Boom in Oil, Gas Pipeline Building Could Be Boon for Small Caps

Putting controversy aside for the moment, there are a variety of companies that may prosper

Photo courtesy of neteon.net

Photo courtesy of neteon.net

from the current recovery in oil and gas pipeline building. It’s the kind of boom that can create strange bedfellows, considering the pipe now being built from Iraqi Kurdistan to Turkey scheduled to open in the third quarter of 2013. The Kurds and Turks are not known for being friends.

The recovery in oil and gas pipeline building should be fueled by investment in unconventional domestic energy sources like gas shale and oil sands, pressure to repair and replace aging infrastructure and the uptick in the residential construction markets, according to a forecast from IBISWorld.

And if the proposed 1,700-mile Keystone XL pipeline from Canada to the Texas Gulf Coast gets approved, and its fate certainly remains in doubt, that would only add to the local boom. Supporters say it would create thousands of jobs, while environmentalists say it will endanger the environment and possibly the ground water supply. A decision from the Obama Administration is expected by summertime.

A random search turned up four small caps of the many companies involved in oil and gas pipeline business. We’re not endorsing them by any means. Please do your homework before investing.

Dallas-based Crosstex Energy (Nasdaq: XTXI, http://www.crosstexenergy.com/) builds oil and natural gas pipelines, among other services, and operates about 3,500 miles of natural gas and oil pipelines, as well as 10 natural gas processing plants and 10 fractionators as well as barge and rail terminals and product storage facilities. If you’d like to learn more, tune in to the company’s first quarter 2013 financial results conference call at 11 a.m. Eastern, May 9.  XTXI closed April 23 at $18.64, up 21 cents for the day, with a market cap of $886.5 million. Its 52-week trading range is $11.32-$19.51.

Calgary-based North American Energy Partners (NYSE: NOA, http://www.nacg.ca/) provides a range of construction and pipeline installation services to customers in the Canadian oil sands, industrial construction and pipeline construction markets. NOA’s primary market is the Canadian oil sands where it supports its customers’ mining operations and capital projects. NOA closed April 23 at $4.38, up 16 cents for the day, with a market cap of $159 million. Its 52-week trading range is $2.23-$4.70.

Houston-based Willbros Group Inc. (NYSE: WG, http://www.willbros.com/) is a full service engineering and construction company serving the oil and gas and power industries. Founded in 1908, WG has “developed a brand as a preferred contractor, with a reputation for quality, cost, efficiency and safety over its more than 100-year history,” according to The Motley Fool (http://beta.fool.com/asiavalue/2013/03/25/willbros-low-valuations-insufficient-to-compensate/27767/?source=eogyholnk0000001). Back in 2007, before the recession, WG was trading for more than $13. It closed April 23 at $9.79, up 56 cents for the day, with a market cap of $481 million. Its 52-week trading range is $4.07-$10.45.

Sarver, PA-based Geospatial Holdings (OTC: GSPH, http://www.geospatialcorporation.com/) provides pipeline management technologies and services for managing pipeline infrastructure assets in the U.S. Geospatial Mapping Systems, which provides centerline mapping of pipeline infrastructure, is a wholly owned subsidiary. GSPH closed April 23 at $0.08 with no trading for the day and a market cap of $3.5 million. Its 52-week trading range is $0.05-$0.22.

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David Fondrie from Heartland Advisors: A Glass-Half-Full Guy Looks at the Sequester and Economic Growth

David Fondrie is a Senior Vice President and Portfolio Manager for the Select Value Fund at Heartland Advisors in Milwaukee (www.heartlandfunds.com).   He joined Heartland in 1994 and subsequently served as Heartland’s Director of Equity Research for ten years from 2001 to 2011.  He also held the position of CEO of Heartland Funds from 2006 to 2012.  He’s a Badger from the University of Wisconsin and served with the armed forces in Korea.  He started his career with Price Waterhouse and is a CPA.  Our paths have crossed repeatedly over the years since we had interests in some of the same companies.  Like many Midwesterners, he is a plain-spoken man.

Dave Fondrie, Heartland Advisors Inc

Dave Fondrie, Heartland Advisors Inc

We had an opportunity to chat on March 1, the day the much-discussed government spending sequester went into effect, and I asked him what he thought would happen as a result.

DF:  The headline effect is likely to be worse than the real effect.  It’s not going to be as devastating as the articles in the press would have us believe.  There will no doubt be some pain inflicted on defense stocks, for instance.  But for the most part people have been expecting this to happen, so it is not a surprise, and it is built into the market.  There are too many green shoots in the economy now for something like the sequester to knock them all down.

JA:  Are you seeing it more like a speed bump than a brick wall?

DF: Yes, exactly.  I think Congress will get around to the budget and the cuts, adjusting them to what makes more sense.  If you look around at the United States economy right now, what is striking is what is going on in the oil and gas field.  Suddenly we are one of the lowest-cost energy producers and consumers in the world.  Not only does that have a direct effect on business, it is creating a new industry that is building out the infrastructure that will allow us to provide low-cost natural gas energy to industrial America.  This has put us in quite a positive situation.

We are paying $3.50 for natural gas, where Europe is paying $12.00 and Japan is paying  $16.00.  So to me that means that companies that rely on energy for their operations are much better off here than in other major developed economies around the world.  A steel forge, for instance or a company like Precision Castparts Corp (PCP), which use enormous amounts of energy in making parts, are a lot better off here than anywhere else.  Fertilizer plants.  The renaissance in chemicals here is extraordinary.  There are 12 new ammonia plants on the drawing boards, and they all will have a reliable and lowcost stream of natural gas as both energy and raw material.  We can use that ammonia domestically and stop importing it from other economies.

LNG.  There are a number of proposals for LNG plants.  These days we are talking about exporting LNG, where we never thought about anything but importing it in years gone by.  I think this low-cost energy source is underappreciated.  In fact it will spur the continued development of oil and gas, infrastructure, chemical plants, and other types of industrial expansion.   All of that is good for the economy.  Add to that some continued improvement in employment and housing, with home prices increasing, and we foresee stronger consumer confidence, especially as a result of higher home prices.  Already 401(k) values have been improving, and it is undeniable that we are in a low interest-rate environment as well.

All this headline talk about the sequester risk is overblown.  There is no doubt that federal spending and the size of the national debt have to be brought under control.  Entitlement plans have to be rationalized.  But add to the overall situation the fact that China is clearly recovering.  Chinese electrical usage is up, their industrial consumption of materials and energy is up, and as China grows, their growth is good for the other economies that feed her growth.  Europe is not likely to get any worse.

We’re looking for 2.5% to 3% GDP growth in 2013.  The stock markets continue to be reasonably valued.  Corporate balance sheets are good; earnings are good and continuing to improve modestly.  The S&P 500 is trading at 14 times earnings, where in the past it has traded at an average of 16 times earnings.

The wild card is what happens with interest rates.  People have not yet abandoned bonds, but the inflows have receded after several years.  There have been outflows from the equity markets for five years.  Now we are seeing a trickle-back return to the equity markets.  Sadly there is a pattern that is repeating itself, with many buyers entering at the midpoint of an equity run, not at the beginning.  But this is the way cycles go.  We are in the 4th or 5th inning if you take a long view of this bull market over the last three years.

JA:  So are you buying energy companies?

DF:  Not particularly.  Low energy prices are not particularly favorable for exploration and production companies.  But we are looking closely and buying companies that supply goods and services to the energy patch.  For the last two or three years, for instance, it has been apparent that there will have to continue to be huge investments in the energy patch.  If you are drilling in North Dakota, you may have no infrastructure to bring the liquids you are pumping to the refineries, which all tend to be downriver by quite a distance.  We have huge backups in Oklahoma because there is not enough pipeline to carry all the energy.  One company we have owned for 2 to 3 years is Mas Tec Inc (MTZ).  We bought it in the 12s and it closed Friday at $30.78.  Part of their business is in pipelines, and they have also done well at the gathering systems in areas where energy is being produced at the wellhead.  Those are both high-growth areas; the stock was trading cheap two years ago, and it has given us a reward.  Quanta Services Inc (PWR) is very much the same story – we used to own that stock as well, but we sold it when its valuation reached what we thought was a sensible level; in their case they are exposed to pipeline development and new high-voltage lines.

JA:  How about life sciences companies?

DF:  The FDA has been problematic as they have increased their oversight of the industry resulting in complex regulations and inspection observations (commonly called 483 observations).   We own Hospira Inc (HSP), which was a spinout a few years back from Abbott Laboratories  (ABT).  They have run awry of the FDA at a manufacturing facility in Rocky Mount, North Carolina.  In Hospira’s case, addressing the 483 observations and revising processes and procedures has resulted in over $300 million in costs and reduced output of drugs that are already in short supply.  We are all concerned with safety; however those concerns should be balanced with a sensible and timely regulatory process.

JA: Does that put a caution flag out?

DF:  I can’t speculate on what kinds of furloughs the FDA will have to put into effect.   I doubt that we will have chickens rotting on processing lines waiting for FDA inspectors as the press and certain congressional members have suggested, but the big issues around drug approvals will continue to be important, and is likely to be slowed down even further with the automatic budget cuts.  Hopefully they will prioritize their cutbacks and the expense reductions will have less impact than we might expect.  But government does not always work very efficiently.  We hope they will be smart and furlough the poor performers instead of just following  a LIFO pattern.

JA:  How do you feel about ObamaCare and stocks?

DF:  I do sense that there is a bit more thought being given to the impact of ObamaCare.  We just reviewed the 2014 Medicare Advantage benchmark payment rates by the Centers for Medicare and Medicaid Services (CMS), and the cuts were more draconian than expected.  But the government was clear that they are not trying to cripple the HMOs because they are a vital part of the new program.  I am a glass-half-full guy most of the time, and I think if people sit down and talk they can get to some reasonable results; let’s hope that happens.  There is always give-and-take with reimbursement rates, and they end up meeting someplace in the middle.  US businesses are resilient; once they know where the boundaries are, what the rules are, they adjust.  What happens is what you expect in a capitalist system: change comes quickly.  Capitalism works pretty well.

JA:  Where do you think people ought to be looking in the equity markets this year?

DF:  I am in the camp that says we will continue to have a modest economic recovery.  In that kind of environment you have to look at cyclical companies.  We are overweight in industrials and information technology companies.  Everyone is going to look at productivity, and technology is important there.  People will continue to invest in technology to improve productivity.  We are going to be hooking up all kinds of machines at home and in factories to the Internet.  We think tech plays work.  We might stay away from actual PCs, but mobility will continue to expand, and downloads will continue to grow, keeping  Internet growth robust.  Probably financials are good, due in large part to a stronger housing market.  We are a little more cautious on that because the interest rate environment does not allow much net interest rate gain to banks.  But housing will drive loan growth, and the banks have plenty of capital to lend.  With business loans at 3.5%, it is hard for banks to make money.  If we got an uptick of half a percent, it would do wonders.

In tech companies, we like Cisco Systems Inc (CSCO).  We see Cisco as a chief enabler of the infrastructure of the Internet.  Cloud computing is driving a lot of internet traffic.  Cisco is cheap at 12 times earnings, and there is that nice dividend yield of 3% too.  The balance sheet is pristine; altogether it is a very attractive risk-reward proposition.  I run a value-oriented multicap fund.  Cisco is seen as a growth stock, but right now it is also a value stock.  They have gotten their act together after some unwise acquisitions a few years back; we think the downside is minimal.

JA:  What about social media?

DF:  Social media doesn’t really fit our style.  Even Google is not in an area where we play.  Thematically I like agricultural plays like Archer Daniels Midland Company (ADM).  It is trading a bit above book value, and the dividend yield is 2.4%.  If we have a big corn crop, ADM is going to benefit from processing all that corn.  I believe we will have a big corn crop this year, and we need one.  ADM’s PE is under the S&P 500.  I can’t predict the weather, but we are getting moisture that we badly need in the Midwest, so the water table can support strong crops this year.  We’re looking at fertilizer companies, seed companies, and farm equipment (especially on a dip).  Railroads are a bit expensive right now, but it is worth noting that the number of rail cars carrying oil is growing at 25%, which makes those cars part of the infrastructure for moving energy.  Oil companies and refiners are buying those cars and the rails are moving them.  We’ll buy rails on dips too.

One final area that is more in the later innings is deepwater offshore.  We are particularly interested in drilling off the east and west coasts of Africa.  We like the companies that build out those platforms and subsea infrastructure to bring that oil to market.  We like the boat companies that service those rigs.  These are long-cycle investments; the big international oil companies don’t start-and-stop those projects.

JA:  What about shipping companies?

DF:  There may be too much capacity there.  OSG went bankrupt.  What has happened in the US is that we are importing less oil than we were five years ago, and the amount we are producing here has increased.  Our demand for oil from overseas has decreased.  So tanker ship demand has decreased as well.  If China starts to really boom again, that could absorb some of the excess capacity, but I don’t see that as near-term.

JA:  How about the greenback?

DF: The euro is at risk, but the dollar should hold its own.  If the Chinese let their currency float more that might affect the dollar, but for now the dollar is fine.

JA:  Is there an upside to the 2.5% to 3% GDP growth you mentioned?

DF:  Maybe in the back half.  If we resolve our government problems, that might restore more confidence.

JA:  Thanks, Dave.

Allen & Caron owns none of the stocks mentioned in this interview, and Joe Allen owns none of the stocks mentioned in his personal accounts.  Please do your own research.  JA