Plains All American Pipelines LP (NYSE:PAA)

 Investment Synopsis:

Plains All American Pipelines is the premier MLP for crude oil pipelines and storage. The company has a decade long history of above average distribution growth and total returns. And, in a moment of clairvoyance, the Plains management team forecast the energy price declines in early 2014. Because of their preparedness, they have been positioning the company to get through the current challenging times and be ready to resume growth when energy prices are expected to recover after 2016. Currently, investors get an 8% yield from one of the best long-term infrastructure focused MLPs.

IPO Date: November 18, 1998

• Market Cap: $14.0 billion
• Annual adjusted EBITDA: $1.94 billion (Q2 2015 annualized)
• GP/Sponsor: Plains GP Holdings LP (NYSE:PAGP)

Distribution Facts

• Current yield: 8.1%
• TTM distribution growth: 7.75%
• Forecast annual distribution growth rate: 3%-8%

Business Operations

Plains All American Pipelines operates four platforms for different midstream energy sectors, with crude oil operations as the largest. PAA owns and operates one of the largest crude oil gathering, pipeline and crude storage networks in North America. Plains is primarily known as a crude oil and pipeline company. The other three platforms are natural gas liquids (NGL) transport and storage, refined products bulk terminals, and natural gas storage. Plains operates in all the major North American supply basins and focuses on providing services to the larger, more stable E&P companies.

This chart shows the Plains All American system:

 

The company divides its revenues into three business segments. Results and guidance are provided for each segment. Here are the breakdowns:

Transportation operations consist of fee-based activities associated with transporting crude oil and NGL on pipelines, gathering systems, trucks and barges. Plains owns 17,800 miles of crude oil and NGL pipelines and gathering systems and 29 million barrels of above-ground tank capacity used primarily to facilitate pipeline throughput. This segments brings in about 50% of annual EBITDA.

Facilities segment operations include fee-based activities associated with providing storage, terminalling and throughput services for crude oil, refined products, NGL, natural gas, NGL fractionation services, and natural gas and condensate processing services. Assets to support these services include the following:

• 73 million barrels of crude oil and refined products storage capacity primarily at terminalling and storage locations
• 23 million barrels of NGL storage capacity
• 97 Bcf of natural gas storage working capacity
• 29 Bcf of base gas in storage facilities
• 7 fractionation plants
• 11 natural gas processing plants
• 1 condensate processing facility
• 1 isomerization and fractionation facility
• 24 crude oil and NGL rail terminals
• 1,100 miles of active pipelines that support Facilities assets, consisting primarily of NGL and natural gas pipelines

This segment brings in approximately 25% of EBITDA.

Supply and Logistics segment operations involve the purchase, transport and reselling of crude oil, NGLs, and natural gas using the Plains system. These services provide a base level of EBITDA with the opportunity to significantly increase profits in volatile and contango energy price market conditions (A contango market is when the future spot price is below the current price). Plains generally provides guidance of 25% of annual EBITDA from Supply and Logistics. In the right market conditions, the segment has generated up to 40% of annual EBITDA, with the extra cash flow coming on top of the steady fee based revenues of the other two segments.

Plains All American has generated growth of assets, revenues, and cash flows through a combination of acquisitions and self-developed projects. Larger moves tend to come from periodic, disciplined acquisitions. The company has spent $11 billion to acquire assets since 2001 as shown in this chart:

For its own project development, Plains likes to spread its growth capital spending over a number of smaller projects that add incremental revenue around its existing network. The $2.2 billion of growth capex planned for 2015 fund over a dozen different projects. The money spent on projects this year will produce EBITDA growth that ramps up in 2016 and beyond. Here’s one more chart showing organic growth project spending over the last decade and how that spending generates growing cash flow.

Investment Prospects

Historically, Plains All American Pipelines has provided an above average combination of yield plus distribution growth from a very high quality MLP. Over the last decade, distributions have grown at an 8% average compounding rate. Plains has an investment grade credit rating, which gives a low cost of debt capital to fund growth and acquisition projects. Projects are typically funded with a 50/50 split between new debt and LP unit equity issuance.

The Plains management team forecast the crude oil over supply and price declines as early as their June 2014 Investor Day meeting and presentations. The company has stayed away from the acquisitions market during the high energy production and new MLP growth period of the last few years. Plains has a very positive outlook of the North American energy sector for the intermediate and long terms, but expects the current low prices to negatively affect results in the shorter term – through at least the latter part of 2016. In the current energy environment, and while the company continues to complete projects that will start to pay off in 2017 and later, management has indicated that it expects distribution growth of 0% to 3% for 2016. They have stated that more typical high single digit growth rates should resume in 2017.

On the potentially short term positive outlook, there is the potential for the Supply and Logistics segment to bring in some well above guidance results over the next year and a half if energy prices remain volatile. Also, I would not be surprised if Plains announces a major acquisition in 2015, especially if MLP values remain under pressure and some less financially stable companies in the space experience severe financial strain. The current PAA yield of just over 8% is a nice wage to earn while we wait for distribution growth to get back to historical levels after 2016. Historically, this MLP has carried a 5% to 6% yield, so the current rate is well above average. When distribution growth again ramps up, the market should push the yield back down to the historic range, producing nice unit price gains compared to the current value.

 

Recommendation: Buy and accumulate PAA units at the current above average yield. This is a buy-and-hold investment that will pay off with attractive total returns in 2017 and beyond.