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PAA is a big bargain in the Oil & Gas Transportation industry – is the timing right?

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One of the interesting things about investing is the way emotion often drives the rotation of money from one sector or industry into another. While the market in the broadest sense appears to be shrugging off coronavirus-related uncertainty, stocks in the Energy sector have struggled. That includes stocks in the Oil & Gas Transportation industry, which is down nearly -7% over the last month.

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As the outbreak of coronavirus continues to expand in China, along with the death count, analysts are beginning to forecast lower gas demand for the world’s largest importer, with most estimates forecasting just 6% growth through 2020 versus the 10% it grew in 2020. That is just the latest reason the industry has seen bearish momentum pick up, driving stocks in the industry to new multiyear lows. 

One of the companies in this industry with one of the most interesting fundamental profiles is Plains All American Pipeline, L.P. (PAA). This is a mid-cap company with pipeline transportation, terminaling and storage facilities, largely in the oil-rich Permian Basin area. That puts the company right in the middle of capacity limitations that have led to inventory sitting in the Basin waiting to be transported to terminals in the Gulf of Mexico. PAA is one of the companies working on a number of projects to improve existing pipeline, terminal and storage infrastructure that are expected to come online in 2020 and 2021. Those limitations helped to keep WTI and LNG prices relatively subdued for most of the past year. While uncertainty from coronavirus remains high, pressure on stocks like PAA is likely to remain mostly bearish. Does that mean PAA is a high-risk investment, or a good bargain right now? Let’s find out.

Fundamental and Value Profile

Plains All American Pipeline, L.P. owns and operates midstream energy infrastructure and provide logistics services for crude oil, natural gas liquids (NGL), natural gas and refined products. The Company operates through three segments: Transportation, Facilities, and Supply and Logistics. The Company’s transportation segment operations consist of activities associated with transporting crude oil and NGL on pipelines, gathering systems, trucks and barges. Its Facilities segment operations consist of activities associated with providing storage, terminaling and throughput services for crude oil, refined products, NGL and natural gas, as well as NGL fractionation and isomerization services and natural gas and condensate processing services. Its supply and logistics segment operations consist of the merchant-related activities, including the purchase of the United States and Canadian crude oil at the wellhead, the bulk purchase of crude oil at pipeline, terminal and rail facilities. EPD has a current market cap of about $11.6 billion.

Earnings and Sales Growth: Over the last twelve months, earnings decreased by about -21.25%, while revenues grew almost 4.2%. in the last quarter, earnings improved a little more than 21% while sales increased by 16%. The company’s margin profile is healthy, but narrowed in the last quarter, as Net Income as a percentage of Revenues in the last quarter was 6.45% versus 3.34% over the last twelve months.

Free Cash Flow: EPD’s free cash flow is healthy, at $1.7 billion. That translates to a strong Free Cash Flow Yield of 15.4% and marks a steady, multiyear improvement from $730 million at the end of 2015.

Debt to Equity: EPD’s debt to equity is .88; however the company’s balance sheet indicates operating profits should be adequate to service their debt. Liquidity is a bit of a concern, since their balance sheet shows just $668 million in cash and liquid assets versus $9.5 billion in long-term debt; however it should be noted that liquidity has improved markedly in each quarter of the past year; at the end of 2018, cash and liquid assets were just $66 million.

Dividend: EPD’s annual divided is $1.44 per share, which translates to a much larger-than-normal yield of about 9.06% at the stock’s current price.

Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for EPD is $14.86 and translates to a Price/Book ratio of 1.07. The stock’s historical average Price/Book ratio is 1.46, which puts the stock’s long-term target price at about $21.50 per share – 36.5% above the stock’s current price. The stock is also trading almost 53% below its historical Price/Cash Flow ratio, which offers a target price a little above $24 per share.

Technical Profile

Here’s a look at the stock’s latest technical chart.

Current Price Action/Trends and Pivots: The chart above covers the last two years of price activity. The red line traces the stock’s downward trend from August of last year from a peak at around $28 per share to its current price at a multiyear low around $15.50. The stock’s current momentum is strongly bearish, with the price dropping below a previous two-year low around $17 per share. At this point, the next most likely support level is around $15 per share, with resistance at the list pivot low at around $15 per share – a level the stock hasn’t seen since early 2016. A break above $17 should give the stock room to run to its last peak at around $19.50 per share, which would also mark a useful signal the current downward trend is about to reverse.

Near-term Keys: Given the strength of the stock’s current bearish momentum, I think there is a stronger likelihood the stock should continue to drop; that means that the highest probability short-term trade would come from a push below $15, with room to drop to about $13 based on levels last seen in 2008. That would be a good signal to consider shorting the stock or working with put options. However, if the stock does find a stabilization point, and manages to push above $17, there could be a useful short-term opportunity to buy the stock or work with call options with an eye on $19.50 as a bullish target. The stock’s fundamentals and value proposition are excellent, which means that even with the currently bearish momentum, PAA offers an excellent long-term opportunity, with an annual dividend far above the average for stocks in the S&P 500 or even long-term bond yields. If you aren’t afraid to tolerate some additional near-term price volatility, PAA is a hard stock to ignore.

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