PAGP - Plains GP Holdings: Steady As She Goes

2023-12-21 09:47:59 ET

Summary

• Plains GP Holdings is rated as a hold at current levels after a strong performance in 2023.
• Plains American's strategy of maintaining steady long-term growth in capital expenditure sets it apart from peers.
• PAGP's ideal entry point is when it trades closer to a 7.5-8x multiple, offering a more favorable price for investors.

After a spectacular run-up through 2023, I would rate PAGP as a hold at today's levels. The most recent quarter provided good insight into PAA's continuing strategy and provided comfort to investors, especially those focused on the long-term.

Company Overview

Plains GP Holdings (PAGP), holds a controlling stake in Plains American's (PAA) general partner and an indirect limited partner interest in PAA and regularly distributes available cash to shareholders on a quarterly basis. Plains is a major player in North America's midstream energy realm and operates as a publicly traded master limited partnership. They specialize in owning and managing midstream energy infrastructure, and facilitating logistics for crude oil, natural gas liquids ((NGL)), and natural gas. With a substantial network encompassing pipelines, storage facilities, and transportation assets in crucial oil and NGL production areas, as well as major market hubs across the United States and Canada, Plains is a dominant force in the midstream space. It handles a daily average of over 6 million barrels of crude oil and NGL in its Transportation segment.

Plains' Strategy Has Not Changed Through the Cycles

PAGP stands out among midstream companies for maintaining a steady and restrained long-term growth capital expenditure trajectory, a rarity in the industry post the extensive build cycle of the 2010s. While many peers initially projected lower sustained capital expenditure during 2020/21, several have since shifted gears, opting for more aggressive growth investments in 2023 (and likely 2024). In contrast, PAA has consistently adhered to a $300-400 million growth capital expenditure rate (with approximately $200 million for maintenance capex) for the foreseeable future without significant deviations. In 2023, PAGP is expected to deliver an impressive $1.45 billion in free cash flow, even after allocating $450 million to shareholders.

In the third quarter of 2023, PAGP announced three acquisitions valued at $289 million (net to PAGP) encompassing Permian crude gathering systems in the Midland and Delaware basins. Additionally, the company surprised investors with its intention to pursue similar add-on deals in both Permian and non-Permian basins. Despite these announcements, these actions are not worrisome. The multiples for these acquisitions have been reasonable, falling within the range of 6-7x. This aligns with PAGP's advantageous position as a natural consolidator in the Permian amidst a market favoring buyers. Furthermore, PAGP balanced these 2023 acquisitions by divesting assets worth $248 million from its NGL asset base.

The Ideal Entry Point

Plains GP has provided investors with torrid returns through 2023, with total returns north of 36% YTD at the time of writing. Given the track record of growing distributions and growing its infrastructure, PAGP has demonstrated exceptional execution, and its recent multiple indicates increased shareholder confidence in management's ability to maintain its current trajectory. While the company's business model has continued to grow on its strength, the stock is a hold at its current levels. As the chart below shows, PAGP has traded between 7.8-9x next year's EV/EBITDA. At the time of writing, the stock is currently trading right in the middle of this range.

A more opportune entry point can be had when PAGP trades closer to the 7.5-8x multiple. This should translate to an entry point of $14.5/share, versus the current trading price of $16/share.

Pipelines Are Not Without Risk:

As it pertains to PAGP, the chief risk is the price of crude and natural gas liquids.

1. Price of Crude and Permian Production Growth :

   • Dependency on Crude Prices : The Permian Basin's production heavily relies on the price of crude oil. Lower prices can impact the profitability of extracting oil from this region, potentially leading to reduced investment in production growth or even scaling back existing operations.
   • Economic Viability of Operations : If crude prices remain low for extended periods, it might render some extraction projects financially unviable. Companies might delay or cancel expansion plans, affecting both revenue streams and regional economic development.
   • Market Volatility Impact : Rapid fluctuations in crude prices can disrupt long-term planning and investment. Companies may struggle to forecast profitability accurately, leading to cautious or conservative spending, and hindering growth potential.

2. NGL (Natural Gas Liquids) Commodity Sensitivity :

   • Market Demand and Price Fluctuations : NGLs, including ethane, propane, and butane, are subject to demand and price variations. Dependency on NGLs as a revenue source means sensitivity to shifts in market demand, which could lead to revenue instability.
   • Infrastructure and Transportation Challenges : Unlike crude oil, NGLs require specialized infrastructure for transportation and processing. Any disruptions or limitations in this infrastructure could impact the timely delivery of NGLs to market, affecting revenue streams and operational efficiency.

3. Execution on Asset Acquisitions and Sales :

   • Market Conditions and Timing : The successful execution of strategic asset acquisitions and sales heavily relies on favorable market conditions and suitable timing. Unforeseen market downturns or unfavorable economic conditions may lead to asset devaluation of PAGP's current portfolio or difficulty in finding suitable buyers.

Conclusion

PAGP has built a midstream powerhouse over the years, and their strategy today remains clear-eyed. They have been focused on building on their strengths and using their market agility to drive growth. This has resulted in exceptional growth over the years while also rewarding their shareholders along the way. PAGP has a sound business model that should continue to deliver, barring a major move to the downside in crude or NGLs. At current levels, I would hold the position and look to add or initiate closer to $14/share.

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