Plains All American: Flat Stock Price But Improved Business, Another Buy (NASDAQ:PAA)

In April 2024, I wrote an article about the Plains All American Pipeline (NASDAQ: PAA) arguing that although the share price has seen significant alpha relative to the index, there is still room for further value creation. All in all, the case boiled over more on receiving attractive dividends with very limited risk. Furthermore, the fact that Management has communicated that it will increase the dividend by $0.15 per share per year until the 1.6x distribution coverage is received already implies a forward yield between 8 – 9% (obviously dependent on incremental EBITDA growth ). This is very attractive, especially considering that the target dividend coverage is set at a level from which it will be possible to accommodate growth through internal cash flows and/or maintain a sufficient margin of safety in the Company.

In my last article about PAA, we assessed Q1 2024 earnings performance and concluded that the case remains attractive as the downsides have not changed. Since then, PAA has delivered total returns that are somewhat in line with the market. However, price-wise, the stock is flat, which means that unless something bad happened to the underlying business, my investment case for PAA should remain intact.

Let’s now look at the relatively recently released Q2 2024 earnings report to see if there is still a basis to justify an optimistic view.

Revision of the thesis

In short, Q2, 2024 earnings again include data points that show robust performance and solid fundamentals. During the quarter, PAA reported adjusted EBITDA of $674 million, which is significantly above the level achieved in the same period last year. Improvements were seen at both ends of the core business – ie EBITDA for the clean oil segment increased by 8.8% and for the NGL segment, EBITDA increased by 51%. On a total adjusted EBITDA basis, year-over-year growth landed at ~13%, which is massive in the context of PAA’s EV / EBITDA multiple of 9.3x.

On a quarterly basis, the rate of change in Total Adjusted EBITDA was slightly negative, but this was fully related to the seasonality of the NGL segment (as previously communicated by management and fully expected by the market). If we adjust for seasonality in the NGL segment, total EBITDA generation would be up ~4.4% from the previous quarter.

So, already from these statistics, we could suggest that PAA business has consolidated and delivered solid results, from which PAA could fund further growth opportunities or distribute even higher flows to unit holders. This dynamic does not coincide with PAA’s flat share price and the fact that interest rates are set to fall, which should in theory provide upward pressure on the multiple.

Even aside from the solid EBITDA generation levels, PAA has provided some additional elements that, in my opinion, further enhance the bull case.

For example, during the quarter PAA entered into an M&A agreement by acquiring an additional 0.7% interest in Wink to Webster Pipeline Company, paying a $20 million note. It’s obviously a small business that won’t move the needle, but I think it sends a strong message that PAA is willing to consider mergers and acquisitions to grow the business.

Furthermore, while management kept the production outlook unchanged at an increase of 200,000 to 300,000 barrels per day due to M&A synergies and operational efficiencies arising from previously committed maintenance CapEx, it decided to raise the midpoint for full-year 2024 adjusted EBITDA guidance by $75 million in a range of $2.725 billion – $2.775 billion.

As a result, the level of expected adjusted free cash flow for 2024 now comes to $1.55 billion, which includes $130 million of mergers and acquisitions and $1.15 billion of distributions to common and preferred unitholders. Additionally, according to the Q2 2024 earnings report, the CapEx maintenance and growth programs were largely unchanged at $250 million and $375 million, respectively.

What this means is that PAA continues to have a strong cash generation profile, which is sufficient to leave ample room for maneuver in allocating accumulated capital beyond distribution and ex-quo capital needs.

As mentioned above, some of this excess liquidity will be gradually directed towards further dividend increases until the dividend coverage level falls from the current level of 1.9x to 1.6x. This process and dividend coverage of 1.6x per definition still allows PAA to retain decent amounts of cash. Given that PAA’s leverage is already below the target range of 3.25x to 3.75x (currently at 3.1x), my base case is that we should see increased PAA activity at the end of mergers and purchases. This, in turn, will provide a boost to future EBITDA, from which sustained dividend growth momentum could be maintained even after meeting the 1.6x dividend coverage target.

Finally, there is another critical data point to consider, which is PAA’s long-term agreement in the NGL segment, which will not only guarantee better cash flow stability, but also reduce risk general of the business. Commentary on the recent earnings call from Jeremy Goebel – Executive Vice President and CCO – explains this dynamic nicely:

Yes Tristan, this is Jeremy again. What I would say is we’re not going to provide guidance on the NGL segment, but we’ve done a 15+ year contract that has replaced about a third of our frac spread exposure. We are investing $150 million to $200 million to replace this collection, fractionation, storage, transportation business. So it will look exactly like an integrated NGL value chain, which we already have. This means fixing and strengthening the part. So we’ll go from about 60/40 fractional exposure to less than 50/50. So I would say longer term, this is definitely a more predictable chain, but we like the straddle business and will continue to support that business as well.

The bottom line

All in all, PAA was able to ride another strong quarter where it not only achieved the necessary stability, but strengthened its overall business profitability outlook. Meanwhile, the share price since the publication of my previous article has remained flat, leading to an easy conclusion that the bull case remains intact. Namely, in Q2, 2024, PAA’s business strengthened amid a more favorable interest rate outlook, but the share price remained unchanged.

As a result, I remain bullish on the Plains All American.