2023-12-22 04:42:06 ET
Summary
- The management believes that the tariff volumes and tariffs might increase in the coming period.
- The dividend payment of $1.27 makes a yield of 8.10% compared to current share price.
- The company’s dividend yield of 8.10% is significantly higher than sector median dividend yield of 3.58%.
- After comparing PAGP’s forward P/E ratio of 9.27x with the industry average P/E ratio of 11.79x, I think PAGP is undervalued at its current valuation.
Investment Thesis
Plains GP Holdings (PAGP) owns and manages midstream energy infrastructure in Canada and the United States. The company has a long history of solid dividend payments. In this report, I will examine sustainability of dividend payments by analyzing the company's financial performance. I will also be analyzing the valuation of the company with the help of relative P/E valuation method.
About PAGP
PAGP mainly focuses on owning and operating midstream energy infrastructure in Canada & the United States. The company conducts business in two segments: Crude Oil and Natural Gas Liquids (NGLs). The crude oil segment deals in gathering and transporting crude oil with help of pipelines, trucks, barges, railcars, and gathering systems. It also offers storage, terminalling, and other services using its integrated assets across Canada and United States. The crude oil segment generates 95.57% of the company's revenues. It mainly generates its earnings through pipeline capacity agreements, tariffs, and other transportation fees. It owns assets in Permian Basin, South Texas, the Mid-continent, the Gulf Coast, Rocky Mountain, Western, and Canada. The NGL segment includes natural gas processing, and NGL storage fractionation, terminalling, and transportation. This segment contributed approximately 4.43% to annual revenues.
Financials
The geopolitical impacts and macroeconomic factors such as rising material costs, high interest rates, and evolving regulations and policies affected the demand & supply dynamics. Despite these scenarios, the global oil demand has not been impacted and has risen by 2.3 mbpd in 2023. The industry is expected to boost further at the start of 2024 as a result of high oil prices and improving macroeconomic conditions.
PAGP has been experiencing significant revenue growth for last 3 years. The company's revenue in FY2021 increased from $23.29 billion (FY2020's revenue) to $42.08 billion which is 80.68% YoY growth. The primary reasons behind this humongous growth are 5% YoY increased demand and 50% YoY surged global oil prices (Brent Price was approximately $90 per barrel). PAGP's operating income in FY2021 increased substantially YoY from an operating loss of $2.38 billion (FY2020's operating loss) to an operating income of $851 million. The operating income growth was driven by solid revenue growth. Its revenue growth continued in FY2022. The company's FY2022 revenue of $57.34 billion was a YoY gain of 36.26% against FY2021 revenue. This revenue growth was fueled by surged Crude oil pipeline tariff volumes and continued Permian production. The company reported operating income of $1.2 billion margin in FY2022 which is 51.8% YoY growth compared to operating income of FY2021.
The company has also generated significant free cash flow ((FCF)) in the last three years. At the end of FY2021, the company's FCF was $2.37 billion . It distributed $200 million (8.44% of FCF) to preferred unitholders and $515 million (21.73% of FCF) to common unitholders. After the distribution to preferred and common unitholders, its FCF was $1.65 billion in FY2021. The company managed to generate this significant FCF in FY2021 with the help of asset sales at premium prices and capital discipline with reduced capital expenditures. The company ended its FY2022 with an FCF of $1.6 billion. PAGP distributed $206 million (12.9% of FCF) to preferred unitholders and $576 million (36% of FCF) to common unitholders. In FY2022, its FCF was $828 million after distributions to preferred and common unitholders.
The company has reported its quarterly results. It reported a revenue of $12.07 billion, down 13.65% compared to $14.33 billion in Q3FY22. This growth was mainly resisted due to lower Permian volumes resulting from adverse weather impacts on gas processing capacity. Net income declined by 59.15% YoY from $71.0 million to $29.0 million. It reported a diluted EPS of $0.15. The Crude oil and NGL segment revenues were $11.93 billion, and $0.242 billion respectively. PAGP reported $262.0 million in liquidity and adjusted EBITDA stood at $662.0 million. The firm has recently completed the Rattler Permian Transaction. Under this deal, Permian JV acquired the remaining interest of 43% in OMOGJV Holdings LLC. I believe with the help of its assets the Permian JV can be better positioned to grow its customer base by increasing its service and product offerings and can further expand its profit margins. This can also significantly help to increase its cash flows and further increase its distributions.
The results were impacted by severe weather conditions in the Permian Basin which reduced the gas processing capacity. However, the management also believes that the tariff volumes and tariff might remain at an elevated level in the coming period. The firm is also highly optimistic about the growth and raised its adjusted EBITDA guidance to the range of $2.6 billion to $2.65 billion, which is an upside of $50 million to $100 million from the top end of its previous estimate range. The company also estimates to achieve FCF of $1.45 billion. Currently, demand for crude oil is still high. The high crude oil prices confirm that demand for oil and gas has surpassed its supply. The oil prices are not as high as they used to be in 2022, but still, it is significantly higher than prices in 2021. Therefore, I think we can assume that demand for oil and gas in 2023 and 2024 might be lower than demand in 2022 but higher than demand in 2021. Considering demand for oil and gas, I think it is safe to say that the company can exceed revenue of FY2021 in FY2023 & FY2024 but fail to surpass the revenue of FY2022. That is why, I am assuming the company's revenue for FY2024 might be $55 billion.
To calculate the estimated net income margin of FY2024, I am taking an average of the net profit margin of last five quarters as the economic situation in FY2024 might be as same as the last five quarters. Therefore, I am assuming net profit margin for FY2024 to be 3%. The revenue estimate of $55 billion and net profit margin of 3% gives EPS of $1.69.
Dividend Yield
The company has an impressive history of consistent dividend payout which indicates its well-positioning. In FY2022, it paid a cash dividend of $0.18 in first quarter. It distributed stable cash dividends of $0.2175 in each of the next quarters, which resulted in a total annual payout of $0.8325 and represented a yield of 5.31% compared to the current share price. In FY2023, it paid four quarterly a dividend of $0.2675, which makes the annual dividend $1.07, constituting a dividend yield of 6.83%. Recently the firm announced a 19% rise in annual dividend from $1.07 to $1.27 which is an impact of its recent acquisition and robust demand in market. The dividend payment of $1.27 makes a yield of 8.10% compared to current share price. The company estimates that it would have an FCF per share of $7.39 which signals that the company's dividend payments are safe. Even with my EPS estimate of $1.69, we can say that the dividend payment might be safe in the coming time. The company's dividend yield of 8.10% is significantly higher than sector median dividend yield of 3.58%. PAGP's 4-year average dividend yield is 8.69% which shows that the company has a history of solid dividend yields.
What is the Main Risk Faced by PAGP?
The company's business operations need steel and other materials to build and maintain existing and new pipelines and facilities. If the supply of these materials gets disrupted or if the company fails to obtain sufficient quantities, it can negatively impact its ability to maintain its existing assets and build new infrastructure which might further contract its profit margins. Its operations also depend on having access to large amounts of electricity and other commodities. If it fails to get sufficient electricity, it can affect its operational activities by further reducing its profitability.
Valuation
The company currently experiencing a robust tariff volume and elevated tariffs due to solid demand for oil and gas. The company has acquired remaining interest of 43% in OMOGJV Holdings which can grow its customer base by increasing its service and product offerings. After considering all these factors and EPS calculation in financial section of this article, I am estimating an EPS of $1.69 for FY2024 which gives the forward P/E ratio of 9.27x (share price: $15.66). After comparing the forward P/E ratio of 9.27x with the sector median of 9.97x, we can conclude that the company is fairly valued. The company's primary competitors are Kinder Morgan ( KMI ), Enbridge ( ENB ), Enterprise Products Partners ( EPD ), and Euronav ( EURN ).
If we compare PAGP's forward P/E ratio of 9.27x with the industry average P/E ratio of 11.79x, we find that PAGP is undervalued at its current valuation. After considering a robust demand in the market, elevated tariffs, and PAGP's solid position in market, I think it's safe to assume that the company is undervalued.
Conclusion
The company's recent performance was impacted by the adverse weather conditions. However, it has a strong growth prospect as the industry is booming rapidly and to cater to the growing demand the company has significantly focused on acquisition in the Delaware Basin which can increase its services and offerings to attract new customers and increase its cash flows. Recently the firm announced that it is increasing its dividend payout by 19% as a result of its expansion activities. This makes the company attractive stock to add in the portfolio to earn consistent payouts. However, it is exposed to risk of supply chain disruptions which can reduce its profitability. The stock is currently undervalued and it can benefit the investors to earn consistent dividend payout which can also potentially grow in future as result of strong industry dynamics and its expansion activities. After considering all the above factors, I assign a buy rating to PAGP.
For further details see:
Plains GP Holdings: Solid Financials Supports 8% Dividend Yield