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Plains All American Pipeline, L.P. Message Board

  • s.eranger@sbcglobal.net s.eranger Feb 5, 2014 8:42 PM Flag

    Morningstar's View on PAA...not so great.

    Analyst Note 01/07/2014

    The resurgence of U.S. oil and gas production has been enabled by tremendous investment in midstream infrastructure. With the shale gas and tight oil boom, midstream firms have had their pick of organic growth opportunities in recent years, and investors have grown accustomed to rapid growth in midstream cash flows and distributions. But this level of organic expansion can’t last forever. We believe the midstream industry has entered its midgame, where the easy wins of robust growth will be fewer and farther between.

    While we expect the absolute level of industry capital spending to decelerate over the next decade, we believe that slower organic growth is likely to prompt consolidation, and we still see several key areas where midstream investment spending will remain strong. These include gas processing and NGL infrastructure; LNG and Marcellus projects; and new pipelines for tight oil and oil sands production. In our view, firms with high revenue quality, high asset quality, and solid leverage to these growth drivers are best positioned to shine while industry growth slows.

    To assess these changes to the midstream sector, we’ve overhauled our valuation approach as well. We now equal-weight a discounted cash flow and a distribution discount model to value midstream firms, which resulted in recent changes to numerous fair value estimates. Combining our moat framework with current valuations results in several midstream names worthy of consideration. We favor Canadian midstream giant Enbridge because of its leverage to oil sands infrastructure; Spectra Energy and Spectra Energy Partners for their backlog of attractive projects across the midstream value chain; and Energy Transfer Partners for its balanced exposure to gas, crude oil, and NGL infrastructure and the potential of its LNG export project at Lake Charles. We also like Kinder Morgan’s broadly diversified assets and think Kinder Morgan Management is the most attractive way to play this opportunity.

    Investment Thesis 11/05/2013

    Plains All American Pipeline LP built itself into one of the most successful master limited partnerships by focusing on one thing: supplying the Midwest with crude oil to run its refineries. Through a series of deals, Plains created an impressive network of gathering and transportation pipelines, storage assets, and terminals ideally situated to funnel crude from the Gulf of Mexico, Mid-Continent producers, and Canada into the Midwest. This asset network generates a steadily increasing stream of fee-based revenue, which the partnership amplifies through its gathering, marketing, and logistics operations. Plains is expanding its geographic and product focus to include the entire United States and extend the model that has worked so well for crude oil to refined products, natural gas liquids, liquefied petroleum gas, and natural gas.

    PAA's natural gas exposure comes from its subsidiary, PAA Natural Gas Storage PNG. The business counts for a small amount of cash flow, but has been actively acquiring and investing in low-cost capacity additions and connections, with a long-term view of natural gas opportunities in power generation and transportation. However, in the short term, market conditions remain challenging with sustained low natural gas prices, narrow seasonal spreads, and lower volatility over the last two years. Management has cautioned that recovery may take years.

    In our view, Plains runs one of the tightest operations in the MLP sector. Three operating segments reflect its core businesses: transportation, facilities, and supply and logistics. What this doesn't capture is how segments and assets are interrelated and integrated. By owning transportation and storage assets and operating a top-notch supply, logistics, and distribution business, Plains is better positioned to capture business for each of its segments, earning fees at each link of the value chain. Moreover, we think the supply and logistics business derisks cash flows to an extent by using Plains' assets, line-fill inventory, and price dislocations between physical and financial markets for crude to lock in margins for minimal incremental risk.

    Economic Moat 11/05/2013

    We believe Plains has a wide economic moat. Its main assets of storage terminals/facilities and transportation pipelines are generally wide-moat assets, but Plains is exposed to significant commodity risk in its supply and logistics business, which we believe has no moat on a standalone basis. However, the asset mix has consistently yielded returns above the cost of capital, and we therefore believe Plains' supply and logistics business in fact enhances overall returns.

    Interstate liquids storage and pipelines warrant a wide moat, primarily due to their regulation by the Federal Energy Regulatory Commission. Specifically, FERC regulation controls both new capacity construction--which creates huge barriers to entry and limits competition--and the tariffs that terminal/pipeline operators may charge customers. While the latter can limit potential upside, FERC regulations in fact ensure adequate capital cost recovery and annual inflation-adjusted operating cost recoupment.

    For intrastate storage terminals, construction of new capacity is not regulated. Therefore, there is risk that high-growth or high-traffic regions are overbuilt, which can bring competitive pricing and slim margins. Storage is more affected by commodity prices too, albeit indirectly. Demand for storage is affected by commodity prices (for example, in contango markets, storage is in greater demand and vice versa with backwardated markets). Fee-based take-or-pay capacity contracts mitigate this to some extent, but throughput volumes, a major source of income, can be volatile. On a standalone basis, operating terminals alone is more of a narrow-moat business, but in tandem with a pipeline network, we believe terminals reinforce and enhance the wide-moat characteristics of pipelines.

    Plains' commodity risk is largely contained within its supply and logistics business, which takes title to commodity products and therefore incurs some price risk. Marketers have little control over prices and input costs, as energy trading markets set both. Profitability can be volatile, and there may be extended periods when the differential is unfavorable. Participants can hedge against losses from unfavorable price movements, but this can yield unpredictable results as well. However, we believe Plains runs its margin-based business is run conservatively, relative to peers, by buying and selling its marketable products simultaneously, thereby locking in a profit immediately and hence minimizing price risk. Moreover, we believe Plains' marketing/logistics operation enhances the returns of the core transportation and storage businesses. It optimizes any excess capacity on pipelines and in terminal facilities and therefore garners for higher spot prices on shipping and storage. It also creates a significant barrier to entry, as new entrants must have physical asset scale to compete.

    Valuation 11/05/2013

    We are maintaining our fair value estimate of $48 per unit, which implies forward fiscal year price/earnings of 18 times, enterprise value/EBITDA of 15 times, and a free cash flow yield of 6%. The valuation incorporates updated management guidance, continued heavy investment spending through 2014, lower supply and logistics segment activity, and the time value of money. Our 2013 estimates are in line with the midpoint of management guidance for EBITDA and distributable cash flow at $2.2 billion and $1.6 billion, respectively. As we've observed, Plains' management tends to provide conservative guidance generally and in this instance, we believe the caution is warranted, given how difficult it will be to forecast the precise path of spreads over the next year. From 2014 through 2017, we expect double-digit EBITDA growth in our base case as Plains continues to add bolt-on projects to its crude oil, NGL, and natural gas platforms.

    Both pipeline and terminal rates often contracted with annual rate escalators tied to PPI-inflation. We assume 4% to 5% annual growth through 2017, in line with the historical growth. After investing more than two billion in 2012 and 2013 (or about 2.9 times depreciation), we assume that annual growth spending reverts to about its historical average as a percentage of sales. We assume these investments garner returns of about 6.5 to 8 times EBITDA.

    Distributable cash flow over our forecast period increases at a 8% CAGR, while LP distributions grow at a 8% CAGR from $2.38 in 2013 to $3.35 in 2017. Note that over this period, Plains' general partner takes a growing share of total cash distributions (from about 32% of cash distributions in 2013 to 39% of distributions in 2017), thanks to its incentive distribution rights. This is the main reason why ROEs to LP unitholders stay roughly flat over our forecast period (averaging a respectable 13% annually), despite the double-digit growth we've forecast for Plains' transportation and facilities businesses. The ROE to all PAA unitholders including general partners, in contrast, rises to 22% by 2017.

    Our valuation models use a 10% cost of equity, 7.8% weighted average cost of capital, 3% terminal growth, and a 13 times terminal EV/EBITDA multiple. Collectively, these assumptions imply a fair value estimate of $48 per unit.

    Risk 11/05/2013

    Market and regulatory risks are significant for Plains All American. Commodity market volatility can benefit Plains by increasing margin opportunities, but it also increases exposure to potential bad trades. Sustained low oil prices also reduce margins and could threaten system volumes. Regulatory changes regarding tariff structures or pipeline safety could also affect Plains' business model. As with any MLP, the partnership requires functioning financial markets to access growth capital. Operational risks include the possibility of leaks, fires, or explosions. Higher interest rates could raise borrowing costs and make Plains' units relatively less attractive to investors. Refinery turnarounds can dramatically reduce the amount of crude and petroleum products PAA moves through its pipes and terminals.

    Management 01/30/2013

    Chairman and CEO Greg Armstrong has provided a firm hand and clear strategy for Plains All American since its formation in 1998 and previously served as CEO of Plains' predecessor partnership. The partnership's management ranks are filled with longtime Plains employees, starting with the CEO and continuing through the majority of the partnership's senior officers. We think this organizational continuity has helped Plains recognize business opportunities and trends, and we're full of respect for this team.

    Management has proven adept at allocating capital wisely, as demonstrated through its habit of reinvesting excess cash flow into organic growth projects or acquisitions. The company maintains strict target returns for new investments, and we've seen the results reflected in Plains' consistently growing asset base, cash flows, and distributions. We've also seen management exercise restraint in its recent decision to form a joint venture with Enterprise Products Partners EPD for an Eagle Ford pipeline, rather than build separately simultaneously. After assessing the potential overbuilding in the region, its joint venture decision demonstrates Plains' constant eye to long-term supply and demand needs. On the whole, we therefore view Plains' stewardship as exemplary.

    The board of directors has deep energy and finance expertise, but directors are only elected by Plains' general partner. Like most MLPs, unitholders have very limited rights and have no say in the management of the partnership. However, we do like that a portion of directors' pay is tied to long-term unit prices and that the partnership provides detailed data with its quarterly reports. Management's communication efforts and transparency are helpful for investors, as they provide additional visibility into future profitability and distribution growth.

    Overview

    Profile:
    Plains All American Pipeline provides transportation, storage, processing, fractionation, and marketing services for crude oil, refined products, natural gas liquids, liquefied petroleum gas, and related products. It also controls PAA Natural Gas Storage, a publicly traded natural gas storage master limited partnership. Assets are geographically diverse, spanning the United States and in Alberta, Canada. Seventy-five percent of assets are leveraged to liquids transportation and storage, which also comprise about 70%-80% of cash flows.

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