The growing oil and gas production due to horizontal drilling and hydraulic fracturing (fracking) has resulted in an increasing need for the expansion of the outdated North American pipeline network, which can not accommodate the new volumes any more. Apparently, the pipeline operators belong to the primary beneficiaries of this booming production, and their stocks have risen significantly during the last 6 months. However, the investors have to bear in mind that this rise can not continue if the fundamentals are absent. This time will not be different, and this is not a never ending euphoria.
The careful examination of the key metrics of the balance sheet combined with the growth catalysts for each case separately is necessary for all those who aspire to beat the index and do not want to be caught unaware.
I determine as intermediate pipeline companies those companies with market cap from ~$5 billion up to ~$15 billion currently. This series discusses the intermediate players of the sector, and here is the first Part that captured five of them. This is the second Part, and the third Part will be the last one. The major and the small players will follow later.
Once I am done with these three groups (small, intermediate, major players), I'll unearth some additional pipeline companies, which are brand new entrants into the sector, flying under the radar currently. This group of brand new entrants could hide the pipeline companies with the highest potential and/or some acquisition targets. We will see soon.
Let The Numbers Speak For Themselves
Now that the annual reports are out, let's check the key metrics of the following five intermediate pipeline companies:
EV: Enterprise Value
CF: Annual Cash Flow
EQ: Stockholder Equity
Excluding Magellan Midstream Partners (MMP), all the other four companies have very low operating margins; this does not bode well for their futures. Most of their revenue are also fixed-fee, limiting a quick margin improvement and making these firms work harder on the spending side. However, Magellan is not attractively priced currently, because its compelling operating margin is largely offset by the fact that all its other key metrics are higher than average.
Targa Resources (NGLS) and Regency Energy (RGP) have not only very low operating margins but also high PE. Additionally, Regency has a disappointing cash flow in comparison to its debt, and this should be another concern for any prudent investor. After all, Regency's alluring dividend yield is tricky, and it does not mean anything substantial to me.
The enticing dividend yield looks like a trap for NuStar Energy (NS) too. The company has to improve its annual cash flow, and return back to consistent profitability in 2013. Eventually, NuStar is a "Show Me" case. Sunoco Logistics Partners (SXL) has decent key metrics overall, but it has to improve its dismal operating margin. With such low margin, the company can turn into losses easily if something goes wrong.
Potential Upside Drivers
To give all a more complete idea for the aforementioned companies, I will also provide the major growth catalysts for each one of them, on a going forward basis.
Magellan Midstream is currently working on a major Permian pipeline project, the Longhorn reversal (135,000 bbl/d). The Longhorn Pipeline, originally carried refined products from Houston to El Paso. The new project will reverse the direction of Longhorn's flow, such that it flows from El Paso to Houston. The reversal is expected to be completed by Q2 2013 and more details about it are provided here.
Additionally, Magellan participates in the BridgeTex pipeline (280,000 bbl/d) from Colorado City to Houston. If the project progresses as planned, it should be operational by the middle of 2014. In February 2013, Magellan also acquired 800 miles of refined petroleum products pipeline from Plains All American Pipeline, L.P. (PAA) for $190 million.
NuStar Energy acquired recently TexStar's crude pipeline assets in the Eagle Ford region. The acquisition included a crude pipeline system (100,000 bbl/d) that spans from LaSalle County and Frio County to Live Oak County. NuStar also acquired a 38-mile Y-grade NGL pipeline that runs from Pettus to Refugio, Texas and two fractionators that have a combined capacity of 57,000 BPD.
Targa's major growth initiative was the recent acquisition of Saddle Butte Pipeline, LLC. Targa Resources Partners acquired Williston Basin crude oil pipelines, a terminal system and natural gas gathering and processing operations.
Saddle Butte's business includes 155 miles of crude oil pipelines and 95 miles of natural gas gathering pipelines. Moreover, the acquired business has combined crude oil operational storage capacity of 70,000 barrels, and includes a 20 MMcf/d natural gas processing plant with an expansion underway to increase capacity to 40 MMcf/d.
Sunoco is constructing two pipeline expansions from Western Texas. The first project expands by 30,000 bopd the West Texas Gulf pipeline that currently runs from Colorado City to Wortham, TX then East to Longview, TX. The second project reverses an existing crude pipeline that currently runs from Nederland to Wortham and expands it by 40,000 bopd. Both lines will be in service at the end of Q1 2013.
Another Sunoco's project is the Permian Express Pipeline. The first phase entailed reversing an existing pipeline, which runs from Wichita Falls south to Wortham, and then continues south on a pipeline to the coastal city of Nederland. It is expected to start up by Q2 2013 with an initial capacity of 90,000 bbl/d, which will be expandable to 150,000 bbl/d later in the year. Phase II of the Permian Express will entail an additional expansion of the West Texas Gulf Pipeline, which is expected to add 200,000 bbl/d of capacity form Colorado City to Nederland. Phase II should be up and running by Q2 2014.
Regency Energy Partners expanded recently in the Permian Basin by acquiring Southern Union Gathering Company, LLC. The transaction includes the purchase of a 5,600-mile gathering system and 500 MMcf/d of processing and treating facilities in west Texas and New Mexico for natural gas and natural gas liquids. In addition, the acquired company is currently finishing construction of the 200 MMcf/d Red Bluff processing plant, and an additional 200 MMcf/d cryogenic processing facility is expected to be in service by the end of 2014.
In December 2012, the company also completed the Lone Star Gateway NGL pipeline (209,000 bbl/d capacity) which provides the much-needed capacity from Permian and Delaware Basins to Mont Belvieu, Texas.
Once I provide the data and the potential upside catalysts for all the intermediate players, I ll express my opinion about the undervalued and the overvalued ones along with a capital allocation strategy at the end of Part III.
Disclaimer: Data, facts and premises were determined through review of public documents, SEC filings, news releases, and transcripts. The conclusions are my own. Readers may come to different conclusions using the same information. This analysis is not intended to offer investment advice to buy or sell specific stocks.