Inter Pipeline $IPL is one of the longest held companies in my portfolio; during its Income Trust days of August 2009. Over the years the growing dividend has provided me with an excellent cash flow. One major development in late 2016 was the purchase of Williams Canada and their Natural Gas Liquids business. This acquisition also provided plans for a potential Propane Dehydrogenation (PDH) facility and a Polypropylene (PP) facility. The $3BN capital cost and development of a new line of business has been a big concern of mine and after IPL's last quarter call many questions came to mind (Read:
Inter Pipeline's (IPPLF) CEO Christian Bayle on Q2 2017 Results - Earnings Call Transcript).
Questions:
- The need to "educate" others on the fee structure is concerning.
- Project appears to be much more likely to occur with nearly $455MM already spent on the project with a large equipment piece already ordered.
- 11 of 16 analysts had questions regarding the new projects in planning.
- What is up with all this interest in Polypropylene? Competing facilities planned by Pembina Pipeline and Tidewater Midstream and infrastructure.
- Is there a possibility of a Joint Venture to spread out the risk?
A few days ago I finally had an opportunity to speak with Inter Pipeline's investor relations. Here are notes from the conversation, which was not recorded and notes were hastily scribbled. I tried cleaning it up a bit, but to summarize I think the basic take away is:
The purpose of adding Polypropylene is to take Propane, a landlocked commodity that is currently oversupplied in Alberta, and hence, low priced; and converting it into a higher priced product that can be sold globally.
While I didn't drill down deeply into details the conversation gave me some more confidence with IPL's proposed plans.
Inter Pipeline has four business segments:
1) Oil transport
2) Natural Gas Liquids
3+4) Conventional and bulk liquid storage.
1) Oil Transport is the most stable segment.
- Most revenues: 55% EBITDA.
- Cost of service, no commodity risk.
- Upstream production, guarantees capacity.
- Typically 25 year contracts.
- $600mm/year stable.
- Strategy (crown jewel) with $3BN invested recently is Cold lake and Polaris. It was completed in 2015 with approvals for excess capacity.
- It is a play on oil sands, if the commodity price increases they can expand with reduced regulatory needs.
- Conventional oil in Saskatchewan is fee based.
- When Oil was at $20, throughput was 200k, now with oil higher they are at 208k.
3+4) Bulk storage, Europe. Counter cyclical segment. Storage can be used by clients for contango.
- 98/99% capacity usage.
- Little is actually used for contango storage.
- 15% remaining is operational flow of liquids.
- Liquids stored include things like vodka and vegetable oil.
- Growth through acquisitions.
- Most deal flow for this segment is in Europe.
2) Natural Gas Liquids
- 2004 straddle business bought from Williams.
- 2015 Off Gas business bought from Williams.
- Williams already invested $2.5BN. Unique to Alberta.
- Few upgraders available, which turn Bitumen into better products.
- Byproduct Off Gas is used as feed stock for other processes.
- Byproduct is liquids rich.
- Sent to extraction facility instead of burning.
- Valuable gases/liquids shipped: Ethelyne to Nova Chemicals.
- Oliphineics are not abundant and high demand. "Rare" and not natural.
- Examples: Polypropylene and Oil Sand condensates.
- Propane price is weak.
- $1.35bn acquisition of Williams signalled to the market a 95% commodity exposure.
- Same idea as 2004 when NGL extraction plants were acquired from Williams.
- Natural Gas Liquids to fund other line of business to reduce commodity exposure.
- Biggest growth will be Propane Dehydrogenation (PDH) / Polypropylene (PP) (PDH/PP).
- Alberta has an oversupply of propane by 125k. Projected oversupply is out to 2026.
- Solution is to take excess propane and convert it to high value product: "plastic pellets".
- By 2021 when facilities are constructed this will move the value chain downstream.
- Polypropylene is currently produced in the Gulf Coast (USA).
- Propane is land locked.
- Plastic pellets Polypropylene has less environmental concerns and it is easier to move plastic vs propane.
- Polypropylene opens a global market. It is the second largest polymer used worldwide.
- Examples: Carpets, bumpers, water bottles... Manufacturing industry.
- In the morning drinking his Starbucks he looked at his coffee cup lid and it is made of polypropylene.
- Polypropylene is more attractive than propane.
- The Williams management and staff have been retained from the acquisition, giving IPL their expertise.
- Forecast Global current demand of 66mm tonnes to 2021 of 83mm tonnes.
- North American current 8.1mm tonnes with target 2021 of 9.3mm tonnes.
- Midwest Chicago is the target market, but they can get it deeper: Gulf, Asia, etc
- Polypropylene is better than transporting propane at a Terminal.
- The Hold Up/what's taking time is: Commercial Negotiation.
- Try to derisk the project with contracts.
- What does it mean to "educate"? There are two types of clients:
1) Polypropylene consumer that will either Sell or use it for manufacturing.
2) Alberta propane producers are getting hit from low prices, facilities will offer them access.
- Education of the consumer "carpet maker" who normally expects to buy at spot and unhedged. IPL will be able to offer them long term contracts and the economics is good. The hang up is the 4 year construction period and then signing up for a 5-10 year contract.
- *All commercial factors, the Term is the sticking point. Value is proven by moving up the value chain.
- Making a normal agreement still takes a long time.
- Few periods where it has been a Win/Win. Hard to lock in a 5 year contract after 4 years.
- It is compelling for them to lock in and for IPL to be able to go forward. Mutually beneficial.
- Education is figuring out the framework.
- Investors buy IPL for stability. Acquisitions have been for stability.
- Sufficient take or pay contract.
- Natural Gas Liquid value chain. We are doing as before.
- * 525k tonnes of Polypropylene capacity.
- They will create Polypropylene contracts with some buffer (keep some for themselves to sell) that keeps some commodity exposure.
- The buffer allows them to stay as an active participant in market. Engaged in knowing the commodity market. aka Keeping a finger on the pulse.
- Canada is not a big user, but Canada still imports 500k tonnes.
- Target market for Polypropylene is mostly USA and probably some Canada.
- Pembina Pipelines (PPL) will be building same size +500k, but IPL doesn't think it will over saturate the market. "We would build a second facility if PPL didn't.|"
- 15% growth in north America. 25% growth globally.
- Polypropylene production is unique to Canada, but the technology and building have been done before in the Gulf.
- IPL not worried about less propane available with AltaGas's (ALA) Ridley Island Propane Export Terminal.
- IPL has already spent more than PPL and has bid for components for construction. Getting a fixed quote shows how far we are in the planning.
- Literally want the right contracts for the facility.
- * Comparing with Canexus is not relevant as they are a different sized company with different access to capital, financing, and credit rates.
- IPL's share weakness and lack of transparency is due to the Final Investment Decision (FID).
- IPL's Off Gas business is still being digested and Analysts are still trying to figure out this segment. - Example: $40mm EBITDA in Q1 with IPL vs. $40mm in one year with Williams.
- FID completion will be a catalyst for IPL shares.
- Chris (CEO?) wouldn't do PDH/PP unless it was "good" for shareholders. IPL is investor focused.
- Important to keep in mind the dividend is not underpinned by Commodity Exposure.
- Partnering is not off the table, but it would be a good access to Capital.
- However a Joint Venture would be about more than money. IPL would want them to bring expertise and contracts.
- Example of IPL financial strength, 2013-2015, $3bn deal was done solo and this was when IPL was smaller. Now IPL is bigger and should be able to do it solo.
- Joint Ventures means more complex contracts for supply and product sales.
- IPL has a good track record, so why give up returns. We have experts.
- Financing would be targeting 50/50 debt and equity.
- Target Debt to Capitalization is 50-55%.
- Corridor Oil Sands system has $1.5/1.6 BN of Non-Recourse debt that is serviced by shippers.
- Q2 YTD 55% Debt to Total Capitalization. Debt Covenant allows for 65%.
- Organic project spending over number of months would be funded via the bank line, $1.5bn facility.
- Lumpy spending on the project (not all payments are upfront) means they can draw down their Credit Line then go to Debt market for 7 and 10 Year Issues to repay and then reuse the Credit Line.
- Equity not preferred as share price is down. "not keen on it".
- Currently at the top range of Debt to Capitalization.
- DRIP gives $25mm/month, $300mm/year. (Note: DRIP discount was removed August 2015; Williams acquisition was August 2016; Premium Dividend reinstated Oct 2016)
- DRIP would provide the company with $1.2bn over 4 years.
- Williams and Cold Lake acquisitions pushed Debt to Capitalization over 57%.
- DRIP brought the Debt to Capitalization back down. DRIP also provides flexibility as it is better than doing a bought deal and paying underwriter, fees, etc.
- Macro events always an issue.
- "Not everywhere on market that you can get a 7% yield. Attractive on the market."
Note: IPL has hit a 52 week low of $22.14 (Aug 30, 2017), much lower from the 52 Week High of $30.07. I have been averaging down my position and added more yesterday (Aug 30, 2017) based on the price and to an extent from the conversation with Inter Pipeline. The intention is to continue holding a core position and the excess will be sold if and when the price recovers.
