Plains GP Holdings, L.P.

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 3/5

Plains GP Holdings, L.P. is a limited partnership operating in the midstream energy sector, focusing on the transportation, storage, and marketing of crude oil and natural gas liquids (NGLs) across North America.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview and Analysis

Plains GP Holdings, L.P. (PAGP) operates within the complex midstream energy sector. Understanding the specifics of their operations, competitive landscape, and financial health is paramount to evaluate its potential as a long-term investment.

Revenue Streams

PAGP’s revenue is derived from two main segments:

  • Crude Oil: This segment involves gathering, transporting, storing, and marketing crude oil through a vast network of pipelines, facilities, and terminals across North America. Revenue comes from pipeline tariffs, terminaling, throughput, and related fees.
  • NGL: This segment deals with gathering, processing, fractionation, storing, and transporting NGLs. Similar to the crude oil segment, revenue is generated from volumes and related fees.

Geographic sales primarily target markets in the United States and Canada.

  • Revenues are mainly generated from contracts with customers using the pipeline system, these are both for transportation and for sales.

Industry Dynamics and Competitive Landscape

The midstream energy industry is characterized by several key dynamics:

  • Dependence on Commodity Prices: While midstream companies are somewhat insulated, their operations are indirectly affected by commodity prices. Lower prices can reduce production activity, impacting throughput volumes, and thus, revenue.
    • However, as a toll-taker, PAAP is also able to somewhat mitigate the effects of price fluctuations.
  • Competition: The industry is competitive, with numerous companies offering similar services. Competition revolves around factors such as location, pricing, network density, efficiency, and service quality. The intensity of rivalry is usually highest between players with limited differentiation.
  • Infrastructure Intensity: Midstream operations are capital-intensive, requiring significant investments in pipelines, storage facilities, and other infrastructure. High capital requirements create a barrier to entry, but also high fixed expenses that must be covered.
  • Regulatory Environment: Regulations significantly impact midstream operations by affecting the cost and permitting of facilities and infrastructure. Changes to policies may affect both margins and growth opportunities.
  • Long-Term Contracts and Stable Demand: Typically, these firms enter into long-term contracts, giving them stable cashflows. They also benefit because commodity demand is stable and resilient over the years.

PAGP distinguishes itself from its competitors through:

  • Extensive Integrated Network: Its vast network, spanning across the U.S. and Canada, provides a competitive advantage over competitors with less coverage. This offers customers reliable and diverse options.
  • Strategic Locations: PAGP’s facilities are often located near major production regions and demand hubs, which reduces transportation costs for its customers.
  • Focus on Crude Oil and NGLs: The company’s focus on both crude and NGLs allows for greater diversification, and offers a full service to customers.

A recent trend in the industry, has been the increasing demand of energy security and stability to offset geopolitical concerns. Because of Russia’s invasion of Ukraine, both Europe and other countries are scrambling to meet their energy needs, and that increases the demand for North American Energy. Companies like PAA, that can quickly and efficiently transport oil and gas, become very valuable in those times.

Financials Deep Dive

Let’s take a deep look at how PAGP is operating. To properly understand, it is important to dissect their financials to understand the business better.

  • Revenue and Operating Income:

    • Revenues are primarily generated from the Crude Oil and NGL segments. Historically, crude oil revenues are significantly higher, but NGLs are becoming a more important revenue source over time.

      • In the 9 Months Ended September 30th, 2023, Plains GP Holdings reported total revenues of $30.9 billion. This was made up of Crude Oil revenues of $27.9 billion, and NGL Revenues of $3.0 billion. This has increased from the prior year of $20.4 and $1.3. A large part of the boost was a result of increased oil prices. This highlights the reliance the company still has on the crude oil markets.
      • The adjusted EBITDA was $2.7 billion.
    • There have been some concerns about the volatility of NGL prices. If a company can produce and sell both oil and NGLs, they have the opportunity to earn both. However, the margin may come primarily from their oil revenue as NGL prices are more volatile and the margins much lower.
    • Operating margins for both segments can fluctuate due to operational costs and price fluctuations of commodities.
      • The company’s operating expenses have increased from 10,615 million to 12,080 million in the first nine months of 2022 and 2023. This shows that while they are increasing revenues, their costs are also rising.
  • Return on Invested Capital (ROIC):
    • ROIC is a key metric of value creation and is determined by a company’s profitability relative to invested capital. While difficult to calculate directly from filings, the company has consistently shown returns that are above their cost of capital.
    • However, due to the volatility in commodity prices, ROIC can fluctuate.
  • Leverage:

    • PAGP has a significant amount of long-term debt, totaling $18.3 billion as of September 30th, 2023. Management has said they are focused on reducing their debt.

      • During periods of volatile energy prices, companies may face difficulties in generating sufficient revenues to cover their debts, if prices fall too far. In these periods the company may have a negative ROIC.
      • However, management’s goal is to reduce their long-term debt. A lower debt will give more stability for the future, with decreased debt expenses.
  • Capital Expenditures:
    • The company has made significant capital expenditures. These expenses are needed for expanding capacity of their existing business.
  • Cash Flow:
    • The cash flow has been significantly higher in 2022 and 2023. The 9 month operations have seen a net cash flow of $2.2 billion.
    • Free cash flow of the company can vary due to fluctuation in revenues and capital expenditures.
  • Recent Concerns/Controversies:

    • A recent concern raised by some investors is the impact of energy transitions and potential government policies on the future demand for fossil fuels. While management acknowledges that it is hard to predict the future, they have indicated they will continue to evaluate their business to better serve their customers.

      • They also recognize the need to pivot toward new forms of energy in the long term.
    • PAGP has increased capital expenditures as of late, which may be concerning to investors, but the management states that this investment is to meet high customer demand.
    • The company has also had some litigation issues relating to a lawsuit against one of their pipeline facilities in California.

In 2023, the management has stated that they are seeing a very bright outlook for 2024, because of higher oil prices, increased throughput, and cost cutting initiatives. All of this makes them more optimistic for higher revenues in the coming year. * On the flip side, they also mentioned some operational difficulties because of extreme weather patterns they are facing in their regions. Also, their NGL segment has seen decreased volume throughput because of the price increases and lower demand.

Moat Analysis

While PAGP operates a massive infrastructure in the midstream energy sector, a traditional wide moat is questionable. The company’s economic moat can be classified as a narrow moat for several reasons:

  1. Switching Costs: While switching costs exist as customers have an incentive to stay on their existing pipeline infrastructure, they can also choose to pay for transport via truck or rail, if that is cheaper for them.
  2. Cost Advantages: The size of its operations and established network provides a certain level of cost advantages. However, other companies in the space operate similar networks, so their cost advantages are not that high.
  3. Network Effect: While there may be some effects of having a large pipeline network, these are not as significant as an internet business. Having more connected pipes does not mean more demand and sales. * Instead, it often just moves more volumes at the same rates for customers.
  4. Intangible Assets: While contracts have their worth, they do not give any sustainable pricing power over a long period of time.

Based on these factors, it is clear that PAAP does have some elements of a moat, but their value is relatively narrow. Therefore, we will give them a moat rating of 2 out of 5.

Risks to the Moat & Resilience

While PAGP has shown a solid understanding of their industry, several risks could potentially undermine their competitive advantages and/or hurt the business:

  1. Volatile Commodity Prices: Although not directly correlated, commodity price crashes can reduce demand for pipeline infrastructure and thereby decrease revenue. This can also lead to lower margins if the price of contracts does not account for the lower pricing.
  2. Regulatory Changes: New regulations could alter the cost of doing business and affect the profitability of the firm. These may come at any level (federal, state, or even regional) and could seriously affect different areas of the business.
  3. Overleveraging: Their debt load, despite being managed, is quite high. Increased interest rates could have a huge impact on the business and its viability.
  4. Environmental Risks: Accidents or spills can create liabilities and reputation damage for the company. * This is a constant risk when dealing with highly volatile and flammable liquids.
  5. Competition: Increased competition from new entrants or aggressive price wars from existing competitors could impact the margins of the business.
  6. Demand for Fossil Fuels: The overall trend toward renewable energy, and lower production may eventually decrease the demand for the transportation of fossil fuels.

Given all of these points, it can be deduced that the business is somewhat resilient as it operates in a critical part of the economy. There is always a demand for oil and gas, and having long-term contracts will somewhat mitigate the effects of any macro-economic fluctuations.

Understandability

PAGP’s business model is not too complex to understand, given that it provides transportation and logistics for oil and gas. However, the factors that determine its performance, and its business risks are more complicated for the average investor. It requires understanding a little bit about the energy industry and some finance metrics. Based on this, a rating of 3 out of 5 for understandability is appropriate.

Balance Sheet Health

PAGP’s debt and capitalization make their balance sheet relatively healthy, but it could be even better. The long-term debt is still very high, at $18.3 billion. However, their operating activities are very profitable and cashflows are consistently high. This gives them the capacity to pay down debts. They have a good debt-to-asset ratio and have a positive working capital to cover near term liabilities. But the level of long-term debt requires them to have a 3 out of 5 rating.

To conclude, Plains GP Holdings is a key player in the midstream energy sector with a narrow moat and long term contracts that will provide them with stable revenues. However, they do face some risk due to the volatility of commodity prices and potential regulatory risk. The business is somewhat complex and therefore, has a moderate level of understandability. They also have a relatively good balance sheet, but their long term debts need to be watched carefully.