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Coverage Initiation: Pembina Pipeline
Pembina Pipeline (PPL.TO) was founded in 1954 to transport crude oil from the Pembina Field near Drayton Valley, Alberta to Edmonton, Alberta. Following a couple of material acquisitions, the company sold shares on the Toronto Stock Exchange in 1997. At that point in time, the company was structured as an Income Trust—a tax-advantaged entity. Many acquisitions and internal projects later, the company converted into a regular corporation in 2010. (This change was precipitated by the Canadian government altering tax laws so that Income Trusts no longer benefited from their previous tax advantages.)
The Income Trust structure allowed Pembina to avoid most Canadian corporate taxes by distributing income to trust holders. Though not exactly the same, the concept is similar to that of a real estate investment trust, or REIT. Thus, the company has a long history of paying material distributions. Upon conversion, management chose to continue paying a large dividend.
The company’s tag line is “making connections,” which is appropriate considering Pembina’s business of transporting oil and gas. The company breaks its business down into four main segments:
The Conventional Pipelines group (about 50% of 2010 revenues) includes Pembina’s crude oil and natural gas liquids pipelines in Alberta and British Columbia. The 7,500 km network transports approximately half of Alberta's conventional crude oil production and about 20 percent of the natural gas liquids produced in Western Canada.
The Oil Sands & Heavy Oil group (about 23% of 2010 revenues) includes the company’s three oil sands pipelines. It transports crude oil for Syncrude Canada (Syncrude Pipeline) and Canadian Natural Resources (Horizon Pipeline) to delivery points near Edmonton, Alberta. Pembina also owns and operates the Cheecham Lateral, which serves oil sands producers operating southeast of Fort McMurray, Alberta. The company is currently working on two projects in this group, the Nipisi and Mitsue pipelines, which, when completed, will provide transportation service to producers operating in the Peace River heavy oil region of Alberta.
The Midstream and Marketing group (about 15% of 2010 revenues) includes a network of terminals, storage and hub services operated on Pembina’s Conventional Pipelines system and a 50 percent non-operated interest in the Fort Saskatchewan Ethylene Storage Facility located near Edmonton, Alberta.
The Gas Services group (about 12% of 2010 revenues) includes the natural gas gathering and processing assets acquired in the purchase of the Cutbank Complex in 2009. The complex is located approximately 100 km south of Grande Prairie, Alberta, and includes 300 km of gathering lines and ownership in three sweet gas processing plants with 360 million cubic feet per day of processing capacity.
Pembina's stated business strategy is “to provide highly competitive and reliable returns to investors through monthly dividends while also enhancing the long-term value of our shares.” This is an enviable focus on the shareholder, backed up by the company’s long history of reliable operations. In fact, the first way in which it plans to achieve its strategy is by providing customers with cost-effective, reliable services. Additional areas of focus include diversification of its asset base, a commitment to both safety and the environment, growth through expansion of existing businesses, acquisition and development of new services, and the maintenance of a strong balance sheet.
The company’s largest segment is clearly its Conventional Pipeline group. Costs in this group are tightly monitored to ensure sustainable operating margins. Growth is sought out via incremental volume gains and system expansion. That said, with an operating history of over 50 years, this is a mature business. Results are driven by the amount of oil and gas transported through the company’s pipelines (throughput), so oil and gas prices have relatively little direct impact on the company. Still, reduced drilling activity, driven by lower prices, can affect results, so commodity prices can exert an influence. Material revenue growth here isn’t likely to be organic or easy to generate, but the group provides a stable base of operations to support expansion in other areas, a fact that has not gone unrecognized by management.
Pembina’s brightest prospects are in the Oil Sands & Heavy Oil group. Here, the company is the sole transporter of crude oil for several material projects in Canada’s oil sands regions. These regions offer vast reserves of relatively expensive to extract oil that have become increasingly viable as oil prices have advanced in recent years. The pipelines operate under long-term contracts that provide for the flow-through of operating expenses to the customers. Thus, results from this group are primarily related to invested capital and not to fluctuations in operating expenses or actual throughputs. The above noted Nipisi and Mitsue Pipeline projects should provide for solid growth in this segment.
The company’s remaining segments, Midstream and Marketing and Gas Services, are much smaller, though together represent almost 30% of the business. These two groups leverage off of the company’s extensive pipeline operations and reputation. The operations allow Pembina to offer additional services to existing customers and, thus, to increase the desirability of doing business with the company.
In general, growth for Pembina will come from the building or purchase of new infrastructure, such as pipelines. Acquisitions and newly built projects are expensive undertakings, making funding the company’s growth a material concern. Although, historically, Pembina hasn’t had much difficulty funding its growth initiatives, this is a factor that could be limiting in the future should financing become tight. That said, so long as the company can continue to expand its operations, corporate performance should continue along a generally positive path.
At the time of this article's writing, the author did not have positions in any of the companies mentioned.