This article was coproduced with Investing with Confidence.

CorEnergy Infrastructure Trust (CORR) is an unusual oil pipeline company in two ways. First, it is a REIT, which means retail investors can earn dividends without having to fill in a K1 tax form. Second, it has suffered a series of humiliations that have caused many retail investors to ridicule the management. We have described the backstory here.

The recent Q2 Earnings Call successfully reassured professional investors who picked up the subtleties, but failed to satisfy many retail investors who did not understand why so little detail seemed to be given and why no question-and-answer session was included.

Reactions from Seeking Alpha commenters included:

Commenter 1

I’m still shocked that there was no deeded land dedication with the Pinedale acquisition. So much for their DD skills. Lol.

Second rate management being raked over the coals dealing in discarded second rate assets. The future shareholders is known and very clear here.

Commenter 2

So, no question and answer session? That’s strange.

Commenter 3

This is a very troubling update. No info, no plan, no q&a . Sell time

Accident-prone they may be with keeping retail investors on side, CorEnergy management should not be carelessly assumed to be incompetent. In this article we study why their actions are rational, and why this should give us confidence to invest in the Preferreds.

Image source: Mystic Investigations

Was it incompetence that lost the Wyoming revenue?

CorEnergy buys pipeline and storage infrastructure and leases it to oil and gas producers. This modus operandi is common to its many counterparts, of which all the publicly traded examples are Limited Partnerships.

In Wyoming, CorEnergy operated an extensive network of pipelines, called the Pinedale Liquids Gathering System. This was leased to the producer Ultra Wyoming and its parent Ultra Petroleum.

The Ultra companies have never had particularly enviable financials, and in 2016 they underwent bankruptcy, during which they attempted to get out of the lease with CorEnergy.

Ultra’s proposal was to instead do some building work to attach their wells to an alternative pipeline (named SWEPI) that they now owned, so that they could avoid paying rent to CorEnergy. However the court upheld the contract, and so rent continued to flow to CorEnergy.

Despite restructuring, in 2020 Ultra toppled again into bankruptcy. This time, however, the financials were so ghastly that the court acceded to Ultra’s request to extricate itself from the CorEnergy contract.

CorEnergy management received criticism from vocal retail investors on many counts:

First, for letting this happen. However, we think it is unreasonable to hold them to blame for decisions of a bankruptcy judge, who has considerable latitude in such dire situations.

Second, for not forewarning investors that this could happen. Naturally, investors feel they would rather know than not know. However, the 2016 precedent (of payments continuing during and after bankruptcy) had been reassuring. Moreover, management may have not wanted to publicly announce concern, when they in court were arguing that the contract was clear and iron-clad.

Third, for agreeing to sell the pipeline system to Ultra at a ludicrously low price. Nevertheless, as painful as the experience must have been, we argue that this was exactly the right thing to do in the dire situation that the bankruptcy court ruling precipitated.

The judge permitted Ultra to reject the CorEnergy contract and instead build some small lengths of interconnecting pipeline to reach its alternative pipeline system. During that building process, they could use road transportation as a temporary stopgap.

With no other possible customers, CorEnergy’s pipeline now had a utility of exactly $0 to CorEnergy. Indeed, possibly less, if CorEnergy had to pay to have the pipeline demolished and the land restored to its natural state. From that unhappy position, selling to Ultra was the best choice.

The price settled on was the price that Ultra would have to spend to build its short interconnect to its SWEPI alternative. That CorEnergy negotiated them up to that price is a testament to management tenacity during a calamity. If Ultra had offered a lower price, a weaker CorEnergy management might have just given in, since the alternative was $0 or negative.

Finally, and most powerfully, investors blame management for ever getting into this situation of leasing a pipeline to a tenant who has an alternative. But they didn’t! As CorEnergy’s Dave Schulte stated in the one-way Q2 conference call:

“As you know, we sold the Pinedale Liquids Gathering System on Wyoming to [Ultra Petroleum] at the end of June, after they rejected our lease [during] bankruptcy. In rejecting the lease, their stated intention was to start construction from their well pads to another system, bypassing our system entirely.

This construction would have severely diminished the value of our Pinedale Liquids Gathering System, and would have been disallowed under our lease, creating an indemnification claim for us under normal times, even in distressed times.

However, while we believe we had a valid damages claim for these actions under our lease, the UPL bankruptcy estate was so severely diminished that no value recovery was going to exceed their second lien position, including the value of our unsecured claim for damages. Unlike the 2016 bankruptcy where UPL had an estate value of more than $6 billion and could pay all claims, just four years later, the estate was valued at only $1 billion.”

This shows that CorEnergy management had indeed specifically built into the contract a ban on Ultra using SWEPI, and financial penalties were that to happen. Those penalties applied not only in normal times but also distressed times, including those of the 2016 bankruptcy. What went wrong for CorEnergy in the 2020 bankruptcy was that the depletion of Ultra’s asset value was so extreme that the judge was willing to authorize lease rejection.

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CorEnergy management were not foolish: they considered the option of refusing the deal and pursuing a claim for damages, but checked the arithmetic, and determined that they would not get any cash out of it. The analysis they presented to shareholders was intelligent, but perhaps too telegraphic, especially for a retail audience impatient and prejudiced to being disgusted:

“On consultation with the lender partnered with us on the LGS System, we had deep familiarity with UPL’s state from that prior bankruptcy. We believe that the sale was in the best available course of action. The proceeds were approximately equal to UPL’s cost of the proposed construction project and they were turned over to the lender in exchange for fully discharging the associated subsidiary’s secured debt of approximately $32 million.

We’re extremely disappointed in the Pinedale outcome as an example of the worst aspects of a bankruptcy process amplified by market and economic conditions. In short, the low gas price environment and pandemic created a perfect storm that swamped that asset and the protections we would have normally been able to deploy to protect our interests.”

How in hell did they screw up the GIGS deal too?

But it was the duality of CorEnergy’s revenue collapses that drew the most criticism amongst retail shareholders.

Jack: I have lost both my parents.

Lady Bracknell: To lose one parent, Mr. Worthing, may be regarded as a misfortune; to lose both looks like carelessness.”

Source: The Importance of Being Earnest, Oscar Wilde, 1915.

Texas oil giant Cox, through its subsidiary Energy XII GIGS, had been making regular payments on a giant network of pipelines to transport oil from a group of about 20 oil wells in the Gulf of Mexico, to the Louisiana shore.

In early 2020, with the oil price collapse, Cox switched off those particular wells, and announced to CorEnergy that it would not make rental payments because it was not sending oil through the pipelines. This is as ridiculous as refusing to pay rent for some months because you happen to choose to stay at a friend’s house.

CorEnergy management was criticized for allowing this situation to develop, and for not slapping Cox and Energy XII back into the twenty first century. However, they can’t be blamed for unilateral action by one party. They should only be blamed if they responded incorrectly.

Maybe some commenters were unhappy that CorEnergy management did not launch a public campaign of vitriol against Cox and Energy XII? They did not get themselves onto talk shows or national newspapers, lambasting their customer for not paying rent. Shareholders may have wanted more noise and fury.

CorEnergy management did not act as retail shareholders wanted. They acted as shareholders needed.

In the short term, triggering a big stink is exciting and provides short-sighted shareholders with demonstrable evidence of activity. But for us strategic investors, the only term that matters is the long term.

Management launched a careful court action, highlighting the specific points that they had built into the contract, whereby rent is indeed due regardless of whether the tenant chooses to use the pipeline or not. This is more useful than complaining to the press or whining on social media.

The tenant, Energy XII, countered that it was uneconomical to pump oil from those wells, and that we are bankrupt, and please take pity on us, a tiny little oil producer.

CorEnergy management issued a cleverly worded press release indicating that the cessation of pumping was a decision from Cox headquarters (and not a local decision of Energy XII) to halt production.

This successfully triggered an ill-tempered and somewhat foolish reaction from Cox, inadvertently revealing that it was busily pumping away on its oilfields that weren’t dependent on the CorEnergy pipeline. This embarrassing faux-pas self-destructed Cox’s assertion that it was uneconomic to pump oil in the Gulf, and drew attention to the fact that Energy XII was merely a puppet of Cox.

Cox/Energy XII were also withholding more than rent. As part of the lease contract, they had a duty to provide certain minimal financial details to CorEnergy, for the company’s corporate purposes including being able to correctly describe for shareholders the counterparty risk.

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While Energy XII had been an independent public company, this financial information was easy to obtain. However, once it became a subsidiary of the private Cox, the flow of financial information dried up as quickly as the oil. CorEnergy pursued them through the court, and the judge awarded a summary judgement in CorEnergy’s favor. Cox appears to still be refusing to comply with this court judgement.

In the end, Cox gave up pretending that it couldn’t possibly make a profit in the Energy XII fields, and started pumping again. Less temperate CorEnergy management might have crowed in victory. But they didn’t. They were obliged to keep investors informed, and they did so, with maximal diplomacy. It is not good business to publicly humiliate your customer; instead one should allow the customer to humiliate themselves. On the Q2 earnings call, CEO David Schulte said just this:

“We’ve also been challenged by the refusal to pay rent from our tenant at the Grand Isle Gathering System. However, with oil prices recovering into the 40s, the tenant recently resumed transporting oil on the system. While they have not paid rent since April, the lease is clear. Their rent is due whether or not oil is flowing. I cannot provide further details today around our GIGS conversations. We’re working to resolve these issues directly and to move forward.”

Prospects for cash flow

Projected annual expenses (excluding Depreciation/Amortization)

Expense

Detail

Amount

Transportation and distribution

Operating MoGas and Omega, i.e. residential distribution

$5.2 m

Management fees

Based on worst-case scenario of no reduction, despite reduced asset base

$6.8 m

Legal fees

iREIT estimate, including an allowance for acquisition activity

$4 m

Distribution to convertibles

With repayment of 2020 convertible notes, now only $120 m nominal, at 5.875%

$7.1 m

Other

$1.4 m

Total Expenses

$24.5 m

Projected annual revenues

Revenue

Detail

Amount

MoGas and Omega

$18.8 m

GIGS

Was $26.4 m in 2019

$ gigs

New income streams

From purchasing assets with:

$110 m cash

$55 m bank credit lines

$ new

Total Revenues

$18.8 m + $gigs + $new

Projected net revenues minus expenses

Revenues: $18.8 m + $gigs + $new

Minus expenses: $24.5 m

Cash flow = $gigs + $new – $5.7 m

We can use this formula to look at the impact of various scenarios, on the ability to pay the annual $9.2 m of preferred dividends. To do this, we apply various values for (i) $gigs, (II) $new and (III) a potential preferred share buyback.

(i) GIGS produced $26.4 m of revenue in 2019. Let’s consider three cases: continuing to collect the contracted rate, or agreeing to a reduced rate of (SAY) 75% or 50%. Let’s be pessimistic and set aside the likely corollary to any reduction of base rent, which might be a tie to the oil price to capture any upside.

(II) The $new revenue, we could conservatively estimate as a 5% yield on invested capital of $110 m.

(III) An open-market buyback and cancellation of some preferred shares would be a wonderfully accretive maneuver for CorEnergy. For example, if just half the $110 m cash was used for this purpose, the preferred outgoings would fall from $9 m to $4.5 m: of course this would mean that only $55m would be available to purchase new revenue streams ($new).

Example scenarios

Cash flow as proportion of amount needed to pay preferred dividends can be calculated under various possible values for each of the 3 future unknowns: GIGS at 100%, 75%, or 50% of previous rent, Preference share buyback at 50%, 25% or 0%, and return on invested cash of 7%, 5%, or 3%. This is shown in the table below.

Source: Investing with Confidence

As you can see, in all of these scenarios, there is more than enough cash flow to pay the preferred dividend. No dividends can be paid to common shareholders unless the preferred shareholders are paid in full their entitlement, together with any previously missed payments.

A clue to light at the end of the tunnel?

Read this paragraph from the Q2 conference call. At first it seems like the usual corporate waffle, not stating anything concrete. However, when reading it, please pick out which three adjacent words are not routine boilerplate.

“I can share with you today that we’re actively pursuing new opportunities with conservative risk profiles, including diligence activities, and our goal is to complete a transaction before your end. Now, these opportunities may include assets where we can leverage our private letter ruling to both own and operate infrastructure assets. We intend to emerge from these challenging times with greater insight, better position to capitalize on our pioneering business model.”

Did you see them? “Including diligence activities”. Why would this infamously spartan conference script contain these extra words? We suspect they are sending a signal to astute investors.

When does one do “diligence activities”? Is it when window shopping, or when a deal has been hammered out in detail, and both parties are poised with their pens to sign on the dotted line.

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This company can never be accused of excessive verbiage, and unless you believe they have suddenly had a change of heart, tilting to the lyrical, in the middle of a conference call, we think this is a hint that they are nearly ready to announce a purchase that would provide a $new income stream.

A question of competence

In this article we have explained why we do not share Seeking Alpha’s retail commenters’ view of CorEnergy management as incompetent. A very rare confluence of external events beyond their control destroyed the Pinedale (Wyoming) revenue through a judicial action to override a careful and clear contract. Their handling of Cox’s shenanigans was also far more proficient than the market gives them credit for.

Perhaps they could have explained in much greater detail the events surrounding Pinedale? The iREIT team is fortunate to have the experience to draw inferences as to what went on, but many amateur investors were angry at being starved of a more discursive description of the Wyoming scenario that engulfed the company and the various maneuvers that it had attempted.

As for GIGS, they could have explained in more detail why it is not advisable to discuss in public the details of an ongoing delicate legal dispute. The sensitivity is all the more intense because Cox is clearly in the wrong, and has infuriated the court by disobeying a summary judgement.

Given the choice between a management that messages well to retail shareholders, or a management that handles extreme business threats skillfully, we at iREIT will always choose the latter. We recommend our members to also do the same.

Consider the Risks

Seeking Alpha commentators have been unhesitating in heaping abuse on CorEnergy management. But careless investor hatred is our opportunity.

If you believe that the GIGS revenue will be less than 50% of the contracted amount and they will not hit upon the idea of a Preferred buyback and they botch the investment of the cash and get less than 3% return, then and only then should you expect the preferred dividend to not be covered. If even one of these misfortunes does not occur, the preferred dividend is covered.

As Pinedale showed us painfully, although we expect courts to enforce contracts as one of the pillars of a properly functioning economy, sometimes bankruptcy courts can reject contracts. Thankfully, the situation at Pinedale is unlikely to be repeated at GIGS.

Importantly, unlike the Pinedale fiasco, where both the driller and its parent both went bankrupt simultaneously, there is no sign of Cox, the parent of Energy XII, going bankrupt. The actions of the court so far seem to indicate its intention to uphold the law. Especially now that oil is flowing in the pipeline, a contract rejection is almost certainly out of the question.

Recommendation

CorEnergy’s Preferred stock has now convincingly moved up from its lows, but is still yielding 9-10%. This should be a reliable yield for the long term. After a few quarters of demonstration of dividend flow, investor confidence will have brought its price up to par, which is a +43% gain.

For an investor willing to experience some fluctuation in capital value in return for a strong likelihood of steady and large dividend yield and a good prospect of a sizable (albeit finite) capital gain, this is a good addition to a diversified portfolio.

Please note that our recommendation is solely for the Preferred shares, for which our model allows us a good degree of confidence because of their current unjustified low price. Modelling outcome for the common shares is much more complex and uncertain, and we are not recommending them at this stage.

Author’s note: Brad Thomas is a Wall Street writer, which means he’s not always right with his predictions or recommendations. Since that also applies to his grammar, please excuse any typos you may find. Also, this article is free: Written and distributed only to assist in research while providing a forum for second-level thinking.

The Preferred Source for REIT Preferreds 

At iREIT, we’re committed to assisting REIT investors navigate the sector. As part of this commitment, we decided to provide our readers with a 20% discount to our service and we will also be included a copy of my book, The Intelligent REIT Investor. Don’t miss out on the opportunity as we are limiting the 20% discount to our first 25 new members.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

Additional disclosure: IwC is long CORR.PA



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