The Dominion Energy Tredegar Campus is pictured on July 6, 2020 in Richmond, Virginia.Zach Gibson/Getty Images
After Warren Buffett snapped up U.S. pipeline operator Dominion Energy Inc.‘s natural gas transmission and storage network in a US$9.7-billion deal (including debt) announced on Sunday, Canadian pipeline stocks barely moved.
But that’s good news if you are considering a foray of your own into the energy midstream sector: Share prices are down from recent peaks and dividend yields are high, even after the stunning stock market rebound of the past three months.
Consider that, year to date, the S&P 500 is nearly flat while the Alerian Midstream Energy Index of North American companies, which includes Canada’s Enbridge Inc. (full disclosure: I own this stock), TC Energy Corp. and Pembina Pipeline Corp., is down 38 per cent over the same period.
What’s more, the average dividend yield in the Alerian index at the end of June was a remarkable 8.6 per cent. That suggests the pipeline sector is either flashing a warning sign amid low crude oil prices and a sharp downturn in economic activity, or it is offering a rare opportunity to scoop up recession-proof bargains.
Mr. Buffett, who through Berkshire Hathaway Inc. sat out the broader market rally that began at the end of March, may be in the latter camp.
While the Dominion assets he is buying are in the United States, the deal nonetheless underscores some of the bullish properties of the broader midstream sector in Canada: It’s relatively easy to understand, it’s not going anywhere and existing pipelines could become increasingly valuable as expansion efforts are thwarted by opposition and regulation.
“A lot of these midstream stocks in the U.S. and Canada have really gotten hit – not as much as E&P [exploration and production], but really hit. And this is Warren saying that the businesses are still sound and it is getting harder and harder to build pipelines and transmission assets,” Laura Lau, the chief investment officer at Toronto-based Brompton Funds, said in an interview.
“I think pipe in the ground is worth more than before because it is so much harder to build,” Ms. Lau added.
Indeed, the Buffett deal followed a flurry of setbacks for expansion-minded companies in recent days.
On Monday, a U.S. federal judge ruled that the Dakota Access pipeline in the Midwest, which is partly owned by Enbridge, must be shut down in early August pending a new environmental review that could take 13 months. On Sunday, Duke Energy Corp. and Dominion abandoned plans for their Atlantic Coast Pipeline across three states because of regulatory delays and uncertainty.
And TC Energy’s long-delayed Keystone XL pipeline project running from Alberta to the U.S. Midwest, 12 years in development, continues to face U.S. political risk. Joe Biden, the presumptive Democratic presidential candidate, has said he will cancel the Keystone XL permit if elected in November.
With the price of West Texas Intermediate crude, a North American benchmark, now trading at just more than US$40 a barrel (down from about US$60 at the start of the year) and U.S. fracking trailblazer Chesapeake Energy Corp. filing for bankruptcy protection in June, no wonder pipeline stocks are reflecting heightened risk.
Mr. Buffett, of course, got a good price for the Dominion assets. He paid an estimated 10 times EBITDA (earnings before interest, taxes, depreciation and amortization) while most publicly traded pipelines trade for more, according to CBRE Clarion Securities. Enbridge, for example, trades at about 12 times EBITDA.
“On the other hand, the transaction offers validation that there are large investors with an interest in high-quality pipeline assets. We expect there will continue to be strategic transactions in the pipeline sector, given the limited ability to grow by developing new infrastructure,” Hinds Howard, infrastructure portfolio manager for CBRE Clarion Securities, said in an e-mail, adding that Canadian pipeline operators will be among the acquirers.
Mr. Buffett may have set in motion a round of dealmaking that will support the whole pipeline sector – and reward investors.
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