Zeev's Turnips Patch-No Politics (ZEEV)

[Train Guy]

Big deals, big payout
21 Oct 2004
Marc Gerstein Director of investment research
Reuters.com

This year, Plains All American Pipeline became a bigger company, which is paying a bigger dividend.

I seriously doubt I need to expound on the favorable aspects of energy investing right now. I see the Reuters.com traffic figures. I know what topics are more likely to garner the strong interest. I know energy is big nowadays, so much so that the contrarian in me almost wants to lean against the tide just for the heck of it. Actually, though, no two energy investments are alike (just like in 1999, no two internet stocks were alike, and so on and so forth). So it's still a good idea to try to pick and choose within energy to find names that merit interest based on something more than the industry they're in. Plains All American Pipeline (PAA.N), qualifies by virtue of its recent appearance in the Reuters Select Institutional Ownership screen (introduced in a 10/16/04 article presenting this week's bottom-up investing theme) and scored well in the sort routine set forth in the dowlodable spreadsheet that accompanied the article. Also, sometimes you get a bonus. That's the case here because as it turns out, PAA is a viable income vehicle.

M+L+P=Yield

PAA is an MLP. The latter stands for Master Limited Partnership.

There are many distinctions between an MLP and the sort of garden-variety corporations we're used to dealing with when we own stock. The one that's most important to the average investor is the fact that MLPs can escape taxation if they meet certain requirements relating to how much of their income should be paid out as dividends. Skipping the technicalities, the answer is a lot, so much that a lot of MLP payout ratios wind up topping 100 percent (bear in mind non-cash expenses can also fund dividends, though sometimes MLPs dip into capital reserves).

The tax break isn't without strings. Shareholders get hit with the tax burden the partnership escapes from. But there are also other kinds of tax breaks available here. For details check with your tax advisor. If you don't have a tax advisor, pass on MLPs.

The upside is that MLPs, a commonly chosen form of business organization among energy pipelines, tend to be nice income vehicles for investors. Lately, they seem right up there with electric utilities and REITs.

The PAA flavor

At first glance, all energy pipeline MLPs look alike. But on closer examination, PAA stands out largely by virtue of its acquisition practices. It's not the acquisitions in and of themselves. Other energy pipelines acquire too. PAA is distinct because of the sizes of recent purchases; two early 2004 purchases wound up doubling the trust's pipe length.

Its' also distinct by virtue of how it acquired its way into other, complementary aspects of the energy middleman businesses. It now also engaged in crude oil gathering, terminaling and storage, and marketing.

The latter could be seen as a silver lining or a dark cloud, depending on one's perspective. In this instance, marketing translates to trading. PAA buys some oil that goes through its pipeline and re-sells it, with a little margin of course, at the back end.

This is one way PAA can use its expertise of market dynamics to add spice to its bottom line. That's the silver lining. The dark cloud is the possibility that something could go wrong, as occurred here in 1999-2000 when a rogue trader caused some trouble. PAA isn't the only energy trader that had issues like this (I'm sure we all can easily name some much bigger names). But to be fair, it's been several years since PAA cleaned that up and tightened its controls on this activity.

PAA tried to design its overall business mix so there would be some counter-cyclical balance between the pipeline and marketing units, with storage serving as a stabilizer. It's hard to say how that will work if energy turns frosty; the reality of counter-cyclicality, from my experience, has tended to trail the dream.

But for now, that does not appear to be a major issue. The cycle is such that PAA is flying with a good industry tailwind. Management recently raised its earnings guidance and indicated the November payout would be increased to a level that reflects a 3.9 percent sequential jump and a 9.1 percent year-to-year increase, which would be ahead of the stated long-term goal of a 5-7 percent rate of annual dividend gains.

Income

Because of the stock's (or rather . . . unit's) 6.3 percent yield, I decided to value it as an income play.

I estimated that it would take a 3.2 percent annual rate of dividend growth to make the units worthwhile at their recent price.

Because acquisitions have changed the trust's business profile, it's hard to draw much conclusion from historic data relating to dividend growth capacity. For what it's worth, the number I came up with was 4.15 percent, which is just above the aforementioned required growth hurdle.

However, management has been suggesting a stronger growth rate and the near-term dividend action looks like they're serious. I give credence to management's target because that seems better aligned with where acquisitions have brought PAA.

http://dai.investor.reuters.com/Article.aspx?docid=6515&target=%2f%2fcompanyoftheday