Why infrastructure trumps producers in the oilpatch
It should come as little surprise that energy infrastructure stocks have outperformed energy producers in the past year given the dramatic pullback in oil prices.
But the infrastructure space has also done much better — with lower volatility — than the energy sector over longer periods as well (five, 10 and 20 years), in large part because of rising spending and production levels.
Between 2000 and 2007, oil prices averaged about US$40 per barrel. Yet capex in Canadian energy infrastructure rose tenfold, with spending driven by production growth rather than commodity prices.
Spending on energy-related infrastructure such as pipelines, storage, transportation, marketing and processing hit an all-time high in 2013, and should do so again when 2014 numbers are reported.
“We think production growth is going to continue, just not at the pace it has over the past five years, because price declines are not incentivizing as much drilling activity,” said Genevieve Roch-Decter, who runs LDIC Inc.’s North American Energy Infrastructure Fund with co-managers Andrew Pink and the firm’s chief executive Michael Decter.
Rising production helped drive most of the fund’s holdings to a record year in 2014 in earnings and cash flow, while dividend growth averaged 17% for the top 10 positions.
The portfolio managers don’t see oil prices returning to US$90 per barrel anytime soon, but that may not affect production. Roch-Decter noted that gas production continues to hit new highs even though prices have been cut in half over the past five years.
“We see a pretty similar scenario for oil,” she said, “We’re just going to be in a lower-cost environment, which continues to fuel revenue, EBITDA and dividend growth for all these companies.”
One big reason for the relatively lower volatility offered by energy infrastructure stocks is their cash-flow stability.
Some companies have take-or-pay contracts that require producers to pay them regardless of whether any volume moves through their pipelines or processing facilities, while others are paid on volume.
“Investors presume that when the oil price gets cut in half, the pipelines are going to suffer,” Decter said, pointing out that they are not directly tied to the price of oil.
Their stability also allows them to have low costs of capital, so they’ve been able to raise debt at rates near 3% to 3.5%, while generating rates of return for their overall operations of 15% to 17%.
As a result, some players are buying plants and gathering systems from energy producers, who are now more strapped for cash.
For example, Keyera Corp. bought a stake in a Bellatrix Exploration Ltd. gas plant and its related pipelines late in 2014. Around the same time, Encana Corp. and Mitsubishi Corp. sold gas pipeline and processing assets to Veresen Inc. and KKR & Co.
Fund- h ol d i ng Secure Energy Services Inc., which treats and disposes oilfield byproducts, recently raised nearly $200 million and it’s looking for acquisitions as many pro- ducers still handle their own waste water.
“Producers are starting to outsource more to companies like Secure,” Roch-Decter said. “You’re going see more deals of this nature as producers get more and more desperate.”
She also noted companies such as Secure that serve producers that have already drilled wells stand to benefit as the wells age and produce more fluid. This is particularly true given how quickly production has grown in the past five years.
Another name the managers like is Parkland Fuel Corp. (PKI/TSX), one of the fastestgrowing independent fuel and petroleum products marketers in North America.
The company has grown very aggressively through acquisitions (22 since 2006), and recently bought Pioneer Energy LP’s assets. Roch-Decter noted that the deal will boost Parkland’s EBITDA by 30% and gives it the highest retail presence for Esso gas stations across Canada.
The company subsequently announced it was buying Chevron’s locations, giving Parkland more than 1,000 new locations because of the two deals.
Parkland’s fuel margins remained steady when oil prices crashed in 2008/2009 and “they are showing that same stability now,” Roch-Decter said. “They are sort of insulated from this oil price correction, and still growing through acquisitions.”
A less obvious name in this space is Macquarie Infrastructure Co. LLC (MIC/ NYSE). It’s one of the biggest operators of airports catering to corporate and private jets, which means a third of its business benefits from a recovering economy and lower fuel prices.
About half of the company’s business is also in the storage of petroleum and bulk liquids all over the U.S. and it’s been making some sizable acquisitions in this area.
The company has grown its dividend as a result of its larger cash flows, and LDIC’s managers expect more big acquisitions are coming.
It’s also converting to a corporation from an income fund, which means the stock will be included in some indexes and that could create a lot of buying volume.
Production growth is going to continue
from international value funds, which have also fared well thus far in 2015.
Minimum and low-riskweighted strategies are delivering decent results.
China, despite concerns that have been overhanging markets for several years now, is an ongoing bet that its authorities will step up to install whatever measures are required to ensure a reasonable economic landing. The latest news on that front is that rules pertaining to secondary residences have been eased somewhat.
Continued strength in Indian equities is reflective of the anticipated positive effect of recent reforms.
There are now many different ways of gaining exposure to international equities. Which ones are best suited for your circumstances may require additional thought.
But the bottom line is that Canada’s equity market continues to face challenging circumstances. Given that we are all guilty of being overexposed to it, pursuing additional diversification internationally is a reasonable strategy — unless you are adamant the bottom in oil prices is behind us.