PVR Partners' (UNKNOWN:PVR.DL) pipeline business has ramped up more slowly than expected this year. However, management believes pipeline volumes will hit internal goals by the start of 2014. And a recent deal with Hess (NYSE:HES) should support growth next year and into 2015.
A changing business
PVR has been adjusting its makeup lately, shifting away from its coal royalty business, which was once its sole focus. For 2013 coal is projected to represent less than a quarter of the partnership's earnings before interest, taxes, depreciation, and amortization. It was as high as 60% just two years ago.
In fact, coal is on the back burner right now because management believes the pipeline business will provide better long-term returns. That's a similar choice to CONSOL Energy (NYSE:CNX), which has operations in coal mining and natural gas drilling. In the past decade, CONSOL's natural gas volumes have more than tripled. It expects another 25% increase in production between 2013 and 2014.
Capital spending at CONSOL's coal operations, meanwhile, is currently set at "maintenance" levels. Free cash flow has been earmarked for the natural gas segment. In other words, coal will continue to shrink as a percentage of the company's business. That sounds pretty good, since weak coal markets effectively dragged the company's second quarter results into the red.
Coal is alright, gas not so much
So, PVR isn't alone in its shift away from the coal arena. However, the partnership's coal operations have performed as expected this year while its pipelines have lagged because of slower than expected well hookups. The slow pace isn't because of lost business but merely a factor of delayed drilling and connection activity. So, management believes volumes will still hit year end targets.
That means that 2013 is probably going to be a little rough versus early year expectations, but that 2014 should be much better. And a recent deal inked with Hess sets up further growth in the second half. The project is for a gathering pipeline that should begin operations in mid 2014. Moreover, PVR believes that it will be able to contract with other drillers for use of the pipeline as it's built out.
So, Hess is providing the foundation with growth potential coming from additional partners. Assuming timely completion of the project, that sets the stage for growth in 2014 and 2015.
Another shifting business
Hess managed to reduce its well costs around 30% last year. Through the first six months of this year, those costs were reduced an additional 5%. With gas prices still trading at historically low levels, cost containment is a key factor that will support continued expansion efforts.
In addition to that, the company is in the midst of shifting to a pure exploration and production model. To that end, it has been shedding non-core assets such as the Energy Marketing business it recently agreed to sell to Direct Energy for about $1 billion. Such sales will not only help refocus the company and return value to shareholders via dividends and share buybacks, but they will also lend support to the company's drilling efforts.
Dipping a toe in
It's also noteworthy that this is PVR's first foray into the Utica Shale area. So not only is PVR getting a new partner, adding Hess to a list that includes such dominant companies as ExxonMobil, Chevron, and Shell, it's also entering an entirely new operating region. While it is too soon to tell if this pipeline will be the foundation on which a larger regional presence is built, the prospects are promising. And that makes growth potential beyond 2015 look increasingly alluring.
The market, however, appears to be put off by PVR's slow well connections so far this year. The units are down about 20% since mid to late July and yield around 9.5%. This, however, could be a buying opportunity if you are willing to look beyond near-term weakness. In fact, the partnership appears to be setting up a "pipeline" for long-term growth.
Speaking of Growth in the Energy Sector
Reuben Brewer has no position in any stocks mentioned. The Motley Fool recommends Chevron. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.