PAGP - Plains GP Holdings: Healthy Financials Coupled With Upside Growth Potentials

2023-08-30 12:27:48 ET

Summary

• Plains GP Holdings is a prominent midstream service provider in North America, with a focus on crude oil and NGL in growing producing basins.
• The company has a solid balance sheet and capital structure, with increased cash generation and declining net debt.
• Plains has strong cash flow and ample free cash flow, allowing for deleveraging and higher shareholder distributions in the future.
• Healthy cash and capital structures resulted in strong leverage and liquidity conditions that eliminate risks of further financial and economic constraints in the future.

Introduction

Plains GP Holdings (PAGP) is a publicly traded Delaware limited partnership; since the end of 2022 , the company's cash flow has been completely derived from an indirect investment in Plain All American Pipeline (PAA). It is worth knowing that Plain All American is one of the prominent midstream service providers in North America that connects producing regions to demand centers and export terminals. Their key assets and services are focused on crude oil and NGL in the most growing producing basins like the Permian Basin through the United States and Canada. Through this analysis, I investigated PAGP's business and financial outlooks to realize if the company is a valuable investment option.

PAGP's business and financial outlooks

Plains All American has a prominent position and infrastructure in the Permian Basin, which is the most important basin in North America. As the management stated , the Permian Basin drives volume growth in the crude oil markets in the United States, thereby leading to higher production in the future. In the North American oil production outlook, the Permian Basin has the highest production growth rate. Given this prediction, Plains has an outstanding opportunity to grow its production, even in the face of wider economic constraints. Also, it is worth noting that the company's general policy to structure its purchases and sales under fixed-fee contracts makes it resilient against commodity price fluctuations and their effects on its operating income. The benefits of Plains are not limited to its desirable operation location; the company's cash and capital structures are healthy and provide a 7% dividend yield, which is very attractive (see Figure 1).

Figure 1

As mentioned earlier, a solid balance sheet and capital structure is one of the strong elements of Plains. The company was successful in increasing its cash generation during the last year. It reached a cash balance of $983 million in the recent quarter versus only $327 million in 2Q 2022. Higher cash generation improved their balance sheet by declining their net debt to $7.2 billion in 2Q 2023 year over year compared with $8.6 million in the same time in 2022. Thankfully, their equity level of $14.8 billion is far higher than the net debt, which offsets the risks of future debt and equity financing (see Figure 2).

Figure 2 - PAGP's capital structure (in millions)

Furthermore, the solid cash structure of Plains is another element that makes the company prominent. After a deep drop in their operating cash flow from $941 million in 3Q 2022 to $334 million at the end of 2022, they increased their cash flow from operations and reached $887 million at the end of 2Q 2023. Thankfully, their capital spending remained at a reasonable level of $159 million, thereby leading to an ample amount of $728 million of free cash flow at the end of the recent quarter. Except for 3Q 2022, their generated free cash flow hit the highest amount in the previous quarters. In the recent quarter, the management declared a $0.2675 dividend per share, which accounts for approximately $52.5 million of dividend payments based on 196,000,000 outstanding shares. According to their large amount of FCF, there is room for both deleveraging and higher shareholder distributions in the future (see Figure 3).

Figure 3 - PAGP's cash structure (in millions)

The management predicted to keep their leverage level at lower than 3.5x by the end of 2023. After analyzing their healthy cash and capital structures in the previous quarters, it goes with no surprise to see that their guidance is easily reachable. The wake of the COVID-19 outbreak and the downturn of 2020 caused leverage ratios of Plains to surge over 7x; however, the company enhanced its leverage condition considerably through successful deleveraging in the last couple of years. Ultimately, Plains' net debt-to-EBITDA ratio is 2.8x in TTM, and its net debt-to-CFO ratio is 2.5x in TTM (see Figure 4).

Improved financial flexibility paves the way for higher cash returns to investors and allows the management to consider a new capital allocation framework. The management plans to increase its cash distribution by $0.15 per share per year, and this increase will continue until its unit distribution coverage ratio reaches approximately 160%. Their guidance for their unit distribution coverage ratio by the end of 2023 is 215%, which shows that the company has plenty of room to grow, and its unit price, therefore, has an upside potential to rise.

Figure 4 - PAGP's leverage condition

It is worth noting that the company's healthy liquidity condition, coupled with strong coverage conditions, eliminates risks of probable economic recessions to a great extent. During the recent quarters, the company improved its liquidity condition across the board of current and cash ratios. The company's current assets are well enough to pay back its short-term obligations, with a current ratio of 1.0x. In addition, their cash ratio became twofold to 0.2x in 2Q 2023 versus 0.1x at the end of the first quarter, which indicates the company is capable of paying circa 20% of its obligations only with its generated cash, which is attractive (see Figure 5).

Figure 5 - PAGP's liquidity condition

Risks related to Plains investment

The first and foremost risk associated with Plains operations and profitability is related to any major or minor changes in supply and demand for crude oil, natural gas, NLG, and other services that PAA provides. Shortages in supply and demand, which can be caused by a variety of factors that are not under the management's control, may adversely affect their operations and financial condition. Also, the management's prediction for 2023 WTI crude oil is $82.5/bbl on average. If oil prices drop more, other projections and operations may adversely become affected. It is important to mention that Plains distributes all of its available cash; thus, its growth process may be slower than businesses that reinvest their available cash to expand their operations.

Conclusion

Plains is a stable and well-performing business in the oil and gas industry; it is one of the most prominent midstream companies in North America. The company's operation and financial results have been on the same path as the management's guidance, which shows their stability for more growth in the future. The management plans to increase its cash distribution by $0.15 per share yearly until its unit distribution coverage ratio reaches approximately 160%. Based on this year's 215%, we can say that the company has plenty of room to grow, and its unit price thereby has a good potential to rise. Furthermore, the healthy cash and capital structures of Plains resulted in strong leverage and liquidity conditions that eliminate risks of further financial and economic constraints in the future.

For further details see: