Pembina Pipeline (TSX: PPL, NYSE: PBA) had a roller coaster year. The stock price remained strong all last summer during the initial crude slide only to struggle later in 2014 with concerns over recontracting, equity needs, and Statoil’s deferral of their Cornerstone oil sands project. The stock has stabilized since the analyst day in early March (slides available here) as investors now know much better what they can expect. The move towards fee-based EBITDA has been highlighted in nearly every energy infrastructure company’s analyst day presentation, and Pembina was no different. The message from management involved taking on less risk by focusing growth on their fee-for-service and take-or-pay sources of EBITDA.
Where Pembina’s message was unique was management’s presentation of how the company’s acquisition multiples have changed after the fact. As we’ve mentioned before, the main reason large North American energy infrastructure players believe M&A has not happened despite the challenging market environment is that the bid-ask spread for desirable assets remains wide. The deals that are getting done aren’t home runs from a multiple perspective. Many are neutral in the near term, and some are even mildly dilutive. Over the long term, efficiencies and synergies do bring down multiples. This is the thinking behind deals like Energy Transfer Equity (ETE) offering to buy Williams Companies (WMB)—the focus is on 2019 and beyond. Lots of words are written about where multiples will move to, but it’s nice to be able to see the before and after, rather than just the projections.
The first questions to ask around interest rate sensitivity are fairly similar to the first questions about cash flow. How much debtdo you have, and how much of that is fixed rate versus floating? (Just like, how much cash are you earning, and how much of that is fee-based versus commodity price sensitive?) Raw debt is rarely useful, so measures like leverage ratios (Debt/EBITDA) are frequently used. In this way, comparisons can be made not only over time, but also between companies.
Looking at a snapshot in time of leverage ratios is helpful, but does not consider the whole story in the same way that a $500 payday loan is not the same as a $250,000 30-year fixed-rate mortgage, is not the same as $40 borrowed from your buddy, is not the same as a $100,000 10-year floating-rate mortgage. Both time frame for repayment and the cost of the debt matter. Given that nearly everyone expects interest rates to increase, locking in low rates now for long-term debt can be a very smart move.
Not every large energy infrastructure company has leverage this low, a percentage of fixed-rate debt this high, and debt terms this long, but much like most of them now have a high percentage of fee-based cash flows, this type of credit profile is becoming more the norm than the exception.