Pembina Pipeline Corporation

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 3/5

Pembina Pipeline Corporation is a Canadian company that operates pipelines and related infrastructure for crude oil and natural gas.

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.

Pembina’s business is complex, encompassing various aspects of energy infrastructure. It’s crucial to remember that the most current information from earnings calls and SEC filings should hold more weight.

Business Description

Pembina Pipeline Corporation (PBA) is a midstream company primarily involved in the transportation and storage of hydrocarbon liquids and natural gas. Its operations are spread across Canada and the U.S., with key infrastructure assets like pipelines, terminals, and processing facilities.

  • Revenues:
    • Pipelines: The core of PBA’s business is its pipelines, which are used for transporting crude oil, natural gas liquids (NGLs), and natural gas. The fees they receive are based on throughput volumes and tariffs, often structured under long-term, fee-based contracts, which can provide a relatively stable revenue stream. The company’s revenue is not as affected by the price swings of commodities because of the volume-based structure. The pricing is primarily based on the cost of transporting per unit, and is highly regulated.
    • Facilities: This segment includes processing plants, fractionation facilities, and storage terminals. The company takes a fee for services offered like processing or storage and is often based on volume and contracted for long periods of time.
    • Marketing & New Ventures: PBA buys and sells commodities and operates export facilities. This revenue source is more volatile than pipelines and facilities as it is directly tied to the price of the commodities, especially if it’s not hedged.

Overall, PBA’s diverse revenue streams are designed to create stability but not all parts are equal: pipelines and facilities are much more stable than the marketing and new ventures.

  • Industry Trends:
  • Energy Transition: The energy sector faces strong push for greener and less carbon-intensive energy. This means future growth opportunities might be in sustainable fuel infrastructure.
  • Demand for Hydrocarbons: Although there’s a push towards renewables, the demand for hydrocarbons is still growing in emerging markets. So this is a mixed outlook.
  • Consolidation: Midstream companies are consolidating to reduce costs and create efficiencies. In the past couple of years, smaller companies have been bought up by larger companies.
  • Margins:
    • Pipeline and facilities segments generally enjoy higher margins than marketing and new ventures, because they are more protected from commodity price swings. The margins depend on the long term contracts and the regulated tariffs and fees, which also provide predictability.
  • Competitive Landscape:
    • The midstream sector is fiercely competitive and is mostly consolidated to a few large players. However, smaller players are also present with specific localized assets.
    • Competition is based on geographic footprint, cost efficiency, reliability of service, and access to key infrastructure and assets. Having assets that are difficult to replicate and a diversified set of operations in different areas of operations is a massive strength.

The industry is constantly changing, so one must look at all the latest data instead of historical reports to make sure their analysis is correct.

Moat Analysis: 3/5

While PBA doesn’t possess an impenetrable wide moat, it has some durable competitive advantages that give it a solid narrow moat rating.

  • Network Effect & Scale:
    • PBA’s pipeline network spans across a huge geographic area in North America and has connections to key oil and gas basins. This infrastructure has created a high barrier to entry for new competitors due to the high capital and regulations required for new projects. Once pipelines are in place, they are difficult to replicate and offer unique connectivity to their customers. Their ability to connect producers with the most suitable customers provides them with a competitive edge that has a limited availability in the market.
    • Their facilities such as fractionators, processing plants and storage terminals, are also critical pieces of infrastructure in their regions and allow them to offer a unique service, with very high switching costs.
  • Switching Costs:
    • Customers rely heavily on PBA to transport, store, and process their hydrocarbons, so there is a high cost to switching to a new midstream company. A company switching to another midstream company would need to invest heavily into building new connections and may jeopardize their supply chain for extended periods of time.
  • Cost Advantages
    • PBA has a large, integrated midstream system, meaning it is able to lower costs and gain a cost advantage due to efficiencies of scale.
  • Barriers to Entry: The pipeline business requires massive upfront capital, and is heavily regulated. This limits potential competition and also creates a barrier of entry. Moreover, regulatory and environmental approvals can be a big hurdle for any potential entrant.

Although PBA enjoys several moat advantages, new technologies and renewable energies might present competitive risks in the future.

Risks to the Moat and Business Resilience

While PBA’s business is relatively stable, here are potential risks to be aware of:

  • Regulatory Risk: Changes in regulations could increase costs for the business. Some governments might tighten environmental requirements and might not allow expansions of certain infrastructure.
  • Technology Risk: Advances in technology, like transportation methods, or carbon-capture technologies may diminish PBA’s existing advantages in the long run.
  • Commodity Prices: Although it is mainly a fee-based structure, it still holds some exposure to commodity prices which may affect the demand for its services.
  • High leverage: As you’ll see in the next section, the company has taken out a lot of debt. With higher interest rates, their interest expenses are high which can squeeze out their profits. This is a very critical point to note.
  • Geopolitical Risk: Tensions between nations and policies regarding resource extraction and energy transport can affect the energy sector significantly.
  • Disruptive Technologies:
    • Long-term, the company faces a massive risk because of new technologies and renewable energy sources.
  • Customer Concentration: Any major loss of their customer base may drastically impact the company’s earnings.

To maintain business resilience, management needs to continuously explore new markets, engage in new projects to improve returns on invested capital (ROIC) and maintain a strong balance sheet.

Financial Analysis

The overall profitability of PBA is pretty high, but you need to be aware of some risks related to the debt the company has amassed over the past years.

  • Profitability:

    • Revenues: Exhibit 31.14 on page 667 of Valuation: Measuring and Managing the Value of Companies show that the company’s revenues are a mixed of pipeline, facilities, and other sources.
    • Margins:
      • The operating margins have been relatively high (around 20-30%), with the facility and pipeline segments usually being the most profitable and most consistent.
      • However, marketing and new ventures have significantly lower margins due to higher price volatility and the company’s exposure to commodity prices.
    • ROIC: Exhibit 33.1 on page 731 of Valuation: Measuring and Managing the Value of Companies notes that energy industry companies generate modest to high returns on invested capital. Although the company’s overall ROIC might look attractive, remember to take into account the company’s cost of capital.
    • Earnings and Free Cash Flow: Overall, the business generates good cash from operations (around $2.7 billion in 2023 according to the latest report in the Form 6k document from January 4th, 2024), and the management has been mostly successful at retaining and increasing overall profitability. You should check for trends in the free cash flows as it indicates the amount of available cash for dividends and other discretionary spending.

  • Balance Sheet:

    • Debt: The company is highly levered, due to a lot of borrowing over the past couple of years. Their short-term debt was $2.1 billion while their long-term debt was $8.8 billion. Their total assets are $28.8 billion, as of December 2023. High debt levels make the company vulnerable to interest rate changes, and may create trouble for the company, if they can’t refinance at decent rates.
  • Asset Value: A big part of the company’s assets are in long-term assets like their pipelines, and related infrastructure which are difficult to liquidate. Also, intangibles, such as goodwill, may also have uncertain valuation.
  • Share Dilution: You should also be on the look out for continuous share dilutive behavior, which means that the management may be willing to dilute existing shareholders, to pay for growth or acquisitions.
  • Cash: The company does hold a fairly good level of cash at $669 million, which helps maintain financial flexibility.

Based on the 6-K report released on Jan 4, 2024, the company’s net income saw a massive growth over the prior year, which is a huge positive and it seems their aggressive growth strategies have been paying off. However, high debt and interest expenses have also created a drag on the business.

Understandability: 2 / 5

PBA’s business isn’t complex to understand at the basic level of transportation and storage. However, it involves intricacies like long-term contracts, pricing regulations, infrastructure management, commodity market participation, and financial engineering, which can prove complicated, especially when analyzing the company’s financial statements.

Balance Sheet Health: 3 / 5

Although the company has a massive asset base, which is good, its high debt can be a big risk and is the reason it gets a 3/5 rating. The high debt is especially concerning in this current economic environment, with interest rates constantly rising. This means they’ll have to devote more and more of their cash flow towards debt repayment, leaving them with less available for shareholder returns and other value-creating activities. Management needs to take steps to reduce the debt over the next few years.

To truly get a grasp of this business you must thoroughly analyse all the recent financial and management reports.

Conclusion

PBA is a midstream company with critical assets in the energy transportation space. Its moat is not the strongest, but its infrastructure assets and customer relationships give it a solid competitive advantage, which are protected by a few barriers to entry. The company is complex, and it’s important to take into account its high debt levels, while looking to invest. It’s essential to analyze the company consistently for changes in regulations and the competitive landscape. As always, it’s crucial to analyze the latest information available about the company rather than historical reports that may already be stale.