MAY 26, 2015
Summary
- PAA is a premier liquids focused midstream MLP.
- However, the recent oil spill in California could prove to be an extremely expensive nightmare.
- As a result, I think there are better options out there in the midstream space.
Two ways to buy into Plains All American
PAA is part of the Plains All American family of companies which also includes its general partner Plains GP Holdings, LP (NYSE:PAGP). To put it simply, PAA as the MLP owns most of the physical assets while PAGP owns 100% of the GP and hence is entitled to IDRs. While both are partnerships, only PAA issues a K-1 form, while PAGP issues a 1099 via a complicated arrangement where it is taxed as a C-Corp.
Source: PAA Barclays Investment Grade Energy and Pipeline ConferenceAsset Overview
PAA's main draw is its nationwide midstream footprint. The company handles mostly liquids (75% crude oil and 20% NGLs), and most of its assets are fee-based at 77%. PAA's business model is to be a fundamental part of the national energy supply chain, with over 18,900 miles of pipeline, 125 MMBbls of liquids storage, 235,800 Bbbls/d of fractionation capacity, 8,100 crude and NGL rail cars, 149 barges, among other assets.
Source: PAA Barclays Investment Grade Energy and Pipeline Conference
Growth Projects Overview
Even with crude oil prices in the gutter, PAA is still planning to grow its midstream business. Guidance for 2015 has organic investments coming in at $1.85 billion, all with double-digit teens returns. Given that PAA plans to fund this growth via a 55/45 equity-to-debt ratio, these projects should boost DCF going forward, allowing for continued distribution growth.
Source: PAA Barclays Investment Grade Energy and Pipeline Conference
A look at the distribution growth
Due to the impact of weak oil prices, PAA management has lowered its expected 2015 distribution growth rate to 7%, compared to the 9%. This is largely a result of a weakening DCF coverage. For 2015, PAA expects to post a 1.00x coverage ratio, down from 1.1x in 2014.
Source: PAA Barclays Investment Grade Energy and Pipeline Conference
This is a modest setback for PAA as it will leave little excess cash flows to fund growth. Historically, PAA has used its retained cash flows to boost growth without issuing equity/debt. This has resulted in the yield of PAA's stock increasing to 5.75%, compared to its average yield of ~4%.
Major risk factor: California oil spill
One major risk with PAA is the potential impact of the recent California oil spill. A PAA-owned pipeline ruptured, leaking 21,000 to 101,000 gallons into the sea. A large cleanup effort is ongoing.This is a major piece of bad news for PAA. The pipeline is obviously shut down, and will not be allowed to restart until a battery of tests and analyses is completed, as mandated by regulators. Furthermore, this spill and the associated clean-up will be expensive for PAA, though some costs are expected to be covered by insurance. Lastly, given the location of the oil spill in California and the tons of unfavorable new coverage coming out, PAA might face some legal headaches from environmental groups, adding to its expenses.
Source: ABC News
Conclusion
PAA is a great midstream MLP. However, given the tight coverage ratio and the ongoing oil spill mess, I think the risk-adjusted reward is too low. This spill could very likely reduce the 2015 distribution growth rate even more. Given that there are some midstreams like Kinder Morgan (NYSE:KMI) and Williams (NYSE:WMB) with 4.5% yields and 10-15% growth, I would avoid the stock for now.Disclaimer: The opinions in this article are for informational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned. Please do your own due diligence before making any investment decision.
Source: http://seekingalpha.com