Friday, July 3, 2020

US Pipeline Companies: Part #2

Williams Companies

Their business: Mostly Natural gas, they break down their segments by geographic region:
  • West: Gas gathering, processing and treating in several Western US shale oil fields.  27% of 2019 EBIDTA.
  • Northeast G&P: Gas gathering, processing and fractionalising in the Appalachians.  30% of 2019 EBIDTA.
  • Transmission and GOM: Transport along their Transco pipeline, with a little gas/oil gathering in GOM.  42% of 2019 EBIDTA.
Transco is irreplaceable - more than one fifth of US natural gas consumption flows through it.  for Northeast G&P, Morningstar estimates that Williams collects about a third of overall gas volumes across the Appalachian region.  Their other assets are more exposed to market forces, especially declining crude.

West could be badly affected by crude oil shut-ins, as 30-40% of US natural gas production is associated with crude oil (the gas is an unwanted by product).  Northeast G&P would not be affected  and may even benefit if gas prices rise due to a falls in associated gas.  Transco would likewise be unaffected or benefit.  I believe more than half of GOM's natural gas production is associated with oil wells, so they may be hit too.

Leverage: 2019 debt was 5.4 times EBIDTA.  Very high.  They aim to reduce it to 4.2 times.

For operating leverage, 2019 CFO was 40% of revenue (excluding product sales).  ie: Service revenue would have to fall by this much before they start losing cash.

Valuation: Trading at a 7% trailing yield, with CFO at 1.8 times their dividend.

Growth: Still growing.  Capex in 2018 was 4.2bn, 2019 was 2.4bn, 2020 is expected to be 1.5bn.  For comparison, 2019's CFO was 3.6bn.  They have not announced further cutbacks to 2020 capex.

Near term they have earmarked 3.2bn:

Longer term they have other opportunities:

Management recently said they expect to have "positive free cashflow" from now.  Specifically: without any asset sales, their operating cashflows should support both their capex and dividends.

Long term or political risks: Don't see any.  Natural gas is environmentally clean and has low carbon emissions.  Oh wait...all fossil fuels are bad - one of their proposed pipelines was just killed by NY.

Worst case scenario:  Again, lets say US crude production halves. I'm going to assume that all gas production in their 'West' segment is associated with oil (1) (2).  So if gas production halves, revenue halves, and the company's CFO drops by 900m or 25%, to 2.8bn.  After the projected capex, they would have to cut their 2020 dividends to ~ $1.05,

Kinder Morgan

Their business: Mostly Natural gas:
  • Natural Gas: interstate and intrastate natural gas pipeline and storage systems, gathering, NGL fractionation, and LNG liquefaction & storage.  57% of EBDA.
  • Refined Pipelines: pipelines that deliver refined product, and some crude.  Including some terminals and mixing facilities.  15% of EBDA.
  • Terminals: Terminals, and Jones-Act qualified tankers.  18% of EBDA.
  • CO2: produces, transports and sells CO2, used for crude oil production.  8% of EBDA
KMI owns the Tennessee gas pipeline, one of three large interstate pipelines supplying Eastern US natural gas.  The company says that 40% of US gas passes through its pipelines.  They would be considered irreplaceable,

CO2 would be badly affected by crude oil demand, while natural gas gathering would be affected by oil production.  Refined pipelines would be affected by covid.

Leverage: 2019 debt was 4.8 times EBIDTA.  Pretty high.

For operating leverage, 2019 CFO was 60% of revenue (excluding product sales).  ie: Service revenue would have to fall by that much before they start losing cash.

Valuation: Trading at a 7% trailing yield, with 2019 CFO at 2.2 times their 2019 dividend.  It would cover the newly raised dividend ($1.05/year) by 2 times.

Growth: Still growing.  They announced they were reducing 2020 capex from around ~3bn to 2.2bn.  For comparison, 2019's CFO was 5bn.

Their new projects before the announced reduction are here (slide 13).  The reduction was probably in CO2:

Long term or political risks: The usual ESG stuff.

Worst case scenario:  Again, lets pessimistically say US crude production halves.  And KMI gets corresponding reductions in revenue as customers go broke.

For Natural Gas, how much would be affected by the halving crude production?  They say that gathering and processing was only 10% of EBDA (slide 21):

I can't relate this to revenues, but assume it cashflows from this fall to zero, as revenue is halved.    Thats an 800m reduction in earnings/cashflows.

For CO2, its easier - halving 2019 revenue subtracts 600m from earnings/cashflows.

So total, we lose 1.4bn from cashflows, which is now 3.6bn.

This gives us enough to cover the 2.2bn capex, but not enough to cover the 2.4bn in dividends - the $1.05 dividend would have to be cut to 60c to be cashflow neutral in 2020.

Lets also say that their refined revenue halves over 2020, due to covid.  This is realistic - not pessimistic - but its only temporary.  KMI's refined revenue also halves, as refined fees are usually volume based.  That removes 900m from their Products revenue, they will still have 500m they could use for dividends, or around 20c per share.


I like Williams and KMI the best, as natural gas is not affected by covid, and is only partially affected by crude.

Although both have high leverage, I can't see any way either company fails.  The dividend is comfortably covered under normal conditions.  And both have growth potential.

KMI has slightly more short-term downside due to more refined exposure.

In general, these types of businesses are predictable and profitable.  Its the black swan risks to watch our for (like Deepwater Horizon).  Or the political ones (Green New Deal).

Wednesday, July 1, 2020

US Pipeline Companies: Part #1

US pipeline companies are trading at 8-10% yields.  When stocks trade at that valuation, usually it means theres something wrong with them.  But these are exceptional times.  Lets take a quick look.

All of these companies own pipelines, with most revenue from long term take-or-pay contracts that don't depend on volume.  Their revenues should hold up - unless their customers go bankrupt, which is what the market is concerned with.

I'm trying to see how badly their businesses may be affected by the plunge in crude prices.  The crude market looks terrible now, I expect US crude production to drop in a seesaw pattern for 1-2 years, then grow.

Magellan Midstream

Their business: 62% of 2019 profits are from Refined Products (pipelines from Texas/GOM, up to Wisconsin/North Dakota/Wyoming), 38% from crude (pipelines covering Permian and GOM).

Their Refined business is large enough to be irreplaceable: they provide more than 40% of refined product in 7 of the 15 states they serve, and can access nearly half of nationwide refining capacity.

Refined usage has taken a beating due to covid.  I expect it to get worse for the year - the previous outbreak hit New York, the next outbreaks will equally spread in rural/red states. Probably get a recovery in 12-18 months, as the US situation changes from lockdowns into a normal recession.  For now, refined product demand has bounced a little after falling off a cliff:

Source: Macrovoices #122 Art Brennan, slide deck

Leverage: 2019 debt was 3.1 times EBIDTA.  Pretty low.

For operating leverage, operating expenses (excluding D&A, including interest and G&A) were about half 2019 transport/terminals revenue.  ie: revenue would have to fall by half before they start bleeding cash.

Growth: Limited.  They are paying out most of their cashflows as dividends.

Valuation: Trading at a 9+ percent trailing yield, estimated payout ratio 90-100%.

Long term or political risks: Gradual decrease in fossil fuel usage, replaced with electric cars/trucks/planes.

Worst case scenario: Lets say US crude production halves, and Magellan's crude revenues (620m in 2019) halve with it (half their customers go bankrupt).  Rough guess, this removes 300m from their profits, reducing the CFO by the same amount, and dividends by 1/3rd (slide 10).   So even if you think US crude production is permanently and badly impaired - which I don't - the dividend is still 6%.

Long term, I don't see Refined dropping.  They are under long term take-or-pay contracts.  The problem is if their customers go bankrupt during the lockdown period.  I estimate lockdowns will be on/off in different states for another 18 months.

I can't see any risk to this company's long term prospects, and I think their cashflows/dividends may take a temporary hit before going back to 2019 levels.  Short term, if their dividends drop, so does the share price.  Long term, its a cyclical play where you're paid to wait.  The only downside is limited growth.


Their business: 2019 EBIDTA breakdown:
  • Liquids Pipelines.  A series of pipelines transferring crude through Canada to the US.  Also covers most US shale basins, handling 25% of all US crude.  Tolls on the Canadian Mainline are based on volume (pp14-15), tolls on the US interstate pipelines are long term take-or-pay.  56% of 2019 EBITDA.
  • Gas Transmission and Midstream.  Long continent-spanning pipelines transferring gas from Canada to the Vancouver/US, and from US producing fields (especially the Marcellus) to consuming states.  Take-or-pay.  25% of 2019 EBITDA.
  • Gas Distribution and Storage.  A regulated utility consisting of last mile distribution of gas to Canadian households.  Also an unregulated storage business.  13% of 2019 EBITDA.
  • Others.  7% of 2019 EBITDA.
They are heavily exposed to crude oil volume:
  • Its 56% of EBITDA.  
  • Canadian Mainline pricing is volume based, so lower volumes will be felt immediately. Morningstar estimates that Mainline accounts for 30% of EBITDA.
  • It will have new competitors: TCE's new Keystone Phase 4 is expected to be operating in 2023 (unless Trump loses) and will compete with them.  Same with the Trans Mountain pipeline.
  • Meanwhile, Canadian crude output has fallen due to low prices.  Canadian crude usually trades at a large discount to WTI, because it is landlocked, and must go to the US for refining.
  • Canada's crude production is also energy intensive (like using steam to melt bitumen), so have high fixed costs, despite unlimited reserves.
  • So I think Canadian crude producers are marginal producers.  They may do very badly during this crude crisis.
Enbridge's US interstate gas pipelines (TETCO) distributes gas from the Marcellus down to the Southern US, and is irreplaceable. It would also be unaffected by crude.

So we have 30% of EBIDTA serving marginal (ie: Canadian) producers on volume contracts, in a market crunch, with long term competition coming up.  And another 26% on the US side under take-or-pay (where we would only be worried about customer bankruptcies).  With the 38% of EBIDTA being stable.

I don't see this as a dividend stock, but more cyclical, levered to WTI (actually to the WTI and WCS differential).  If I want to play an oil price recovery, its probably better to buy Enbridge's customers (CNQ & Suncor).  Right now I'm looking for steady dividend stocks.

Enterprise Products

Their business: Their business segments by 2019 Gross Operating Margin (similar to EBITDA - p83) is 49% NGLs, 25% crude, 13% Natural Gas, 13% petrochemical & refined.

What are NGLs?  Natural Gas Liquids extracted from natural gas at the wellhead.  Different NGLs have different uses, in industrial, heating and transportation:

Source: EIA

In general, the 'wetter' the gas, the more NGL's it has.  So dry gas (from the Marcellus) has less NGLs than associated gas (from shale oil):

Source: IHRDC training course: Gas Processing and Fractionation.

EPP's NLG pipeline covers most shale (oil and gas) in the west and south US:

Source: EPP System Map

EPP's NGL processing revenue is currently mostly fee based (top of p5)... ie: based on volume, with contracts lasting one to ten years.  Their NGL pipeline revenue is also volume based (p7).  Their NGL fractionation revenue is a mix of volume, and commodity prices (bottom p11).

Given these, their EPP's NGL earnings are dependent on crude prices.  First, as associated gas production falls, NGL production falls with it, affecting their volume based payments.  Second, associated gas has more NGLs than dry gas.  The effect on falling crude on NGL supply/demand is very complex.

Lets look at crude (13% of Gross Operating Margin).  Their crude pipelines cover the Permian, Eagle Ford, Haynessville and GOM, with pipes running to Cushing.

I'm guessing that most of their crude is from shale, and will decrease as prices drop.  Their crude pipeline profits are volume-based (bottom p15).  So dependent on crude oil prices.

Their Natural Gas assets (13% of Gross Operating Margin) seem to be around shale oil fields (except for GOM):

And profits are volume-based (bottom p20), so this is again dependent on crude prices.

For Petrochemical and Refined (13% of Gross Operating Margin), they do not say specifically, but I guess they are dependent on the economy.

I like EPP's long term track record, but all their business segments could be exposed to falling crude production.  I can't estimate how much.  Too risky now.  I may look at them later as a cyclical play if they are hit by falling crude production.