Niska Gas Storage NKA

Business:

Niska is the largest independent natural gas storage companies in North America. Using old salt mines Niska stores natural gas in four areas.

AECO: Two fields located in Canada in old hydrocarbon reserves. The two fields have a combined 89 wells and hold 150 Bcf.

Wild Goose: Located near Sacramento, it's an old salt mine that has 15 wells and can store 35 Bcf. They are in the process of expanding both the size of the well(adding another 15 Bcf), and also increasing the injection/withdrawal speeds (up to 0.65 Bcf/1.2 Bcf respectively).

Salt Plains: Located near Oklahoma City, there is 13 Bcf of capacity and 30 wells.

NGPL: Gulf coast areas, 8.5 Bcf of capacity.

They have three different means to make money, long term storage, short term storage and optimization. LT gives them predictability with lower returns, $1.03/MMcf in 2011. ST commanded prices of $1.61/MMcf in 2011. Finally their optimization program attempts to use excess capacity to exploit seasonal spreads. This has the potential to be their cash cow, contributing 2.61/MMcf and 36% of the realized revenue despite only taking up 15% of their capacity in 2011.

Thesis:

This is a different angle to the natural gas play, a mid-stream player. If natural gas will ever become a great base load power supply, large amounts of storage will be required. While no expert, the use of LNG seems counter intuitive due to large energy demands and structural needs.

There are also multiple contrarian bets placed within this. First, the glut of natural gas has to go somewhere and storage will be necessary. Second, while volatility has dropped (and thus spreads to Niska have dropped), could it spike again? The hope here is to understand how profitable Niska is, how capable management is, and determine the probability that they will make money for the next five years.

Will volatility return?

This is difficult to understand. From PNG's 10K(another NG storage company):  
"While there are a variety of factors that have contributed to these softer market conditions, we believe the key drivers are (i) relatively flat natural gas consumption over the last year and projected flat consumption for the next several years, (ii) increased natural gas supplies due to production from shale resources, (iii) net increases in storage capacity, and (iv) lower basis differentials due to expansion of natural gas transportation infrastructure in the U.S. over the last five years."

Here is a company that like NKA wants to see spreads return. There are several problems though. I think natural gas is the future, just not right now. Maybe four or five years from now, but not now and demand reflects that (having only increased by a little over 12% since 2001-pg 10 PNG 10K). 

This is really a race to the bottom. Niska has increased gas storage, which creates a larger gas reserve, which lowers spreads, which impacts the profitability of Niska (and PNG). While I don't know the future of natural gas volatility I would not want to bet that spreads will return to 2007 levels (up to $4.75/MMBtu). 

How capable is management?

Simon Dupere is fairly new, having only been CEO since July of 2011 his track record is unknown. In August of 2011 he believed that spreads were at their lowest, effectively calling a bottom, a brave call for the new CEO. Eight months later, with the benefit of hindsight, we notice he may have been a wee bit early. 

Second, they are allowing Carlyle/Riverstone (parent fund) to reinvest their distributions as common units. This totals $18M every quarter. They have used some of the money that was reinvested to pay off their Senior Notes ($659M outstanding as of 2/2/2012). This was done in Q1 of 2011 at a predetermined price of $16/share. At that price the money saved on interest was equal to the money spent on distributions. 

With share prices significantly lower now (mid 9's now), a $0.35 quarterly distribution is a 50% hike in cash flows out compared to senior notes. Right pocket left pocket can work when it's zero sum. But when the left pocket is 50% more expensive, not so good.

I have not seen whether or not they continued this program. The last two quarters debt paydown has been through inventory management. While it may turn out to be prudent it could also be the equivalent of burning the furniture to heat the house.

Finally, can they stay profitable?

Probably yes, but I can't grasp how much and for how long. Spreads are low, really low by historical standards, but NKA will be making money on ST and LT contracts. While less profitable they do provide consistency. I have little to add here unfortunately. Inventory management has aided profitability too, this is only supposed to continue for another year.

Conclusion:

It seems like a race for the bottom. Couple that with the leverage (which was downgraded recently) and unproven management I fear being snagged by a falling knife. 

Adjusted EBITDA is estimated to be $125M for 2012, this seems optimistic considering managements track record of forecasts. Backing out interest (~$57M depending on further payments) and maintenance CapEx ($3M) I estimate FCF to be ~$65M or $0.95/share. They have been spending millions on expanding their facilities so true maintenance CapEx is open to debate. Spending more just to keep up needs to be considered a true cost of business. Thus CapEx figures will be substantially higher if the future includes never ending storage expansion.

At 10X FCF this seems overvalued. The distribution will need to be cut, or debt will have to be issued, and with the recent downgrade it's unlikely they'll secure debt at 8.75%. I'll let the yield pigs have it for now.