Don't Let Kinder's Pipeline Woes Scare You

It's been a busy week for energy news. In this week's medley episode of Industry Focus: Energy, host Sarah Priestley and Motley Fool contributor Taylor Muckerman dive into a few of the biggest stories. Gas prices in the U.S. are at four-year highs and consumers are finally feeling the pinch of OPEC's production cuts.

Kinder Morgan's (KMI -0.35%) Trans Mountain pipeline is running into a wall in British Columbia, and while this could be a huge deal for the company, long-term investors shouldn't give up just yet. A new road in China will be able to charge electric vehicles as they drive over it, which has exciting potential implications for electric and self-driving cars in the future. And the hosts close out with two promising stocks that they've been looking at recently. Tune in to find out more.

A full transcript follows the video.

This video was recorded on April 19, 2018.

Sarah Priestley: Welcome to Industry Focus, the show that dives into a different sector of the stock market every day. Today, we're talking Energy and Industrials. It's Thursday, the 19th of April. We're going to be talking about some interesting recent happenings and maybe pitch a stock. I'm your host, Sarah Priestley, and joining me in the studio is Motley Fool Canada Premium analyst, Taylor Muckerman. Taylor, how are you doing?

Taylor Muckerman: I'm wonderful! How are you?

Priestley: I'm good. Are you enjoying the baseball season?

Muckerman: That, and we started today off with a party at the office. We had our board meeting --

Priestley: Oh, we did! We had breakfast, donuts.

Muckerman: Yeah, loving it.

Priestley: I never ate as many donuts as when I started working at this office. [laughs] 

Muckerman: [laughs] Well, all we have here are sandwich shops and donut shops near the office.

Priestley: It's true.

Muckerman: So, it's one or the other.

Priestley: Yeah, we're very big Dunkin Donuts fans.

Muckerman: Have you been to a game?

Priestley: No. [laughs] You caught me on it.

Muckerman: Austin is glaring at her through the screen here.

Priestley: I know Austin has, but, yes, I have not. And honestly, when I usually go, I spend most of the time at the food area.

Muckerman: Yeah. You want it to warm up a little bit before you go. Kick back.

Priestley: Oh, yes, definitely. First things first, we want to talk about the prices at the pump. Yesterday's average was $2.73 a gallon. In some parts of the country, it reached as high as $3.50 a gallon, the highest prices that we've seen for the past few years. The Energy Information Administration, EIA, says this is due to production cuts by major exporters, so OPEC production cuts are working. We've been seeing that. Now we're feeling the pinch in our own wallets. It's great news for U.S. oil stocks, but bad news for U.S. consumers, I guess.

Muckerman: Yeah. We usually see the price come up in the summer, because it's more expensive to refine gasoline for the summer, because it requires certain additives that prevent it from evaporating due to higher temperatures in the summer. So, you don't want to have your car just sitting there costing money without actually being turned on. But, yeah, you've seen gas prices creep up, almost to three or four-year highs. It seemed like they started creeping up before the price of oil did. You've seen refiner stocks do really, really well compared to producers, services companies, or pipelines over the last couple of years. And, likely to do with so many feedstocks flowing their direction, and the export market is really booming. But, three or four-year highs on gasoline, not something that consumers are looking forward to. That tax break, right out the window. [laughs] 

Priestley: It's funny that you mention the summer grade gasoline, because I'm pretty sure Britain does not have that issue. [laughs] 

Muckerman: No? Uh-oh. [laughs] 

Priestley: This is an aside, but the chocolate is the same. Apparently, the mixture of your chocolate is different than Europe because of the massive temperature fluctuations that you have.

Muckerman: Interesting.

Priestley: So, U.S. oil futures have risen about 40% since OPEC and Russia originally put the cap on oil output. Right now, those offsets are making up for a slight increase in U.S. shale. U.S. is now exporting a record amount.

Muckerman: Go us! [laughs] 

Priestley: Yeah, it's incredible. But, oil demand exceeded expectations by about a million barrels a day. So, this is strong gasoline and distillates demand, long may it continue to prop up what will inevitably be a production increase.

Muckerman: Yeah. You're starting to see us pretty almost too much, especially out of the Permian. There's been a number of articles come out in the last couple of days about pipeline shortages. Which, when you think about American pipelines, a shortage is one thing you wouldn't expect. But we're just out-producing our capacity to transport this oil. That's one area that we've had the advantage over the rest of the world, in terms of our shale resources. China and Argentina and other countries have plenty of shale resources, but they just don't have the infrastructure to transport it. So, they can't drill it if there's nowhere to go with it. So, now, we're starting to bump up, in certain areas, against transportation capacity. Maybe we'll see some returns to crude by rail, crude by truck. Thankfully, though, the Permian is close to the Gulf, so it won't be as long of a trek, as you saw years ago when they were doing the same thing out of the Bakken up in North Dakota.

Priestley: I was actually talking to an analyst here at The Fool about shippers the other day.

Muckerman: Like a high seas shipping?

Priestley: Yes, it's a fascinating part of the industry. But, hopefully we'll talk about that soon. We might as well go straight to another topic that we wanted to talk about, which is the showdown that's going on regarding a pipeline in Canada over the Trans Mountain pipeline.

Muckerman: Yeah, speaking of capacity constraints. [laughs] 

Priestley: Yeah, this might be a big one. On Monday, Alberta passed legislation which could potentially halt exports of oil and gas to British Columbia to try to force the province to stop their opposition to the pipeline. So, the Alberta Premier Rachel Notley said she doesn't want to use it, but she wants to make sure the province has every available tool to make sure the Trans Mountain gets build, because obviously for them, it's economically a huge boon.

Muckerman: Yeah, it surely would be, and even for the entire Canadian economy, Prime Minister Justin Trudeau has come out and says he fully supports the Trans Mountain expansion. Basically, Kinder Morgan already has a pipeline going from Alberta to British Columbia, but they want to tack on an expansion, roughly about $7.5 billion Canadian, $5 billion U.S.D. They've already dumped a considerable amount of money into that, almost $1 billion U.S.D. over the last five years, into planning and initial construction. But, British Columbia, still fighting back against this pipeline. We're looking at tens of billions of dollars at stake here for the Canadian economy over the next few years, and tens of thousands of jobs as well. They've already shot down a couple of pipelines. When you look at Enbridge's Northern Gateway Pipeline and TransCanada's Energy East Pipeline. 

And with the United States being the main export market for Canadian oil and natural gas, and the U.S. producing so much on its own now, they need to find an access to outside markets, we're looking at Asia and Europe here in particular. So, a pipeline like this would be quite necessary, but British Columbia is worried about more oil potentially spilling on the Pacific coast, even though we haven't really seen much of that in a long time. That's their reason behind voting against it. But, certainly, if Alberta decides to ship their crude somewhere else, British Columbia could be feeling the pain at the pump far more than the U.S. consumers are at the moment.

Priestley: Yeah, absolutely. There could be gasoline shortages, and Vancouver is the second biggest airport in Canada, and they'd see much higher jet fuel costs.

Muckerman: Yes.

Priestley: Then, also, like you said, you're looking at Alberta potentially losing a key market for crude and refined products.

Muckerman: For sure.

Priestley: It's interesting, because Kinder Morgan's CEO Steve Kean basically said, I kind of predicted this, he said these recent events have confirmed his concerns about the viability of the project, and that's spooking investors. He said, we've pointed out there are significant differences between governments, and those differences are outside of our ability to resolve. So, right now, they've stopped building, but by the end of May, then they have to come to a resolution.

Muckerman: Yeah. That's the line in the sand, May 31st.

Priestley: So, some legal challenges there.

Muckerman: They're only one vote shy. They have 44 seats on one side, 43 seats on the other side. They just need to swing one vote their way, and this pipeline could make its way westward.

Priestley: And this is a pretty big deal for Kinder. They're America's largest pipeline operator, so you could argue that it's a drop in the bucket, but it's not. A lot of people's growth projection for them is based on this five-year backlog of all these projects that amounts to about $12 billion. Like you said, $5 billion worth of that would be this project.

Muckerman: Yeah. And what you see with this company, the share price has been quite subdued, and obviously this could be one reason why. But, it's a recommendation we have in Pro Canada, and our lead advisor, Jim Gillies, confident that even if this doesn't go through, the shares are definitely undervalued. You see tons of cash flow generation with this company, and we look for them to continue delevering. 

They actually just announced earnings yesterday and boosted the dividend a little bit. So, they feel confident enough in that end. And this is a company that, I think you aren't going to go out there and now say, "They're just boosting their dividend because they want the market to think they're in a good financial standing." I think they're scared straight when it comes to the dividend after they caught it a couple of years ago and the share price plummeted. It's yet to recover from that. So, I don't think this is all optics, I think they're very serious and think they can fund a dividend increase moving forward while delevering the balance sheet.

Priestley: I've been looking at Kinder myself. On a price to book basis, they're looking incredibly attractive for all those value investors out there.

Muckerman: And the access and exposure to natural gas is a huge plus in my book. That's why I owned Spectra Energy before Enbridge bought it, because of the exposure to natural gas. I think that's a key reason why investors should take a look at Kinder Morgan.

Priestley: And if this does go through, the pipeline is already supported by three oil companies, and they've signed 15-20-year contracts. And that would be about 80% capacity of the pipeline, is that right?

Muckerman: Yeah, it's that take-or-pay fee structure we love with these pipelines. You get this long-term contract, renewable, consistent payment there.

Priestley: It makes them great stocks to own. This is kind of cool, it's our next news topic to talk about, China has built a road that will be able to charge an electric vehicle as you drive over it. They're calling this the intelligent highway, and it includes solar panels, mapping sensors and electric battery rechargers. Bloomberg reported on this, this is what they said, that technologies will be embedded underneath transparent concrete, used to build a 1,080-meter-long stretch of road, about 45,000 vehicles use this section of road every day, and the solar panels inside generate enough electricity to power highway lights and 800 homes. So, to translate that, that's about 3,500 feet of road. So, it's not a huge stretch. It's actually not long enough right now to charge an electric vehicle. But, incredible potential. The biggest thing that stood out for this, aside from the massive opportunity, is transparent concrete.

Muckerman: Yeah, it's pretty cool.

Priestley: Transparent concrete, that's incredible! The future has arrived.

Muckerman: I've even seen some concrete, not in play, but in videos, that's been used that's more porous, so water seeps right through the concrete and asphalt, rather than pooling on top of it or needing to drain off to the side. So, definitely some companies out there doing some interesting things with infrastructure.

Priestley: And this is off on a tangent again, but that could revolutionize going on the road infrastructure because when the water pools and it turns to ice, that's what creates all the fractures in the road. So, that would be incredible. But, yeah, this road is made up of three vertical layers, and it has a shell of the see-through concrete which allows sunlight to come through and reach the solar cells, and then on top it has recharging wires and sensors, and it monitors things like temperature, traffic flow, weight of the vehicle, and it's all to make these intelligent vehicles, as we drive toward more autonomous vehicles, more intelligent. So, I think the Chinese government wants 10% of all cars to be fully self-driving by 2030.

Muckerman: It's pretty cool!

Priestley: That's ambitious! [laughs] 

Muckerman: Yeah, that's a lot of cars. 10% of Chinese cars, I guess you could extrapolate that out to maybe 50%, 40% of U.S. cars by scale in terms of population. Pretty interesting stuff there, especially when you consider self-charging cars while driving, no need to stop at the rest station for 30 minutes to charge your vehicle. And I had seen the idea of parking lots being laid down with solar panels underneath them, but I have never seen it turned into a highway before. It's pretty interesting.

Priestley: In 2016, there was a French construction company, and I think they are the ones who trialed this first. It was a decent stretch of the solar paneled roads, and next year they're going to start to sell those for gas stations and parking lots and things, which will be awesome. But, yeah, potentially this could be really interesting. They're focusing very much on the intelligence aspects of it, in terms of better traffic updates, accurate mapping, avoidance of traffic patterns, and things like that. And it's all part of President Xi Jinping's Made in China 2025 project. So, he's trying to move the perception of the country away from this, "It's where we get our sneakers made," more to, this is a hub of manufacturing and innovation.

Muckerman: Cool. If there's one company out there that folks want to look at smart highways and roadways in the U.S., it's a company called Quarterhill. It's long been a patent litigation company. They buy patents and lease them out, or they litigate patent infringement on behalf of other companies. But, they've since turned half their business into an Internet of Things holding company, so, they've been acquiring small businesses. And most of their acquisitions have been in that smart highway, smart roadway space. So, a company to check out, Quarterhill. 

Priestley: That's awesome. I think, this is obviously breaking down the barriers of some of the thing that might actually stop electric vehicles in the short-term, in terms of like having to stop and charge and all those kinds of things. So, very exciting. Obviously, this was just one experiment. It cost the equivalent of $6.5 million to lay just this stretch, so right now not financially viable, but you don't expect it to be when something is straight out of --

Muckerman: Solar wasn't financially viable for a long time, either, and that rapidly changed. I think they said that the costs need to drop by about 50% before it's commercially viable, so we'll see. Cool either way.

Priestley: It is cool either way. I enjoyed reading that this weekend. So, we are both going to briefly pitch a stock that we're watching right now. We have no idea what stock the other has. [laughs] 

Muckerman: Yeah, hopefully it's not the same one. [laughs] 

Priestley: Well, I don't know. That could be a good sign.

Muckerman: Yeah, that's very good, confirmation bias.

Priestley: Did you want to go first? Do you want me to go first?

Muckerman: I can go. That'll work. One company I'm paying close attention to is Core Labs (CLB). They're based out of the Netherlands, but they have their U.S., maybe global, headquarters in Houston. This is a premier company that's involved in reservoir description and enhancement services. So, when you're looking at a well, they can basically recreate the well in their lab and tell you exactly what kind of fluid, what kind of proppants, what kind of chemicals, what kind of pressure. They can tell you exactly how to get the most bang for your buck. It's not cheap, but it's worth it in the long run. And this company is just continually buying back shares with their money. They generate tons of free cash flow. 

Kind of gone by the wayside when you look at the last few years, because the company's really trying to cut cost. But, as the price of oil creeps back up, this service is undeniably effective, and it can really be a game-changer to set companies that A, can afford it and B, are willing to afford it apart, and maximize their extraction from wells. We generally leave 50% of the oil or natural gas in these wells. Core Labs is helping change that. 

And, if we ever get back to offshore oil, those projects for them bring an even more highly profitable revenue. So, this is a company that I really like, and it's been doing fairly well over the last few weeks, as most oil stocks have. But, down considerably over the last several years. But, I'm looking for this company to rebound. It'll be a nice little ancillary services provider.

Priestley: You're going to think I'm joking, but I was honestly tossing up looking at that because it's just such a great business model, because oil companies are driving so much toward efficiency, and this is a company that can really offer them that efficiency.

Muckerman: Yes, absolutely. I went down there and met them with a few other Fools, probably four years ago, because it was before the 2014 collapse. Great management team. They were actually talking about, companies like Exxon used to do this on their own, and they realized that Core Labs could do it so much better. So, even the biggest energy company in the world gave up on trying to do what Core Labs is doing because they do it so much better, and they outsource to Core Labs. They even have old Exxon equipment in their lab that Exxon had sold to them because they were like, "You guys can probably retrofit this and make it a better machine than we've ever been able to." It's pretty cool to see that.

Priestley: Yes, that's a very big testament. Well, I can't claim anything as nice as having met with them, so mine is going to fall a little bit short. It's a company I think we've discussed on the show before, it's Brookfield Infrastructure Partners (BIP -0.72%). 

Brookfield Infrastructure is one of the world's largest infrastructure companies. They own energy distribution networks, cell network towers, electric lines, toll roads, ports, they even own some timberland. They have a very global portfolio. They have a strategy of acquiring distressed assets and turn them into cash cows and either sell them or keep them. And it's such a great business model, because they have this established asset base, and that allows them to, if they increase rates slightly, this enables them to finance their growth. 

Recently, they just made a $100 million toll road acquisition in India. They're looking further in India to expand cell towers there, which, I think, if you look at any of the trends coming out of that country, it's exactly the right way to go. Now everybody has cellphones here, nobody has phone lines. India is looking to bypass that and go straight to cellphones.

Muckerman: Yeah. You see that was a lot of the third world developing countries, they completely skip a step that America or Europe pioneered, and land right on the new technology. Cell phones, without having to ever bother with the landline. Pretty wild to think about.

Priestley: Streaming over there, too, is getting huge, because that's really being enabled by all this. Although it's kind of legacy technology and some parts, I think in some areas it's actually going in at a higher, better technology than we currently have.

Muckerman: Yeah, I imagine so.

Priestley: They also bought a pipeline from Petrobras in Brazil. So, it's all these new projects that they're doing that I think are in exactly the right areas. They have a 4.6% yield, forward P/E of 15X. They have above average operating margin. I think they have a 31%, average is about 25%. The stocks are down so far this year. If anyone wants to look at this -- and, any of the other stocks that we mention, you definitely have to do your reading -- there are some concerns about the ROI and things like that. But, overall, I'm very bullish on infrastructure trends, generally.

Muckerman: And one thing to consider about this stock as well is that they have the support of their parent, Brookfield Asset Management, a tremendous asset manager. And they have a few other companies along the lines of Brookfield Infrastructure, but it's always nice to have the support of the loaded balance sheet that Brookfield can give credit to or go out and raise money for. So, definitely a nice added bonus there for any interested shareholders.

Priestley: Absolutely, yeah. So, there are our two stocks for today that we're watching.

Muckerman: Sweet. Core Labs and Brookfield Infrastructure Partners.

Priestley: Do you have anything else? Did I miss anything in my pitch?

Muckerman: I don't think so. I think that's pretty solid, yeah. 

Priestley: [laughs] He's just being nice. I feel like I missed something.

Muckerman: Well, I don't want to give everybody everything. We have to let them go do some research!

Priestley: [laughs] Well, that's it from us today. If you would like to get in touch, please feel free to email us at [email protected], or tweet us on Twitter @MFIndustryFocus. As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear. Thank you to Austin Morgan for patiently producing the show today. For Taylor, I'm Sarah Priestley. Thanks for listening and Fool on!