the investment bankers! Please let F.P.I. kindly remind you that Eagle Rock Energy Partners – NASDAQ:EROC is not the only company playing the “raise capital just to pay dividends because our business can’t economically support itself” game!

 

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[scorpioncapital]

As a counter point to the above post, http://seekingalpha.com/article/2726185-eagle-rock-with-a-yield-over-10-percent-this-well-hedged-mlp-is-worth-much-more-than-3

 

What do folks think about the fact that they've hedged production at high levels for several years and it's possible oil & gas stays low. Is it still true that they are spending more in capex than pulling in via net cashflow?

[Fat Pitch]

Look at the cash flow statement after the deal and estimate maintenance capex after looking at their reserves. That will answer your question. Sure they can use that cash to buy cheap assets now, but there are quality businesses on sale with way better management.

[scorpioncapital]

What makes the management so poor? Seems they are doing a 100m buyback and at $2.85/share, that represents 23% of shares outstanding at 55% of book value.

[Fat Pitch]

Look at the capital destruction since they went public. A monkey can probably hit it out of the park now considering what these assets are fetching for so they will probably do alright now.

[scorpioncapital]

Wasn't there a quote somewhere about a monkey eventually running any business? ;)