Nick Sciple: Welcome to Industry Focus, the podcast that dives into a different sector
of the stock market every day. Today is Thursday, November 15th, and we're talking pipelines.
I'm your host, Nick Sciple, and today, I'm joined by Motley Fool contributor Matt Dilallo
via Skype. How you doing, Matt? Matt Dilallo: I'm doing great. How are you?
Sciple: Doing well. I was talking to you before the show. We're getting the first snow of
the year down here in the D.C. area. I just moved up here a few months ago from down in Alabama,
so I'm adjusting the best I can to this new weather. But we're doing alright.
Dilallo: My wife and I went the opposite direction. We moved from the North to
the South to avoid the snow. Sciple: We'll make it. It's been a new experience for me.
I'm sure many more days to come. Dilallo: Oh, yeah.
Sciple: First off on the show, I wanted to talk about the fires out in California.
First off for our listeners, I want to say, our thoughts and prayers out to everyone that's
been affected. There's been multiple people who've passed away or have been dislocated
from their homes, some people that are still missing. Since we're an investing show,
we want to talk about how these sorts of things are going to affect investors. The biggest
story this week related to the California fires has been PG&E. PG&E is the largest utility
in California, has over 5 million customers. It's down over 50% this week. I saw this morning
it was down another 20%, over rumors that a defect in their equipment may have been
to blame for causing the wildfires that are ravaging California right now.
Matt, I want to ask you, investors in a company like PG&E bought into a utility stock that
was supposed to be stable, pay a dividend over time, be very predictable. And now,
you're seeing this liability coming up from the fire that's really changed the whole narrative
for the company. When you encounter situations like this in your holdings or your investments,
what do you think is the most appropriate way to respond to something like this?
It just comes out of nowhere and changes the entire dynamic of the business that you're holding.
Dilallo: This is a tough situation. Again,
my heart goes out to California. My uncle lives out there. I know that the smoke in
the air is making the air quality bad. It's a tough situation for those people out there.
It's hard to then switch gears and talk about investing. Investors are just losing money. Nobody wants
to lose money, but losing your house or your life ... so, I guess investors should frame
it that way first. It is money. It's really not ever fun to lose money. Especially the
type of investors that would be in a stock like this. They're looking for the dividend.
It's the low-risk investments. It's a reminder to us all that there's no such thing as low-risk in investing.
There's things that come out of nowhere.
There's the BP disaster a couple years ago. That company made a mistake and created this
huge environmental disaster. In this case, we have fires here that potentially were caused
by an electric malfunction. If that's the case, it could really devastate the company,
because they could be held liable for a lot of this damage. I saw that they had taken
out their line of credit. The bank's basically given them a credit card, and they maxed it
out and put that cash on the balance sheet. That's preparing themselves for not being
able to access money in the future. If they're held liable, they're not going to be able
to issue bonds or sell stock. It doesn't look good for investors here. I
saw this happen a lot during the oil market downturn. When companies were about to declare bankruptcy,
they would max out their credit, so they have that liquidity. I wouldn't say
rush out and sell, because you don't know what's going to happen. But it doesn't look
good for investors in this stock. Sciple: Exactly right. It's hard to know where
to proceed from here. There's so many unknowns. If it turns out that they're not liable, you've got
a double if it were to return to the previous levels. But it's so hard to know. There are
so many question marks in the air. Dilallo: I would not be buying hoping for
that to happen. As a human being, you hope that the fires are put out quickly. You hope
for the people who work for this company that they don't go bankrupt. But I wouldn't be
buying on that hope. Sciple: Let's pivot into your main discussion today,
which is pipeline companies. The first company we want to talk about is Crestwood
Equity Partners. Their an MLP pipeline business. They yield a little over 7%. Up about 28%
year to date. They have a fairly well-covered distribution, about a 1.2X distribution coverage ratio.
When you look at Crestwood Equity, what really stands out to you about that business?
Dilallo: They've done a lot over the past couple years to turn around. I've been watching
them for a little while. I actually bought some units earlier this year. I saw the turn
in their financials, their leverage ratio, which is the amount of debt they have to earnings.
That's gone from over 5X to around 4X. And then, their coverage ratio, as you mentioned,
is up 1.2X. They were paying out more than they were bringing in for quite a while.
They sold assets, they cut their distribution a few years ago, they partnered with a bunch
of companies to bring in cash, but also to help fund grow. They've done a lot to turn around,
and it's finally starting to show up in their financials. Their earnings were up
about 8%, which is good for a company that's been steadily declining. It was nice to see
that turn. And that turn's going to accelerate going forward. They've had success.
What they do is, their main business is gathering and processing. That's taking natural gas
from the wellhead. They'll take that and separate out the natural gas liquids. It's a business
that's very dependent on volume. As oil and gas companies are drilling, the volumes go up.
That's been one of the things that has driven them lately, this uptick and drilling,
especially in places like the Bakken, where they have a good position. They're also in
the Delaware Basin, which is part of the Permian, and the Powder River Basin, which is out in
the Rockies. They've got these three growth engines. They're starting to finish up some projects.
As those projects are coming online, it's allowing companies to drill more wells,
complete more wells. That's really starting to accelerate their growth, and they're starting to take off.
Sciple: Let's talk about some of those new
pipeline investments that are coming online. You mentioned partnering with some other businesses
in the Delaware base. They're working on their Orla natural gas processing plant and pipeline.
They've announced a joint venture for the Nautilus Orla pipeline, with Shell Midstream Partners
for what Shell's doing. Similarly, in the Powder River basin, they're partnering
with Williams Companies to help support the growth of Chesapeake Energy. Latching onto
these producers they're servicing, what advantages does that give them? Does that give them some
steadier cash flow opportunities because they're partnered with these producers? Give us some
color on what that means for the business. Dilallo: We'll start in the Powder River
Basin, where they're working with Williams Companies to support Chesapeake Energy. Chesapeake's
one of the bigger drillers out there. Chesapeake really sees a lot of growth potential out
in that area there. Production is up like 100% in the past year off a low base.
They're putting more rigs out there. That gives Williams and Crestwood visibility. They can tell
"Okay, Chesapeake's production is going to grow by X%. To support that, we need to build these
gathering pipelines," which will take the raw production from the well to these processing plants,
which separate the natural gas from the natural gas liquids. They get paid fees
as they do this. So, as the volumes go up, the fees go up. It's a really good visibility business.
It is tied to, we call it the supply side versus the demand side. It's really driven
by drilling. With oil prices recently going up this has been really driving that.
By working with both Chesapeake and Williams, they have a very good idea of what's going on,
as far as planning how many wells. And then Williams, they help fund half of it.
For a company that's paying out with a 1.2X coverage ratio, that's probably over 70% of
their cash flow, they don't have a lot of retained cash to reinvest. So, that's helping them
with that. The same thing in the Delaware basin working
with Shell. Obviously, a massive company. They have their own MLP and they're working
with them to follow along with what Shell's doing so they can time these gathering pipelines
coming online. You mentioned the Orla plant, that's the first one. They'll probably build
a second one there. It's really being able to time these plants so they're not building
a natural gas processing plant on speculation, but they know that the volume is coming, so
they can make that return very quickly. Sciple: Right. As a result of these investments,
Crestwood is projecting a cumulative annual growth rate in their cash flow per unit at
15% through 2020. They're really thinking that there are some significant growth opportunities.
We've discussed the Bakken and the Permian in the past, and the real opportunities,
once we get this infrastructure online, for that growth lever to really get pulled.
Looking forward for Crestwood over the next few years, if an investor wants to start a
position or wants to start following the stock to think about maybe starting position in
the future, what are the things that investors should watch going forward or pay attention
to what this business? Dilallo: One of the things I like about
Crestwood is that they're focusing on growing earnings per unit, focus on the individual growth as
opposed to absolute. That's what will create value, more so than, "We're going to double business,"
but if they're issuing a whole lot of new shares to do that, it really doesn't
help the investor. I like that focus on the per unit. That'll make sure that they're able
to grow the distribution. This is an income-focused stock. As they're able to grow that distribution,
they probably won't grow it at 15% per year, but they might grow it 5-7% a year,
which would be more sustainable. That will give them more free cash flow later on to reinvest into
new projects. I like that it'll be a steady grower. You're not going to see another 30%,
I doubt it, in the next year. But a good, steady grower with the distribution.
Sciple: Matt, the next stock we're going to discuss is Brookfield Infrastructure Partners.
Key thing to point out with Brookfield Infrastructure, it's more diversified than Crestwood. Also,
in addition to having some pipeline investments, they also have some investments in data centers,
they have some investments in regulated utilities. They yield about 4.8%. Their distribution
has grown at a 11% cumulative annual growth rate since 2009. What really stands out to
you about Brooklyn Infrastructure? Dilallo: As you mentioned, it's diversified.
It does have the pipelines. They've got a pipeline through North America, they've got
one in Brazil, they're buying one in India. Not only do you get the North American that
you can get in any of these MLPs, but you get the global pipelines. And then, in addition
to that, they're savvy of knowing what type of infrastructure is needed elsewhere.
You mentioned the data centers. They see data as being the new oil, exponential growth in data.
They're investing in cell phone towers, data centers, fiber networks. They're also
big on transportation-type businesses like ports, toll roads, and rail. Really a broad
way to diversify into infrastructure generally. It's a different way to play this side of the market.
Sciple: The way to think about it with Brookfield
Infrastructure is, if you need to move something from place to place, whether it's data, oil,
goods on a toll road, or anything like that, that's something that they're going to pay
attention to and look for opportunities in that space. About 95% of their adjusted EBITDA comes
from regulated or contracted revenues. You're getting a pretty steady cash flow through
the business. It's very predictable business. Let's talk about their acquisitions.
With their cash flow being relatively steady year over year, a lot of their growth is going
to come from acquisitions. They just announced about $1.8 billion in new investments,
$1.4 billion of which is going to go into energy, while the rest of that is going to go into
data centers and some other opportunities. Do you want to talk about what they're looking
at with these new investments, and what opportunities Brookfield has to pursue there?
Dilallo: One of the things Brookfield does is, they'll buy a business and they'll own it
for a long time. They just sold an electric transmission business in Chile. They're using
that money to reinvest in some other higher-growth opportunities. They've got about
six deals going right now. One of them is, they're buying Enbridge, the Canadian pipeline company.
They're a gathering and processing business in Western Canada, focused on the Montney shale,
which is a natural-gas-liquids-type of shale play up there. They see that as a growth opportunity
as Canada starts exporting natural gas. It has really good returns up there. They see
that as a good organic growth opportunity. They also are buying a pipeline in India.
India's the faster-growing energy market going forward. China was the big story for the past
couple decades. But India is going to grow very, very fast the next couple years.
This is their inroads into India. They also bought a residential infrastructure company.
What they do is they lease things like home heating systems and water heaters, those sorts of things,
to homes and businesses. That's their energy investments.
They also bought a gas utility in Colombia. Again, spread all over the world, diversified.
And, as you mentioned, a lot of these are contracted cash flow. Just like a pipeline
company will sign a long-term contract with shippers, a lot of these are long-term contracts.
You have that stable cash flow. And then, they have the data infrastructure investments,
ones that deal with AT&T device and data centers. Another, they're partnering with
a real estate investment trust to buy data centers in Brazil. Again, you've got that diversification,
both in sector and geography. It's a way for them to grow faster than a
typical pipeline company. They have so many more opportunities. Another benefit of this
switch from the Chilean business to these other ones is, the Chilean business is going
to grow about 2-3% a year, and they see these as growing 5-7% a year organically.
So, they can accelerate the growth rate, plus getting the uplift from a really stable business to
businesses that are growing faster. They see this as accelerating the growth rate going forward.
Sciple: Let's talk about the advantages.
We talked about some of the diversification that Brookfield gives you because they're not just
in the oil space. A lot of these other energy, oil plays can get affected by the cyclicality
we see in the energy market. Is Brookfield more insulated from that because of these opportunities?
If the oil market's doing really well and assets are over-inflated,
they can push assets to those other areas, data centers and things like that. For an investor,
is that a thing that you think about when you're deciding how you want to allocate or go into
these businesses? Dilallo: Yeah, they're very contrarian.
They'll look at a situation where nobody else wants to invest, and that's when they'll buy.
I think it was two years ago, Brazil was in some trouble. The oil prices really hit Brazil's
oil company Petrobras pretty hard. On top of that, they had a political scandal.
So, nobody wanted to invest in Brazil. That allowed Brookfield to buy a really good pipeline business
for a fantastic price. That focusing on looking for opportunities when nobody else is has
enabled them to get some really good deals. Right now, the midstream sector is under pressure
in North America. Nobody wants to buy midstream assets because with interest rates going up,
that's put pressure on stock prices. Midstream companies are selling to Brookfield for pretty
good values. That's how they play it. They look for opportunities when things are down,
and that's when they'll pounce. Sciple: I pulled some data from one of Brookfield's
investor presentations earlier this year. You talk about the market downturn.
Brookfield's balance sheet sets them up to be in a good position to invest there. Less than 5% of
their debt is maturing in the next five years. 90% of their debt is at a fixed rate.
They have no significant maturities in the next five years. While we're at this bottom or
weakness in the MLP market, they have the opportunity, without significant obligations
on their balance sheet, to throw some money into where opportunities present themselves.
Dilallo: Yeah, and that's by design. They like to sell assets not when they have to,
but when they're at full value. For example, Enbridge, they sold their Western Canadian
gathering processing business because they had to. The market put a lot of pressure on
them because their debt load has been higher because they're building all these pipelines
in the U.S. and Canada. They needed to de-lever, and that provided Brookfield the opportunity to buy.
That's one of the things that sets them apart. They'll sell when the values are high.
That hurts them in the short-term. Their earnings have gone down the past two quarters.
However, it gave them the cash to buy a bunch of really good assets when prices came down.
Sciple: Awesome. Going away on Brookfield, again, if an investor wants to start a position
or tracking this business to maybe think about starting a position in the future, what should
they be following? What should they be paying attention to? What are the important things
that they should be tracking with this company? Dilallo: Like we mentioned, they have six
deals going on right now. Their focus right now is closing those deals. If they all close,
they believe that'll boost earnings 20% starting the second half of next year. There might
be some pressure in the near-term. Fourth quarter earnings might be down. They did close
some deals recently. But I see it as an opportunity to buy. I just bought not that long ago.
The focus on them is the long-term. They're looking three to five years. They believe
they can grow their distribution by 5-9% per year. It'll be more generated by the organic
growth that they can get from these businesses. They have a pipeline joint venture with Kinder Morgan,
for example, that they're expanding. They have some other businesses.
They're building these small projects that can increase earnings. That's going to drive a lot of this growth
going forward. And then, the acquisitions, if they can get good deals, it's like icing
on the cake. Sciple: Awesome. Let's go ahead and
talk about our last talk we're going to talk about today, which is Plains All American Pipeline,
ticker PAA. It's exactly what it sounds like. It's a pipeline company that's all-American.
It's all in North America. They own gathering terminals and storage facilities in California,
Louisiana, Oklahoma, Texas. In Canada, they're in Alberta and Saskatchewan.
Yields about 5.2%. Has more than 90% of its cash flow tied up in long-term contracts. What stands out
to you about Plains All American? Dilallo: Plains All American, even though
you mentioned how diversified they are, they're really a Permian Basin story. They have one
of the best positions there in the Permian. They've got a lot of growth projects in the pipeline,
so to speak. They just finished the Sunrise expansion pipeline. That's taken
crude oil up to Wichita, and then it's going to go up to Cushing, which is the nation's
oil hub. Then, they have another one, the Cactus II pipeline. It's an expansion of another
pipeline that'll take oil to Corpus Christi, Texas, which is a big hub down along the coast.
They've got these projects, and they've got a lot of other little what they call "de-bottlenecking projects."
They look for if there's too much oil flowing in one direction, how can we fix
that and invest capital and get a return and improve the flow of oil? They're really focused
on the Permian, which is a great place to be. It will grow so fast once they get these
pipelines online next year. Sciple: We've talked about the Permian in
the past, about the pipeline constraints there and how it's held back production in that region.
A couple questions here. First, because there's a shortage in pipelines,
what kind of leverage does Plains All American have in negotiating pricing with the producers there?
Secondarily, as these pipelines come online, how quickly is their capacity going
to get filled up and we reach another bottleneck again? There's a massive number of drilled
but uncompleted wells, this latent demand in the Permian. What are your thoughts on
those two questions there? Dilallo: One of the things that the pipeline
crunch has enabled Plains to do is be able to secure partners. They have this partnership
with Exxon Mobil. It'll be the next Permian pipeline that will probably be built.
Exxon signed a big, long-term contract to be an anchor shipper on this pipeline. The pipeline
companies have been able to do that, get big producers to anchor these pipelines. It de-risks
the projects so that smaller producers are okay with signing on with them. That's helped them
plan ahead and get the next ones lined up. This pipeline, it'll probably be 2021.
So, now, they're starting to get ahead of the curve.
I think there's three pipelines that are supposed to be finished by the end of next year. Energy
Transfer and Magellan have a pipeline that's coming 2020. They're basically staging them
almost every year. That should help them get ahead of the curve, as long as there's no
permitting issues or other problems like that. It's really helped them to be able to get
producers to focus on, "Yeah, I need to sign on now so that I can grow later."
Sciple: Right. It's the problem these producers have been having now. If they don't have some
kind of pipeline deal to get the oil out, it's a useless asset. You're selling your
oil below the spot price, and all those sorts of things.
We're seeing Planes All American building out all these new pipelines. They've also
sold and some of their assets. They sold against their BridgeTex asset, a 50% stake in that,
to Magellan Midstream Partners. They're going to use that cash to de-lever a little bit.
What's their balance sheet looking like at Planes All American? What are the prospects
for that going forward? Dilallo: That's been the driver.
They sold a lot of assets in the past couple years because they, like a lot of companies, were a little
bit too tight when the market crashed. They've been trying to get that leverage ratio down.
They expect to hit their target early next year. That's going to free them up to do some
other things. In the case of BridgeTex, they didn't sell the whole thing, they sold a part
of it so that they can still keep that. But there's kind of disconnect in the market where
Permian pipelines are selling for ridiculous prices. They're cashing in on that, then using that cash
to build new Permian pipelines for a really good rate of return. They're making
a really good trade there. Then, as these pipelines come online,
the cash flow will go up. That's already starting to happen this year. They're projecting 12%
growth next year. It's growing its cash flow stream at a time that their balance sheets
are getting better. That's going to free them up to start increasing their distribution,
probably next year. They're talking, with their May pay-out, they'll probably increase it.
They could do any number of things. They're going to be covering their pay-out by 190%
this year. It could go up substantially, or they could hold some back so that they can
build some of these projects. We mentioned the Exxon pipeline. Exxon's going
to help fund that. They've got another joint venture partner there. As they secure more
venture partners, it's less capital that they need to put up, and that's more potential
growth for the distribution. That's what I think is interesting about them. They're heading
into this period of growth. Their balance sheet's getting better. And, they're pretty cheap.
It's a really interesting company. Sciple: All these things seem to be lining up.
I think anybody can tell there's a massive shortage of pipelines in the Permian and there's
going to have to be investment there over time. What would have to occur to disrupt
this thesis for Plains All American and all the pipeline players supplying into the Permian?
What would have to occur for that direction -- it looks like we're moving when it comes
to pipeline demand there -- for that to be disrupted?
Dilallo: All this oil is flowing to the Gulf Coast, which is good because there are a lot
of refineries there, but there's only so much that the refiners can handle. Some of the
oil companies are concerned that the WTI brent spread -- WTI is West Texas Intermediate.
That's the domestic oil price. Brent is the global oil price. There's a $10 a barrel difference.
They're worried that's going to widen. Unless you have access to exports and can sell your oil at brent,
it's the same thing with producing in the Permian now, you're selling at a discount.
Unless companies start building more export capabilities or more refineries get built,
then we're going to be in the same trouble. At $10 a barrel, and the U.S. produces
10 million barrels a day, that's $100 million that they're potentially losing out with these
pipeline and infrastructure issues. One of the things Exxon's looking at doing
-- and that's why they're partnering with Planes -- is, they're looking at building
a new refinery or expanding a refinery. Exxon will have this cheap source of oil that they'll
be able to refine to make more money. You'll see these downstream investments, where companies
will look at, how can we make money on this discount? Are they going to build export terminals?
Are they going to build new refineries? That's where the focus needs to be. How are they
going to use this oil now that they're producing it?
Sciple: Sure. Maybe you answered my question then, of what people should watch if you're
going to start a position in Plains, or monitor it going forward. Is refinery capacity the
thing that you should be paying attention to? Like downstream? What are the things that
investors should focus on to make sure that growth story is still playing out?
Dilallo: That's part of it. The nice thing about a company like Plains is, they already
have long-term contracts with the pipelines that they have. They pretty much know where
that cash flow is coming from for the next couple of years. In this case, it's more of,
where's the growth coming after 2020? They're pretty confident that they're going to build
this pipeline with Exxon. There's another pipeline that they're looking at up in Oklahoma.
That'll move oil down south, as well. But, where's the growth coming next? They know
the Permian is going to keep growing and growing and growing. But if we're not going to be
able to get that oil to global markets, then the growth is going to stop, because it won't be
as profitable to produce. I would also pay attention what's going on downstream.
Look especially at export capacity. There are a lot of companies that are trying
to do that. Phillips 66 and its MLP, they're building some export capacity along the Gulf.
That would be something I'd pay attention to.
Sciple: Matt, last question going away. This is general market. If we come back and record
this podcast three years from now, do you think there will still be pipeline constraints in the Permian?
Dilallo: Probably not. It seems like they
might actually overbuild at this point, with the number of pipelines they're doing now.
Private equity companies are also involved in there. They'll build more on speculation
than a lot of the publicly-traded companies. I wouldn't be so worried about the Permian.
We might run into pipeline issues elsewhere. Or, like I mentioned, so much oil flowing
to the Gulf that they just can't handle it. Sciple: Awesome. Matt, great to have you on
as always. I'm sure this stuff is only going to continue to develop going forward.
We've seen the oil market just the past year, you never know what you're going to get.
We get all-time highs, then we're tracking down again. This has been a fun story to follow.
I look forward to having you on again to continue tracking it.
Dilallo: It makes my job fun. Sciple: Thanks so much, Matt!
Dilallo: Thank you! Sciple: As always, people on the program
may own companies discussed on the show, and The Motley Fool may have formal recommendations
for or against any of the stocks mentioned, so don't buy or sell anything based solely
on what you hear. Thanks to Austin Morgan for his work behind the glass. For Matt Dilallo,
I'm Nick Sciple, thanks for listening and Fool on!
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