Plains All American Pipeline (NASDAQ:PAA) can't catch a break. The oil pipeline MLP seems to take two steps forward and then one back, thanks to all the oil market volatility in recent years. But 2020 was an even bigger reversal than the company was expecting because oil prices tanked, which impacted its volumes and growth prospects.
Because of that, Plains All American's unit price plummeted 50% this year. That pushed its dividend yield above 8% even though it slashed its payout by 50%.
However, while 2020 was a rough year for the oil pipeline company, that doesn't mean it can't get back on track. Here's a look at the bull and bear cases for this high-yielding oil stock.
The case for buying Plains All American Pipeline
Despite all the turmoil in the oil market this year, Plains All American's financial results have held up reasonably well. The company expects to generate around $2.585 billion of adjusted EBITDA this year, which is slightly ahead of its initial $2.575 billion forecast. That's due to the overall stability of its transportation and facilities assets and its ability to leverage its integrated footprint and use its supply and logistics expertise to capture money-making opportunities in this year's volatile oil market.
Because of that, along with reductions to its distribution and capital spending program, and asset sales, Plains All American is on track to generate excess cash. That has allowed it to pay off debt and drive its leverage ratio down to 3.3 times debt to EBITDA at the end of the third quarter, which is within its 3.0 to 3.5 target range.
Meanwhile, given the significant decline in its unit price, Plains All American believes the market has undervalued its stock. It's currently on track to generate $2.35 per unit in cash flow this year, while the stock trades at less than $9 per share, implying a bottom-of-the-barrel valuation of less than four times its cash flow. That led the company to authorize a unit repurchase program of up to $500 million. It plans to repurchase up to $75 million of its units in 2020 and allocate 25% of its free cash flow after distributions in 2021 on additional repurchases.
The case against buying Plains All American Pipeline
While Plains All American Pipeline is on track to achieve its initial 2020 outlook despite all the volatility in the oil market, its results will still be well below 2019's level due to asset sales and the volatility of its supply and logistics business. Meanwhile, they're on track to decline even further in 2021. In the company's view, it will only produce about $2.2 billion of adjusted EBITDA next year, which for perspective is about $1 billion below 2019's peak.
As mentioned, one reason its earnings are declining is that Plains is selling assets to repay debt. The company plans to sell another $600 million of assets next year, which will dent its earnings when combined with recent sales in 2020. On top of that, it only expects to generate $50 million in earnings from supply and logistics, well below this year's $250 million projection and a fraction of the $803 million the segment produced in 2019 as it exploited dislocations in the oil market.
With earnings coming down, it needs to focus on repaying debt so that its leverage ratio doesn't rise above its target range. That's why it's earmarking 75% of its expected excess cash in 2021 toward debt reduction.
Looking further ahead, it's unclear if Plains will return to growth mode. Due to this year's collapse in oil prices, it could be years before U.S. oil producers start expanding their production again, which would drive the need for new oil pipelines. As a result, Plains only expects to invest $500 million to complete expansion projects next year, with that number expected to fall to between $200 million and $300 million in 2022 and beyond.
That's a far cry from the more than $1 billion it invested annually over the past three years. Thus, it seems that Plains All American's earnings will remain flat at best, if not continue declining in the future.
Deep value with no growth catalysts
There's no doubt that Plains All American is dirt cheap these days. Add in its high-yielding distribution and repurchase program, and it has some upside potential. But the company's earnings are in decline, with no apparent growth catalyst on the horizon. Because of that, it's not a compelling buy when other pipeline stocks offer higher yields and more-enticing growth prospects.