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This Unusual REIT's New Acquisition is a Game Changer by TMFDeeJ aka Jason Knapp.
Today I want to talk about an oldie but a goodie. This is an unusual situation that Mr. Market has left for dead, but one that might be back after what I believe is an extremely significant acquisition that it announced after yesterday's market close.
The stock that I present you today, CorEnergy Infrastructure Trust ($CORR) is a strange company that I have been writing about since January 2013 (And the new mystery stock is...). Here's some background information on how this unusual company came to fruition and what makes it a special situation from my initial post:
"For a week or two now I have been alluding to a mystery stock that I have established an initial position in. Some have tried to guess it, but to be honest with you, it's so obscure that I'm not surprised that no one got it. It's actually pretty funny, I haven't established a massive position in this one yet because I'm still researching it, but so far it seems like it was almost like it was tailor-made for me. I'm not saying that it's the perfect stock, but it has all of the attributes that I personally love, a special situation REIT conversion with catalysts and a big dividend that seems to be out of favor at the moment because of a temporary situation...I laughed, I cried, it was better than Cats.
This new stock is actually everything that another company that I sniffed around for a while, Power REIT (PW) should be, but isn't (that's another interesting one, but for another day).
This new company that I have been buying is...CorEnergy Infrastructure Trust.
CORR was formerly a closed-end fund (I've also seen it called a BDC, it doesn't really matter much at this point because it is not one any longer) called Tortoise Capital Resources ($TTO). I actually remember when the company initially went public several years ago. As a yield hound, it popped up on my radar, but I decided to pass at the time.
A little while ago it decided to shift gears away from owning securities in things like MLPs and REITs to actually providing funding to companies in the sector through sale / leaseback agreements. It is attempting to become a brand-new type of REIT (pending) that is being created to own energy infrastructure. Heck, if casinos and prisons can become REITs then companies in energy infrastructure should be allowed to. Anyhow, Mr. Market absolutely hammered CORR when it announced a secondary stock offering to fund its first major acquisition in the sector.
Normally I might be a little skeptical of relatively small a company that I had never really heard much about that claims to be transforming into something brand new like this, but it really is...it bought a liquid gathering system from our a company that I know well, Ultra Petroleum( UPL). That's a legitimate purchase. It then leased back the system to UPL for fifteen years. This isn't my favorite type of infrastructure asset because there can be some volatility with its revenue, but CORR was able to iron out a lot of that volatility by negotiating a guaranteed minimum of a $20 million annual payment for its use. Alas, the high-end is capped as well at $27.5mm. There is an adjustment for inflation in the cause as well. This translates to a cap rate of 8.89% to 12.22%, which is pretty darn good in the current low rate environment.
Once cash begins flowing in from this investment, CORR plans to raise its dividend to $0.50/share, which would result in a yield of over 8% at today's share price. Also, after the acquisition of UPL's assets is complete, it appears as though CORR will be trading for over a dollar less than the sum of the value of its assets, including the Ultra collection system and its legacy assets. I suspect that this discount will shrink significantly once REIT status is approved and the lease-back cash flow begins to come in.
One concern about this investment is that CORR has external management. One always likes to see ownership of a company that has a lot of skin in the game so to speak. However, to me this concern is eased somewhat by the fact that Corridor InfraTrust Management, the new entity that was formed to manage CORR, is incentivised to increase the stock's dividend. I have done some research on the operators of Corridor InfraTrust Management and they seem to have a decent amount of experience in the energy infrastructure sector.
Another risk is that CORR is technically not a REIT yet, but it is in the process of converting into one. Should this conversion not be approved for some reason, that would obviously be a bad thing, but to me it seems reasonably likely that it will succeed. The company that is managing CORR is taking all of the necessary steps to qualify as a REIT. Furthermore, if private prisons and casinos are converting into REITs, I personally don't see why something that's as important as energy infrastructure wouldn't be allowed to.
I view this is an interesting opportunity to get in at the beginning of a REIT that is undervalued today and has the potential to grow significantly in the future.
A big kudos to the REIT expert Dane Bowler whose Seeking Alpha article initially brought this situation to my attention."
Since this initial post several years ago, $CORR has gone on to make several impressive acquisitions. Here's what the company's assets look like today:
My main problem with $CORR during its first two years as a new REIT was that the company had been fairly stagnant. Yes, the yield of nearly 8% was nice, but I wanted to see how good its management was at actually implementing the growth plans that they have been talking about since the REIT was created.
Last November the company made an acquisition that I believe the market didn't give it enough credit for, for a reason that the company may have brought upon itself. It paid $125 million for "MoGas Pipeline, LLC and United Property Systems, LLC, which own and operate an approximately 263-mile interstate natural gas pipeline system which originates in northeast Missouri and extends into western Illinois and central Missouri (the "Pipeline System"), and certain related property."
At the time, $125 million was a sizeable chunk of change for a company with a market cap of only around $300 million. Here's where they entered into a Material Definitive Agreement.
The reason I believe Mr. Market didn't give $CORR enough credit for this solid acquisition is its official release announcing the deal was a little light on details. To me, the most important piece of information was missing...what rate of return did the company get on its new investment? I decided to investigate. After e-mailing CORR investor relations literally 5 times I finally heard back from them. Here's their response in regard to my question about the Cap Rate for the MoGas purchase:
Thank you for reaching out. The pro forma cap rate (plus adjustments) is approximately 9.7%. The adjustments take into account the benefit of a contracted rate increase (highlighted on page S-29 of the prossup).
Please feel welcome to reach out with any additional questions."
I personally was very pleased with that number. It is at the very high end of the "total return of 8% to 10% per annum" that CORR management has stated it is looking for from new investments.
While it's never ideal to issue new shares of undervalued stock, that's how REITs grow. I'll issue shares that have a yield of 7.8% to purchase something that yields nearly 10% all day long.
Alas, even after this acquisition, Mr. Market still did not give $CORR enough credit for its amazing yield and its quality collection of assets. After watching $CORR's stock languish for years, I made the difficult decision a couple of months ago to liquidate my position in it for several opportunities that I believed had more immediate catalysts that would unlock value for me as a shareholder.
At the time I sold, yes the company had an amazing 8% yield, but I was less than impressed with $CORR's management's guidance of 3% to 5% future distribution growth. That low growth rate is something that the company's management reiterated as recently as its REIT Week presentation on June 10th.
It seems as though $CORR's management was sandbagging it. Flash forward a few short weeks and the REIT announced an acquisition that blows this forward yield growth guidance out of the water. Last night's it announced that it is raising its distribution by a whopping 11%, with this headline-hitting as well, CorEnergy to Acquire Grand Isle Gathering System for $245 Million.
There had been a theory floating around for some time that the recent drop in the price of oil and gas would be beneficial to a company like $CORR, who was in a unique position to enable cash-strapped E&P companies to monetize some of their assets. While that theory sounded nice, it had not actually come to fruition until now.
$CORR announced last night that they acquired the Grand Isle Gathering System from Energy XXI Ltd. $EXXI, a cash-strapped E&P, for $245M. This is a fairly large deal for a small REIT, so of course it had to issue shares to fund it. As I mentioned in a post last week, REITs that have secondary stock offerings often sell of on the news. It would be completely irrational for $CORR to sell-off on the heels of such an accretive acquisition, even with the secondary offering. If it does, I will be waiting in the wings to scoop up shares and re-enter the land of $CORR shareholders.
Why do I like the acquisition? This was one seriously lucrative deal for $CORR, providing it with annual rent of $40.5 million on an investment of $245 million for a 16.5% annual return. Why was $EXXI willing to sell so cheap? I don't know much about $EXXI yet (I'm working on that), but I suspect that it is fairly strapped for cash and $CORR was one of the few options that it had to gain liquidity. First and foremost, as I mentioned it allows $CORR to blow its forecast distribution growth out of the water. The deal was so accretive that it enabled $CORR to raise its quarterly distribution by 11% to $0.60/share. At yesterday's closing price of $6.68, that amounts to a yield of an astonishing 8.98%.
It's time to fight the bear...
Of course, one should never write-up a stock without discussing the bear case. So what could go wrong with $CORR? Is there any risk associated with the Grand Isle Gathering System? The gathering system was initially built by Exxon many moons ago, likely 50 years or so. It is used to process oil from 6 or 7 major fields in the Grand Isle/West Delta area of the Shelf. Not surprisingly, $EXXI owns and operates most of those fields at this point. It has been attempting to rejuvenate them by drilling new horizontal wells. Should oil prices fall again, or even remain in the $60 ballpark that they are in now, $EXXI might be forced to slow drilling a little bit, limiting the volume of oil that it sends through the Grand Isle Gathering System and limiting the upside of cash flow to $CORR. A prolonged drop in the price of oil from this level could cause major liquidity problems at the highly-leveraged $EXXI.
Another major risk for the asset is a significant hurricane. The Grand Isle Gathering System is situated in an area of the country that was hit hard by Hurricane Katrina. Another significant weather event like that could cause significant damage to the system and even worse cause it to shut down for several months, cutting off the vital cash flow from it.
Lastly, another risk for $CORR is one that is inherent with all REITs, interest rate risk. Many investors have been fleeing yield instruments like REITs out of fear that rising interest rates will hurt the entire sector. I think that we can put that myth to bed. REITs are not fixed-rate instruments like bonds. The yields of well-managed REITs grow. If interest rates are rising, it means that either the economy is in great shape or inflation is an issue and the Fed is trying to nip it in the bud. Either one of these scenarios would benefit a company that is in a position to raise it's yield.
For years I have been of the opinion that the Fed will wait much longer to raise rates than anyone thinks. I have been right about that so far. Even if, gasp, I am wrong and the Federal Reserve does begin to slowly lift the Federal Funds rate it would not be the end of the world for REIT investors. The statistics back that statement up. Back in February I came across an excellent post on Ben Carlson's excellent blog A Wealth of Common Sense about how REITs perform during periods of rising interest rates:
In four out of the six periods where rates went substantially higher, REITs were actually positive. And in three out of the four positive time frames they showed outstanding performance.
$CORR's Grand Isle acquisition is certainly risker than some of it's other deals, but it is also significantly more lucrative for the company and its shareholders. That's a tradeoff that I would be more than willing to make. REITs are a sector that is ripe for the picking, after languishing on what I believe are irrational fears of rising interest rates. I don't know how $CORR's stock will perform when the market opens today, but if it sells off or even stays flat there is a good chance that I will re-establish a position in it.
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