One of the sectors that has seen an impressive rally over the last couple of months is the Energy sector. As measured by the U.S. Energy iShares ETF (IYE), the sector has increased from a trend low point at the end of October by about 54%. Much of that increase has been driven by a push among major oil-producing countries, led in particular by OPEC, to curb production and so restrict supply to a market that is still dealing with generally reduced pandemic-driven demand.
Even as vaccines are distributed on an increasing basis, with the expectation that supply of available vaccines will increase in the near-term to help meet lagging distribution, the truth is that the cold, winter months are seeing measurable increases in infection rates across the country. Hospitals are reporting increasingly strained capacity and resources to meet increasing hospitalizations. Those realities have forced some areas to reimpose restrictions. In the U.K., where a fast-spreading new strain of COVID has wound its way through the country, a new set of stay-at-home orders have been issued to attempt to control that spread. All of this is one more confirmation that no matter how tired we may be of the conversation, the reality is that even with vaccinations taking place, COVID will continue to be a concern in 2021, and it will likely continue to put economic pressure on big segments of the global economy.
In the U.S., pandemic concerns have kept a lot of pressure on stocks in the Energy sector, including the Oil & Gas Transportation industry. In 2020, COVID was really just one more major headwind, as companies in this industry were also confronting capacity issues stemming from limited pipeline and storage facilities needed to transport raw crude from the Permian Basin to the Gulf of Mexico. Prior to 2019, it became clear that aging, dated pipelines and storage facilities were insufficient to match the increased production demand, and that resulted in a large backlog of supply from the Permian that had nowhere to go. A number of projects were under construction, and while some are now up and running, other projects were suspended due to COVID-19. The recent pullback in production means that oil prices for both West Texas Intermediate (WTI) and Middle Eastern (Brent) crude have been increasing, which in the long-term should be a positive; if travel demand, and therefore crude demand begins to increase as some expect in the second half of the year, those prices become likely to remain above their 2020 levels.
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 those just described 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 involved in a number of the projects to improve existing pipeline, terminal and storage infrastructure, some of which are online, with management projecting up to one million barrels per day to the Gulf Coast from just one of those pipelines in the first half of this year. While uncertainty from coronavirus remains high, the stock has rebounded with the rest of the industry from a September low around $5.50 to its current price a little above $10. Is the company’s fundamental profile strong enough to suggest that it is also a good value? 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 $7.3 billion.
Earnings and Sales Growth: Over the last twelve months, earnings decreased by about -11.5%, while revenues were 26% lower. In the last quarter, earnings improved by 84% while sales increased by nearly 81%. The company’s margin profile saw material deteriorations in 2020, which isn’t surprising given the collapse in oil demand, but appears to be turning a corner; Net Income as a percentage of Revenues in the last quarter was 2.45% versus -8.52% over the last twelve months.
Free Cash Flow: PAA’s free cash flow is healthy, at $1.4 billion. That translates to a strong Free Cash Flow Yield of 20.58% and marks a steady, multiyear improvement from $730 million at the end of 2015.
Debt to Equity: PAA’s debt to equity is 1.24, which indicates a high degree of leverage. Liquidity is a bit of a concern, since their balance sheet shows just $46 million in cash and liquid assets versus $9.4 billion in long-term debt. It is worth noting that in its most recent earnings call, management reported it would be retiring more than $600 million in long-term debt, leaving the company with no near-term maturities and increasing available liquidity to more than $2 billion. Even so, the yearly negative Net Income pattern remains a red flag worth watching in the quarters ahead. If Net Income can continue to improve on a quarterly basis, the argument that the worst is behind the company becomes much stronger.
Dividend: EPD’s annual divided is $.72 per share (reduced in 2020 from $1.44 per share), which translates to a much larger-than-normal yield of about 7.56% 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 I like to work with a combination of Price/Book and Price/Cash Flow analysis. Together, these measurements provide a long-term, fair value target around $14 per share. That means the stock is nicely undervalued right now, with 39% upside from its current price.
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 year of price activity. The red line traces the stock’s downward plunge from the beginning of 2020 from a peak at around $19 per share to its bear market low around $3. It also provides the baseline for the Fibonacci retracement lines on the right side of the chart. The stock rallied to a June peak at around $12 before falling back to its most recent trend low at around $5.50 in late September. After rallying to the 38.2% retracement line in December, the stock hovered a little below that resistance level in December before picking up momentum again at the beginning of this year. In the last few days, the stock has pushed above that resistance level, which means that new support should be at around $9, with next expected resistance anywhere between the 50% retracement line at $11 and that June peak around $12. A bearish reversal of momentum, with a drop below $9 should find next support at around $8, with additional downside around $6.50 if bearish momentum accelerates from that point.
Near-term Keys: PAA has a significant amount of bullish momentum going on right now, which means that if you’re looking a short-term trade, this could be a good time to think about buying the stock or working with call options, using a price target between $11 and $12 as good, early exit points. A drop below $9 could act as a signal to consider shorting the stock or buying put options, as long as you are ready to work with quick exit targets, since next support is only about $1 away. I think that the stock’s fundamentals and value proposition really offer the best probabilities of success, especially over the long-term. Even though it was reduced in 2020, this is also a stock 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 the potential for continued near-term price volatility, PAA is a hard stock to ignore.