Investing

Why Investing In Plains All American Pipeline Is A Sensible Option – Plains All American Pipeline, L.P. (NYSE:PAA)

Plains All American Pipeline’s (NYSE:PAA) 8.3% yield is pretty safe. While the stock may experience volatility in the near term, its long-term prospects are bright. This is because the company, as well as the sector, has learnt how to operate successfully in a lower-for-longer oil price environment.

Source: PAA’s investor presentation

As an example, look at the improved drilling productivity. Continued improvements in drilling technology have resulted in up to two-fold improvement in drilling efficiency, as measured by horizontal completions per rig. Similarly, horizontal well productivity too has improved significantly with as much as three-fold improvement in performance. The above graphs highlight the improvements in drilling efficiencies and productivity in the past six years. Such improvements have driven oil production growth – benefiting midstream companies – despite low prices.

Permian Basin has experienced the largest increase in well productivity. The break-even oil prices in the Permian Basin have dropped from $52-65/barrel to $35-45/barrel in the last few quarters. This makes midstream projects feasible in spite of the oil prices trading around $45 per barrel.

At the same time, increase in domestic oil production has boosted the US oil exports. According to a U.S. Energy Information Administration (EIA) report, US crude oil exports have more than doubled in the past six years with a record high monthly average of 1.1 million barrels per day in February 2017.

Source: EIA

The graph above shows the rapid growth in exports of crude oil and other refined products since 2010. After the lifting of the export ban in 2016, energy companies explored the international market demand for improved profitability in a challenging oil price environment. The biggest beneficiaries of the exports boom are the midstream energy companies, including Plains All American, which has well-connected network of assets and potential to capitalize the market trends.

Permian Basin Presence

Plains All American Pipeline is further expanding its footprint across the resilient Permian and Delaware basins. The company has invested more than $4 billion in the Permian Basin in the past five years. It expects a 30% crude oil production growth in 2017 in the Permian Basin.

Source: PAA’s investor presentation

Capital projects and recent acquisitions position Plains All American well to benefit from increased production, even at the current oil prices, as the below slide illustrates:

Source: PAA’s investor presentation

PAA is trading at 8%+ yield

What makes Plains All American more attractive is its yield despite a 29% distribution cut in 2016. It targets a coverage ratio of nearly 1.15x in the long term. It expects to cover distributions fully for 2017, as the below graph shows:

Source: PAA’s investor presentation

The company remains focused on bringing its long-term debt to EBITDA level in the 3.5x to 4.0x range. Plains All American’s leverage increased primarily due to its capital investments, which proved to be ill-timed in retrospect.

Source: PAA’s investor presentation

However, the company remains committed to achieve its targeted leverage levels. I believe this will be achieved as it gets returns from its capital projects and succeeds in better utilization of its existing assets.

Stock Price

In the end, Plains All American’s stock price is driven largely by crude oil prices, given its crude focus. The company’s correlation with oil prices has increased more after the epic fall in prices since mid-2014. This is evident from the chart below, which compares PAA with the United States Oil ETF (NYSEARCA:USO) over a one-year period:

Source: Yahoo Finance

Plains All American with a proven track record is trading cheap currently. Energy sector’s undervaluation is partly justified by the uncertainty over when, and not if, the global oil supply glut will see a meaningful decline. Till that time, capital gains may not be easy to come. I would definitely prefer an 8+% yield in the meantime.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.

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