PAA - A Meaningful Discussion About Plains All American Pipeline's Solid Earnings

2023-11-07 01:06:26 ET

Summary

• Plains All American reported solid earnings for the third quarter raising guidance for the year to $2.65 billion.
• Management unexpectedly raised the distribution by $0.20 instead of the expected $0.15.
• Leverage dropped to 3.4 within the lowered target range of 3.25-3.75.

Plains All American Pipeline (PAA) announced the day before earnings an intention to raise the quarterly distribution by $0.05 instead of the $0.038 it had signaled in past calls. At earnings, the company announced completing two bolt-on acquisitions during the September quarter adding to the cash flow. In past articles , the focus had been on cash flows. With this one, we continue in that direction. The company's business is solid and growing modestly, both organically and through acquisitions. In Plains All American Pipeline's Improved Cash Generation Continued , But May Be At Risk, we highlighted risks in the Permian Basin. The risks played out negatively as forecasted during the last two quarters, yet EBITDA grew in spite. Building solid structures with solid walls is still essential for safety and reward. So, grab the trowel and your work clothes for some inspecting of our own.

The Quarter & Year

Plains reported on November 3rd with great news. A summary of the quarter is shown next.

• Raised full year guidance to between $2.6 billion and $2.65 billion approximately $75 million above the last guide.
• Closed two gathering entities, Rattler Southern Delaware Basin and LM Energy's Norther Delaware Basin. The net to Plains equaled $135 million.
• Lowered the leverage ratio target to between 3.25 to 3.75. Plains closed the quarter at 3.4 within the range.
• Generated $665 million of EBITDA even with significant weakness in Permian volumes.
• Hedging strategies continue to remove volatility with the NGL portion of the business. The 2023 hedges are approximately $0.10 lower ($0.60) in value than 2022.

A slide from the presentation summarizes the quarter.

Management noted several times throughout the call that disciplined and accretive acquisitions are now part of the company's growth strategy.

Distribution, Cash Flows & Expenditures

In this article, we head straight to the wall for inspection asking how safe the distribution is and whether will it likely increase in the future. This inspection includes management's attitude on distributions, future cash generation, and debt structures.

With regard to attitude, management wrote:

[l]ong term, our free cash flow generation continues to support our multiyear capital allocation framework which continues to target annualized distribution increases of approximately $0.15 per unit each year until reaching a target common unit distribution coverage of approximately 160%."

On growth, management offered these thoughts in the prepared remarks.

We continue to expect growth in our crude oil business primarily driven by operating leverage, continued Permian growth, tariff escalation and full year contributions from bolt-on acquisitions."

A several-prong approach should drive growth going forward.

With respect to cash, several different usages exist. First, during the last quarter, Plains must finish paying off $700 million in short-term debt. With regard to methods, the last 10-Q contains this statement:

We also intend to utilize a combination of cash flow from operating activities, proceeds from asset sales and borrowings under our commercial paper program to repay our 3.85%, $700 million senior notes due October 2023."

It has $450 million in cash available, thus, at least $250 million must be borrowed from its commercial paper.

Next, the distribution increase of $0.20 adds an additional $140 million.

Continuing, Plains self-funds its investment capital. For this year, it equals $325 million. Next year is yet to be disclosed.

The real issue for Plains, in our view, resides with its debt structure. Although the leverage remains conservative at 3.5, the debt structure shown in the next table, paints a possible cash crunch picture.

A slide from the June presentation shows an excess cash of $600 million available for debt reduction. In the 3rd presentation, the same slide lowered the amount to $450 reflective of the $150 used for the two bolt-ons. Assuming that no additional acquisitions occur in 2024 and for modest increases in tariffs, the financial result will demand a continued exercise of the capital markets. For 2024, it's at least another $200 million. In 2025, it's at least $500 million. Investors must remember that these actions won't negatively lift leverage above targets, but will likely increase interest payments.

So, where does all this spending leave the possibility for future distribution increases? Al Swanson answered that question,

We still are committed in the future for the $0.15 annual increase in the 160% coverage at the common level. Part of the reason for moving it up and the extra nickel list is related to the acquisitions that we've completed. They're accretive. . .. . But once we complete this, we're back to the $0.15 and 160% coverage. We think the 1[60] % coverage allows us to basically fund investment capital going forward and number of small bolt-ons in the future without actually needing to raise external money. So, kind of live in our own cash flow means.

A note on bolt-on acquisitions, from a revenue perspective, the hurdle rates are in the 11% to 12% range. The two closed recently are approximately 400 basis points higher (15%).

Regarding the performance in the Permian, original guidance estimated a year-over-year increase of 500,000 barrels a day in growth. The yearly average with weather-related issues is now 350,000-400,000 per day. With that written, the October volumes are 175,000 above the 350,000. Permian is back online for now.

Future distributions ride on the financial success until total distributions lower coverage to 1.6. This year, shown in the next slide, is 2.20. There is sufficient room for increases.

The performance of Plains and its conservative financial position offers both the company and investors opportunities for growth. But the plan still requires access to capital markets at modest levels. Remember, the company will pay higher interest rates.

One last thought before we close, management clearly stated that it has no intention of closing out any of the preferred shares.

Risk

Risks do exist. Reported unemployment soared in the month of September strongly suggesting a possible future demand-destroying recession. Investors must not overlook this. Management's continued approach in lowering leverage, now 3.5, helps mute stresses during lower business cycles. We, also, can't exclude the likelihood of a continuing $0.15 per year distribution increase even with a necessity for financial help in the capital markets. Another market risk exists within NGLs. For example, in the 1st quarter the market generated $192 million in EBITDA while during the 3rd quarter, it dropped to $99 million. The $100 million difference per quarter matters. It, by itself, solves or creates, depending on one's view, the need for accessing capital markets. Any improvement within this business lowers risk and level of access.

With apparent risks included in our thinking, Plains has performed admirably. Our hold rating has been wrong with respect to capital appreciation. But we continue this rating because of yields with unit prices above $15.

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