Thanks to hydraulic fracturing and horizontal drilling, North American oil and gas production has been growing quickly during the last three years. The domestically produced natural gas is the new cheap fuel that will move the economy of North America on a going-forward basis, giving it a huge competitive advantage over the rest of the world.
However, the increasing oil production has caused oil bottlenecks, as the pipeline capacity and refinery demand is really what is moving price differentials for both WTI and WCS (Western Canadian Select). For instance, we need more pipelines to unclog Cushing, a major oil terminal in the Midwest. And relief is on the way; in its last bulletin, the U.S. Energy Information Administration summed up the Cushing bottleneck providing upcoming solutions. After all, the midstream companies benefit a lot from this situation, trying to keep up with the new standards of the oil and gas industry.
In this series, I analyze the small midstream companies. I determine as small midstream companies those with market cap of up to ~$5 billion. I call them the "Davids" of the sector. The first part is here, and the second part is here.
I suggest all the readers to read both parts to get a complete idea about the peers, along with my opinion about them. They can find some good short candidates in those two Parts as well.
Once I am done with these three groups (small, intermediate, major midstream firms), I'll unearth some unknown midstream companies, which are brand new entrants into the midstream sector, flying under the radar currently. This group of brand new entrants could hide the firms with the highest potential along with some acquisition targets. This is why I believe that these articles will be very interesting for the proactive investors.
Let The Numbers Speak For Themselves
Now that the annual reports are out, let's check out the key metrics of the following five small midstream companies:
EV: Enterprise Value
CF: Annual Cash Flow
EQ: Stockholder Equity
Spectra Energy Partners (SEP) looks to be the most attractive firm among the companies above. It combines a high operating margin with an average PE and an appealing annual yield. It is worth noting that the high operating margin in 2012 is not a blip because the company's operating margin was higher than 40% both in 2010 and in 2011.
On top of that, the debt metrics are decent and Spectra Energy Partners is not highly leveraged. I urge all to check out the debt metrics of the peers analyzed at the first and the second Part of this series, to see the obvious difference. From a technical perspective, the stock has risen a bit lately after a very long consolidation period that lasted three years when it was hovering from ~$30 to $35.
Conversely, Targa Resources (TRGP) has the worst balance sheet among the companies above. The low operating margin and the high debt make me steer clear of this company. Additionally, the low annual yield is not alluring even to those income seekers who ignore the dismal fundamentals. Despite these overly poor fundamentals, the stock trades with a very rich premium currently, as both PE and PBV are extremely high. To me, Targa Resources tops my list with the good short candidates from the small midstream sector.
TC PipeLines (TCP) has decent key metrics overall. The eye-catching operating margin has been hovering at these levels since 2010, and the debt ratios are still under control. The annual yield is attractive, too. From a technical perspective, the stock has not moved significantly during the last two years, but it ranges from $40 to ~$55. The thing is that the outlook for one of the company's core projects worsened lately, as mentioned in the next paragraph that discusses the potential upside drivers. After all, I will be cautious and I do not endorse a long position in this company currently.
I am cautious about TC Pipelines and I am skeptical for PAA Natural Gas Storage's (PNG) future stock price appreciation. Both the operating margin and the annual yield are satisfactory. PAA's debt ratios are also below alarming levels, but a good premium has already been priced into the company's current valuation.
I have to point out that the fiscal year of Niska Gas Storage Partners (NKA) ends in March, and only two quarters have been released thus far. After all, some of the company's metrics are subject to change when the annual report for FY 2013 is out. These questionable metrics are shown with (*).
For instance, I intentionally assume that the annual cash flow will be ~$90 million for FY 2013, which is very optimistic because the company had annual cash flows of $8 million in FY 2012, and $53 million in FY 2011. I choose this scenario with the hope that the CF improvement during the last three quarters can continue with the same pace. Apparently, this is not easy.
Even under my best case CF scenario, Niska is a mediocre case and it does not have attractive metrics currently. The company is not consistently profitable, and the high long-term debt remains a concern despite the meaty annual yield.
Potential Upside Drivers
To give all a more complete idea for the aforementioned companies, I will also provide the most significant growth catalysts for each one of them, on a going-forward basis:
1) TC Pipelines has not initiated any major project during the last 15 months. In September 2012, the company announced that its subsidiary Northern Border Pipeline, filed with the Federal Energy Regulatory Commission a settlement with its customers to modify its transportation rates beginning in January 2013. The settlement establishes maximum long-term transportation rates and charges on the Northern Border system. Commencing in January 2013, Northern Border's rates will be reduced compared to current rates by approximately 11%. The settlement includes a three-year moratorium on filing rate cases or challenging the settlement rates, and requires that Northern Border file for new rates no later than January 1, 2018. There were no other major changes to Northern Border's services as a result of the settlement. Northern Border is a general partnership owned 50% by TC PipeLines, LP and 50% by ONEOK Partners, LP (OKS).
2) In June 2012, Niska Gas Storage Partners placed the expansion of Wild Goose facility (15 Bcf) into service which added an additional 15 Bcf of storage capacity at the company's Wild Goose facility in California.
3) PAA Natural Gas Storage has not initiated any major project during the last 15 months.
4) Targa Resources owns a 2% general partner interest (which the company holds through its 100% ownership interest in the general partner of the Partnership), all of the outstanding incentive distribution rights and a portion of the outstanding limited partner interests in Targa Resources Partners LP (NGLS). After all, the growth projects of Targa Resources Partners impact also the operations of Targa Resources.
The Partnership has recently approved two new projects with estimated incremental growth capital of $450 million. The first project is a new 200 MMcf/d cryogenic processing plant to meet increasing production and continued producer activity on the eastern side of the Permian Basin. The new processing plant is expected to be operational in mid-2014. The second project is the expansion of the company's LPG Export Project to increase export capability to approximately 5+ million barrels per month. The original export project scope adds the capability to load four very large gas carrier cargoes of international grade propane per month starting in Q3 2013. The expanded project scope will increase that capability by an additional two to four cargoes starting in Q3 2014.
In January 2013, Targa Resources Partners LP acquired additional property on the Houston Ship Channel ("Targa Patriot Marine Terminal") that provides expansion potential for both its Petroleum Logistics clean fuels business and its propane/butane export capabilities. The initial investment including acquisition of the property and dock upgrade and refurbishment is $25 million.
5) In late 2012, Spectra Energy Partners acquired a 38.76% interest in Maritimes & Northeast Pipeline LLC which owns a natural gas transportation system from the border of Canada near Baileyville, Maine, to northeastern Massachusetts and has market delivery capability of 0.8 Bcf/day of natural gas.
In early 2103, Spectra also expanded its agreement with Eastman Chemical Company to provide an additional 86 Mmcf/d of firm transportation capacity for 25 years to Eastman's Kingsport, Tennessee, facility. Coupled with Eastman's current contracts, East Tennessee Natural Gas pipeline will provide 121 Mmcf/d of firm capacity to the Kingsport facility when the projects are completed. The first project, for service of 25 Mmcf/d, is expected to begin in November 2013.
There is one more part coming to cover all the remaining small midstream players of North America, including the Canadian ones. Once I provide the data and the potential upside catalysts for all the small midstream players, I'll express my opinion overall about the undervalued and the overvalued ones, along with a capital allocation strategy.
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.