A recent addition to The Value Line Investment Survey, Copano Energy, L.L.C. (CPNO) is an independent midstream natural gas company with operations in Texas, Oklahoma, and Wyoming. The company was formed as a Delaware limited liability company in 2001 to acquire assets operated under the Copano name since 1992. It went public in 2004, with an initial offering of common units, and since then has grown through both internal investments and acquisitions, selling new common units almost every year to finance growth. Since its initial public offering, Copano has issued over $2 billion of debt and equity securities.
As an LLC, Copano is managed by a board of directors elected by common unit holders. Like other income-oriented investments, LLCs pay out most of their distributable cash flow (DCF) to unit holders. DCF is essentially net income plus depreciation and amortization and other noncash expenses, minus noncash revenues and maintenance capital outlays. As with other pipeline companies, maintenance capital costs are very low. Unlike its master limited partnership competitors, LLCs do not have general partners that take up to 50% of incremental cash flow. Like partnerships, LLCs are “pass through’’ entities that pay no income taxes but pass through to their unit holders all items of revenue and expense. Unit holders pay income taxes on their proportionate shares of Copano’s taxable income, as stated on the investor’s annual IRS form K-1, rather than on cash distributions; but cash distributions reduce a holder’s tax cost basis, leading to higher taxes when and if units are sold at a profit.
Copano gathers, processes, and transports natural gas in the Eagle Ford shale area of South Texas, the North Barnett region of Northeast Texas, central Oklahoma, and the Powder River Basin in eastern Wyoming; its major focus is the Eagle Ford shale region of South Texas, which is rapidly lifting oil and natural gas production, thanks to around 170 rigs currently drilling there. The company also fractionates gas, extracting natural gas liquids from the raw gas and selling them to chemicals producers, propane distributors, and others. It owns about 6,500 miles of natural gas pipelines, 260 miles of natural gas liquids lines, and eight gas processing plants. Copano does business through fixed-fee, percentage-of-proceeds, and keep-whole contracts. It assumes no commodity price risk on fixed-fee contracts, but it can suffer from price movements under the other two types. Copano’s goal is to lift the proportion of its revenues derived from fixed-fee arrangements, and it has succeeded in raising that figure from 27% of revenues in the first quarter of 2010 to 41% in the first quarter of 2011. Competition will probably prevent the company from completely eliminating percentage-of-proceeds and keep-whole contracts, but it will probably succeed in raising its share of income from fixed-fee deals considerably more, and that ought to reduce hedging costs.
Copano has grown through both internal investments and acquisitions, and we expect that mix to persist. Total capital outlays, including acquisitions and investments in joint ventures, have been uneven, falling from about $200 million in 2008 to $83 million in 2009 and then bouncing back to $159 million last year. But in 2011, they are scheduled to hit a record of around $400 million. These expansions and joint ventures, which should come on stream in 2011 and early next year, ought to boost earnings before interest, taxes, depreciation, and amortization, by $60 million to $70 million. That should permit Copano to raise its cash distribution per unit for the first time in nearly three years. But, to support its credit rating, the company raised $300 million last year in a private placement of 10% convertible preferred units. Distributions on the convertible preferred are payable in kind (that is, in more units rather than cash) for several years, but Copano may have to make them in cash starting in 2016. We think this will not be a problem.
Copano offers investors high current income (present yield: 6.7%) through its expansion efforts in the Eagle Ford, Barnett, and other prospective shale deposits. There is competition from much bigger players, such as Kinder Morgan Energy Partners (KMP), Energy Transfer Partners (ETP), and Enterprise Products Partners (EPD). But these and other large outfits are also partners with Copano in joint ventures, and growth in natural gas and NGL demand ought to give Copano its fair share. Income-oriented investors may wish to take a look at CPNO.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.