Spotting The Undervalued And The Overvalued Small Midstream Companies (Part IV)

by: Value Digger


The booming shale oil and gas production in North America has impacted big the local economy. The natural gas is not expensive any more, and the oil production has started to rise again after almost 40 years of steady decline. The rising oil production has created a shortfall of oil pipeline takeaway capacity, resulting in significant bottlenecks primarily in Cushing, Oklahoma and in the Williston Basin of North Dakota.

The majority of the midstream companies have been investing heavily in new projects during the two, three years, trying to keep up with the increasing oil supply. However, all fingers are not equal and all the midstream companies are not the same. There are always the undervalued and the overvalued ones, giving the investors the opportunity to make money both on the long and on the short side.

This is the last Part of this series that analyzes the small midstream companies. I determine as small midstream companies those with market cap of up to ~$5 billion. The first three Parts are here, here and here.

I suggest all the readers review all these three Parts to get a complete idea about the peers, along with my opinion about them. They can find some good short candidates in those three Parts as well.

A few days ago, I also analyzed all the intermediate and the major midstream companies. The conclusions from the intermediate and the major midstream players are here and here.

Spectra Energy (NYSE:SE) was not included in my two articles about the major midstream players due to mere oversight. There are 60 midstream companies in my list, and obviously, such mistakes can happen. This is why I added Spectra Energy in this Part.

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 and are 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 companies:




















































EV: Enterprise Value

CF: Annual Cash Flow

EQ: Stockholder Equity

Gibson Energy (OTC:GBNXF) entered the public markets in early 2012, and most investors likely ignore this firm. Gibson would be very attractive for me, if its operating margin was not extremely low. I do not like companies with marginal or low operating margins. If something goes wrong, the company will start losing money, and it may be tough for the management team to turn things around promptly.

Keyera Corporation (OTC:KEYUF) suffers from the same problem like Gibson, the extremely low operating margin. However, Keyera is much more leveraged than Gibson, and eventually this deters me from establishing a long position on this company.

Holly Energy Partners (NYSE:HEP) has an envious operating margin, which is not a blip, as it remains at these levels for three years now. The reason is that the company has 100% fee-based revenues, and it has zero exposure to commodity risk. However, its debt metrics are ugly. Moreover, Holly Energy has an inflated valuation, and the company trades at a significant premium currently. After all, this mix of ratios is not my cup of tea.

I will also steer clear of Eagle Rock Energy Partners (NASDAQ:EROC) whose balance sheet has several ominous signs. The company has been losing money for several quarters now. The operating margin is also deeply negative, and this does not bode well for the company's financial health. The debt metrics are not low either. After all, the high annual yield does not mean anything to me.

Spectra Energy does not carry a premium valuation currently. Its metrics look decent in comparison to the other major midstream players. Spectra has kept a very attractive operating margin for three years now, proving the consistency of its business. The debt metrics are not low, but they are still controllable. Considering the valuation of the other major midstream players, Spectra is a good place currently for a mid-term investment.

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) Last summer, Holly Energy Partners acquired HollyFrontier's (NYSE:HFC) 75% interest in UNEV Pipeline, LLC for $315 million. UNEV is the owner of an approximate 400 mile, 12-inch refined products pipeline currently running from Woods Cross, Utah to Las Vegas, Nevada, related products terminals near Cedar City, Utah and Las Vegas, Nevada and other related assets.

In late 2012, Holly Energy Partners engaged URS Corporation (NYSE:URS) to perform preliminary engineering, routing and cost estimates for two proposed new pipelines. The company anticipates that it will be in a position to decide whether to proceed with these projects in Q2 2013 when preliminary engineering and detailed project cost estimates are completed, and if necessary, shipper commitments can be secured.

A few weeks ago, Holly Energy Partners announced that it is proceeding with the expansion of its crude oil transportation system in southeastern New Mexico in response to increased crude oil production in the area. Holly Energy Partners estimates the project will provide increased capacity of up to 100,000 bbl/d across its system, and anticipates it will be in service no later than early 2014.

2) Firstly, I have to point out that Eagle Rock Energy Partners is not a pure midstream company, but it owns an upstream segment too. The company has productive wells and proved reserves in Oklahoma, Texas, Arkansas and Alabama. However, the midstream segment is a significant part of its business, and this is why Eagle Rock Energy Partners is included in this series.

In August 2012, Eagle Rock Energy Partners acquired BP's (NYSE:BP) Sunray and Hemphill processing plants and associated 2,500 mile gathering system serving the liquids-rich Texas Panhandle for $227.5 million in cash. BP's Panhandle System gathering volumes in the first half of 2012 averaged approximately 180 MMcf/d, and the Partnership expects to continue to grow the overall throughput from the Texas Panhandle area based on the drilling programs from BP and third party producers active in the area.

In October 2012, Eagle Rock Energy Partners entered into an amendment to its existing agreement with Anadarko (NYSE:APC) to support Anadarko's drilling program in western Louisiana. As part of the amendment, Anadarko will dedicate to the Partnership more than 800,000 additional acres located in Louisiana under a long-term dedication. This is in addition to the 1.1 million acres already subject to the agreement.

Few weeks ago, the company entered into a new fee-based agreement with Apache Corporation (NYSE:APA) to support Apache's active drilling program in the Texas Panhandle. As part of the agreement, Apache has dedicated to the Partnership all existing and future wells drilled within an area encompassing more than 106,000 gross acres located in Texas.

The associated Apache production will be gathered and processed at one or more of the Partnership's cryogenic processing plants in the Texas Panhandle. Eagle Rock's Texas Panhandle assets consist of approximately 6,500 miles of gathering pipeline and over 480 MMcf/d of high-efficiency processing capacity, with an additional 60 MMcf/d of processing capacity expected to come on-line in Q2 2013 following the completion of Eagle Rock's previously announced Wheeler Plant.

3) Last summer, Keyera announced the beginning of the construction of the Keyera South Cheecham Rail and Truck Terminal, a multi-purpose hydrocarbon rail and truck terminal, designed to support bitumen producers within the Athabasca oil sands area. Keyera also entered into a minimum four-year fee-for-service agreement with Statoil (NYSE:STO), which was sufficient to underpin the construction of the first phase of the Terminal. Keyera will begin receiving revenue under the Statoil agreement upon start-up of the Terminal in 2013.

Few days ago, Keyera announced two initiatives to extend the capture area and to provide customers with enhanced processing capability at its Simonette gas plant. The first initiative is the construction of a sour gas gathering pipeline, which will be called the Wapiti pipeline, from the Wapiti region of northwest Alberta to Simonette. The second initiative involves modifications to Simonette to increase plant capacity and handle the growing quantities of NGLs and condensate being produced in the area. The capital cost of these initiatives is expected to be approximately $210 million .

4) Gibson Energy is not a pure midstream company but it has a downstream segment too. Actually, Gibson is engaged with: truck transportation, terminals & pipelines, processing and wellsite fluids, propane distribution, blending and marketing of crude oil, NGLs and refined products. However, the midstream segment contributes a significant portion of the company's revenue and earnings, and this is why Gibson is included into this series.

In late 2012, Gibson acquired OMNI, a privately held US-based provider of environmental and production services to the oil and gas industry. OMNI has a position in most major oil and liquids focused areas in the United States (including, but not limited to, the U.S. Bakken, Granite Wash, Eagle Ford, Tuscaloosa Marine, Mississippi Lime and the Gulf of Mexico) with a focus on environmental and production-related activities.

In September 2012, Gibson announced two expansion opportunities at its Hardisty Terminal near Hardisty, Alberta. The company received sufficient, long-term, committed customer support to begin construction of two 400,000 bbl oil storage tanks for an aggregate addition of 800,000 bbls of storage. Located immediately adjacent on the East boundary of the existing Gibson's Hardisty Terminal, the two tanks will form the initial anchor for an expansion of the facility. Site preparation for the two 400,000 bbl tanks started in Q4 2012, and commissioning is expected to occur in early 2014.

5) In September 2012, DTE Energy (NYSE:DTE), Enbridge (NYSE:ENB) and Spectra Energy announced the execution of a Memorandum of Understanding to jointly develop the NEXUS Gas Transmission system, a project that will move growing supplies of Ohio Utica shale gas to markets in the U.S. Midwest, including Ohio and Michigan, and Ontario, Canada. The project is planned to be in-service in November 2015.

In September 2012, Spectra Energy signed a Project Development Agreement with BG Group to jointly develop plans for a new natural gas transportation system to serve BG Group's potential liquefied natural gas export facility in Prince Rupert in British Columbia. Spectra Energy and BG Group will each initially own a 50% interest in the proposed transportation project. The 850-kilometre natural gas transportation system will begin in northeast British Columbia and end at BG Group's potential LNG export facility in Prince Rupert. The new transportation system will be capable of transporting up to 4.2 Bcfe/d of natural gas.

In November 2012, Spectra Energy closed the acquisition of a 33% interest in the Sand Hills and Southern Hills pipelines. Spectra Energy, Phillips 66, and DCP Midstream LLC each own a 33% interest in the two pipelines, and will equally fund the remaining capital expenditures through completion. The aggregate investment by Spectra Energy in the two pipeline projects is expected to be approximately $700-800 million.

Few days ago, Spectra closed the acquisition of the Express-Platte Pipeline System, purchasing 100% interest in the 1,717-mile, crude oil system for $1.49 billion. The Express-Platte Pipeline System, which begins in Hardisty, Alberta, and terminates in Wood River, Illinois, includes the Express and Platte crude oil pipelines. The Express pipeline carries crude oil to refining markets in the Rocky Mountain states. The pipeline's capacity is 280,000 bbl/d. The Platte pipeline, which interconnects with the Express pipeline in Casper, Wyoming, transports crude oil predominantly from the Bakken and Western Canada to refiners in the Midwest. Platte's capacity ranges from 164,000 bbl/d in Wyoming to 145,000 bbl/d in Illinois. The Express-Platte System is one of just three major pipelines moving crude oil from Western Canada to the U.S. The system also serves the Bakken and Niobrara shale oil plays.

Bargain Hunting And The Black Sheep

In my previous articles, I explained why the major midstream players are not a good buying opportunity at the current levels. Some of them look good technically, but I am not a momentum trader. I never chase prices or force any investment. I always wait for the right moment dictated by either price or market condition to pounce. After analyzing 45 midstream players (small, intermediate, major), I will allocate my capital as below:

1) I put only Enbridge Energy Partners (NYSE:EEP), Spectra Energy Partners (NYSE:SEP) and Spectra Energy on the bullish camp although picking only 3 out of 45 companies likely sounds strict to many readers. However, I feel quite responsible for my publicly available stock picks, and I always try to eliminate the potential risk by rejecting fundamentally weak or overvalued companies. Actually, I have already recommended Enbridge Energy Partners below $28, and the stock is higher than $30 today. I will add Spectra Energy Partners and Spectra Energy in my buying list.

2) In the meantime, there are some good short candidates. To me, prime short candidates are: Targa Resources (NYSE:TRGP), Tesoro Logistics (NYSE:TLLP), Crosstex Energy (XTXI), SemGroup Corporation (NYSE:SEMG) and Atlas Energy (NYSE:ATLS).

I am also bearish for Energy Transfer Equity (NYSE:ETE), Plains All American Pipeline (NYSE:PAA), Williams Companies (NYSE:WMB), ONEOK (NYSE:OKE) and Targa Resources Partners (NYSE:NGLS).

Apart from piling up long-term debt, the majority of the midstream companies have also been in a placement spree during the last 6 months by constantly diluting their equity base through the issuance of stock. The potential buyers need to bear in mind that the dilutive equity offerings are going to continue, especially for the stocks that fly at their highs.

Bottom Line

I would like to ensure the readers that my winning calls both bearish and bullish, will continue coming. Stocks are not birds to be bought when they fly high. This is one of my investing principles that has saved me a lot of money during the last 25 years. I prefer the bottom fishing bets instead, when they are also supported by good fundamentals.

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.

Disclosure: I am long EEP. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.