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Guest Post: Is It A Good Time To Invest In Pipeline Companies?
Submitted by Marin Katusa of Casey Research
Is It a Good Time to Invest in Pipeline Companies?
Let's begin by positioning the sector. Investing in a pipeline company is similar to investing in a utility: Like electricity providers, pipeline companies operate in heavily regulated environments, and once they are up and running, pipeline operators enjoy stable cash flows from long-term contracts.
In an economy where uncertainty is the new norm and speculation is a more dangerous game than usual, investors are gravitating toward income-generating investments. However, it's not only the current economy that's pushing investors toward defensive stocks. As US baby boomers retire, they tend to reduce the risk levels in their investments and move toward steady-as-she-goes, income-generating stocks.
Unfortunately, those two forces also mean that many of these defensive stocks are trading between 14 to 20 times forward earnings, putting them at the higher end of their historical range. More on that in a bit.
Factors We Look For
The entire existence of these companies is premised upon their pipelines, so not surprisingly it’s their assets we investigate first. Here are some questions we ask:
1. How old are their pipelines? This is a slightly controversial question, because the industry has long held that a well-maintained pipeline should last forever. But a recent spate of spills challenges that claim.
Much of North America's massive oil transportation system is decades old. Specifically, 41% of the oil pipelines in America were built in the 1950s and 1960s; another 15% are even older than that. And many of these old pipelines were built using protective coatings that have since been shown to break down over time.
For example, in July 2010, Enbridge dealt with the biggest spill in the company's history when a six-foot gash in one of its main crude lines in Calhoun Country, MI let some 20,000 barrels of oil escape. The broken pipe had a polyethylene coating to protect it from corrosion – a common technique in the 1950s and 1960s, but investigators found "surface cracks and indications of corrosion."
Granted, sensor technology has reduced the frequency of spills from crude pipelines by 35% since the 1980s. But the Enbridge spill may be a harbinger of problems to come. Over the last year in the United States, three natural-gas pipeline explosions have killed 14 people. Furthermore, the National Transportation Safety Board – whose pipeline investigation team comprises just four people – is swamped.
All told, it's likely that the miles and miles of 50- to 60-year-old pipeline laid out across North America may need major retrofitting in the coming years, meaning major expenses for owners.
2. What plans does the company have for new projects? New projects provide growth and therefore the opportunity for increasing value. However, they also come entangled with long permitting processes that carry no guarantees of success, and a permit denial can mean the loss of significant capital investments. Updated regulations also mean new lines have higher operating costs than older lines.
3. And the universal question, especially these days: How much debt does the company carry? Debt is often a necessity in business, but a company's debt levels must be reasonable compared with its cash and its expected income.
The Search Is On
So with these characteristics in mind, we set off searching. We compiled a list of all the pipeline companies listed in the United States with a market capitalization of at least US$1 billion. Then we gathered a series of data on each: cash on hand, debt, 52-week price range, price-to-earnings ratio, all the basic information. We also calculated another ratio, known as EV/EBITDA.
EV stands for "enterprise value," a measure of a company's value calculated as market capitalization plus debt, minority interest, and preferred shares, minus total cash and cash equivalents. Since it incorporates key information about cash and debt in addition to market price, we consider it a more accurate representation of a company's value than straightforward market capitalization (share price multiplied by number of shares).
EBITDA is a pretty good indicator of financial performance. It stands for "earnings before interest, taxes, depreciation, and amortization" – in short, earnings before the company's accountants and tax lawyers start fiddling with the numbers. Put a little more politely, analysts often use EBITDA to compare profitability between companies because it eliminates the effects of financing and accounting decisions, giving a better idea of straight asset performance.
The ratio of the two – EV divided by EBITDA – compares a company's value with its ability to service its debt. Value versus debt – that incorporates the key factors we outlined. Like all metrics, it's not perfect – for example, EBITDA does not take into account the cash required to fund working capital nor to replace old equipment. But for infrastructure-heavy companies – like the pipeline owners we are assessing – EV/EBITDA is one of the better screening tools that we have available.
So here are our options, in a chart showing their EV/EBITDA ratios:
We're looking for a low ratio, because a low EV could mean a company is undervalued, while a high EBITDA indicates good profitability and ability to service debt. With that knowledge, which one stands out? The problem is that none of them do! These companies are virtually all trading at the sector average or above. We'd like to see an EV/EBITDA ratio in the range of 6 to 8. The lack of deviation is in fact remarkable, but unfortunately for us that means there are no good deals.
The best-ish options are Holly Energy Partners (NYSE.HEP), Kinder Morgan Energy Partners (NYSE.KMP), and Sunoco Logistics Partners (NYSE.SXL). If any of their share prices slip appreciably in the ongoing economic storm, we'll re-evaluate these (and look at other metrics) to see whether one of them becomes attractive. For now, they're all too pricey, and we recommend you steer clear.
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all 3 of those stocks are near all time highs. not my cup of tea
Then you have Obama killing or delaying pipeline projects like Keystone XL so ole pal Buffett can transport via his BNSF from fields like Bakken.
http://blogs.dailymail.com/donsurber/archives/46466
When a hurricane is coming is it a good idea to invest in sunscreen?
EP might be good.. not quite at their all time high, but their second highest period. Who knows what the future of oil and natural gas will be though.
stevie ray vaughan & dick dale pipeline - YouTube
1960s version of 'Pipeline' by The Ventures:
http://www.youtube.com/watch?v=-sWII-0JCUQ
The Chantays playing their original 'Pipeline' on America's 'The Lawrence Welk Show', 18 May 1963 ... very classic! ... and hilarious ... dig those moves by the young musicians ...
http://www.youtube.com/watch?v=j09C8clJaXo
Perhaps the greatest surf song ever.
Pipelines. How has that worked out in troubled nations joining together to share. Not so well.
Imagine an angry farmer, or thousands. one leak, they will make sure it is permanent so nothing can come to ruin their livelihoods again.
Although not a good time to buy, very good post for actually offering a strategic idea.
what is this, seeking alpha's sister site?
Articles like this are a lot more interesting than the partisan bullshit rehashes of the Republican Debate Dog and Pony show....
this is fluff, interesting aside, and a waste of time. if i start my conclusion with, well, they are all basically the same, and then go on to recommend two or three, I am filling space and just trying to waer my keyboard down. here's an interesting article topic: sell fucking MLPs if you think EV/EBITDA is an accurate measurement of value.
and one more thing, go run along and kiss obambie's ass while you're at it. there was nothing here to warrant some bullshit anti-GOP comment. yet, clearly, in your universe MLPs=anti-GOP rant. fucking democraps.
Go fuck yourself.... I suppose you think that the Repblican Debates have real valuable content?
And why, in your twisted logic, do you assume that denigrating the Debate fluff somehow implies that I am an Obama supporter?
hey donkey kong - you're the one who found it interesting to bring up the repub debates. for what reason, only those from planet moron may understand. so right back at ya, fluffer nutter.
I brought em up because they generate the most noise here and in big picture they are complete waste of bandwidth. They are only followed closely by any thread that had "Iran" or "Israel" in the title..
Now run along and go fist yourself in the corner...
I was hoping for an adult conversation about MLPs....
Interesting that you've chosen a Spanish/Portugese pseudonym that refers, some would say derogatorily, to Americans, yet are ranting about decidedly American politics and Obama.
PIpelines are great.... there should be more MLP structures, in the that the shareholders get the earnings, not upper management.
Another way to look at it is Market cap divided by length of line. This provides an estimate of the replacement value...Some companies have been as cheap as $2000 per mile whicch is a bargain....
Put my clients in TCLP positions over the past few months.. Rock solid company. Compare the yield (taxed as return of capital) to the 10 year...
The only downside is when they get overlevered....
oh, now i get it. you're a financial advisor. wtf has ZH come to......
"PIpelines are great.... there should be more MLP structures, in the that the shareholders get the earnings, not upper management."
you need to read the fineprint more closely.
Are you vying for the "Asshole of the Thread Award"? You are off to great start....
I've done well with MLPs. I placed a large portion of my liquid net worth into a few MLPs several years ago and it has worked out very well. My biggest position is in KMP and we love it--it has increased roughly 40% in capital value and kicks off big tax free dividends. But the MLP tax structure of these companies is the elephant in the room. Under an MLP, about 90% of the distributions are tax free. One of the best tax shelters around.
But there lies the big issue. If Oblabla or his socialist brethren decide to stick it to the oil business and close some loop holes, they may rescind the MLP tax structure. If they do, these companies lose 20%+ of their value overnight. We all take risks...
I doubt that the MLP structure will change.... a Cap Gains tax hike would affect all equities...
Done very well with ETE, ETP, MWE, EVEP, PSE, LINN and TNH... Building a position in CQP and UAN... the only dissapointment has been BWP...
You pays yo' money ya' takes ya chance....
I'm more worried about Nertle the Turtle McConnell and/or Crybaby Boehner doing something stupid that spooks the market that results in a deflationary collapse....
Yeah...but if the MLP's look that good...expect the Government to figure out new ways to tax them...
Just like they cracked down on all the other ways of gaming the system for the big boys... and they are taxed....
A little off topic... but damn fine insight into the problems faced by the majors
http://www.bloomberg.com/news/2011-11-16/biggest-oil-find-in-decades-becomes-39-billion-cautionary-tale.html
Kashagan was supposed to be "solving" the peak oil problem...
I sold my pipelines a few ago near their 52 week high. A 20% pullback would be nice and is more reasonable ...otherwise too much downsize in this market......other wise I'm out and just hanging out with USO...no management problems....infrastructure costs....etc.
I love laying pipe, and have invested quite a bit in doing so. This is a no-brainer.
When pipeline companies go into a boom cycle, they have get things built, yesterday. That means a lot of up-front cash. Whether or not economic conditions produce enough demand to justify the risk, is another matter. There are more riches to rags stories in the pipeline industry, than the other way around.
http://georgesblogforum.wordpress.com/2011/11/02/the-daily-climb-2/
Buy in for equipment is your biggest issue which means you either commit to purchasing and throw a bunch of cash away or lease and rent which beats down your margins.. you're right about the rags to riches stories - which applies to any industry.
The oil companies here at least pay for the materials, we just build it.
I am the business manager for a pipeline company in Alberta (we have a division in Saskatchewan as well) and it is boom city. The right company with a good business model and competent management is worth its weight in gold now.
We were profitable in the downturn as well, but now is a nice come uppance.
I'm glad we're private of course..
Pricey? Well only if you consider Kinder Morgan's ttm PE of 540 pricey.
Pipelines are a classic sabotage target.
So the answer is: how vulnerable are your pipelines, and how good is your 'insurance'? [looking at Shell in the Delta there, recent Turkish / Iranian pipeline issues, not to mention that Georgia conflict].
i somehow recollect during the gold rush,... only the guys who sold the hardware benefited [shovels, pans, and of course, ammo]
just an analogy
btw - royal dutch shell, did a number on nigeria, and the environment [destroyed their water supplies with pollution, etc., etc.,] ,... but, we have regulation?
ps. it is a worthy article that needs to be addressed sooner rather than later for u.s. energy independence
ps2 metal fatique will occur no matter how well designed the pipes/pumps are, period - preventive[pm] maintenace
If I had a microgram of gold for every fund monkey on CNBC pimping "high dividend payers".... Ugh, vomit.
(4) how much bribery do they have to pay cash strapped local regions for uninterrupted right-of-way?