Description

GEI is a Canadian petroleum products company that has transformed itself since 2014 from a more diversified, lower-quality and higher-risk business into a much lower-risk and focused midstream liquids storage, gathering and processing business.  GEI now operates predominantly a liquids infrastructure business (mainly two terminals with storage tanks, pipelines, etc.) and, secondarily a liquids marketing business, much of which arises from its infrastructure business.  See chart below for illustration of this transformation:

Despite this transformation into a better collection of assets, GEI trades at about the median valuation it has all along, about 10x EV/EBITDA. [Between 2014-2021, and excluding the extreme dislocation during May, 2020, GEI has traded in a range of 7x-12x, with a median of 10x].

The thesis here is that 1) there is solid downside protection because of the valuation relative to peers, there is a decent dividend that is likely to get an outsized bump in the short-run, DCF is safe and “battle-tested” due to take or pay contracts, and because of the possibility of a takeout & 2) there is a strong chance of solid (12-15% return on the shares) over each of the next several years driven by built-in growth drivers in its infrastructure business and the return to more normalized EBITDA levels within the marketing segment. When we add that to the 6%-ish dividend, there would be a total return of about 18-20%-ish/per year.

Downside protection:

1.                Valuation.  Peers and private market transactions suggest 2-4 turns of upside:

2.                The current dividend is about 6%, but I believe there is going to be an outsized bump in February as GEI is at the low-end of its payout ratio range (currently at 72% of their target 70-80% range) and as DCF is set to scale higher over the 2022-24 period:

a. EBITDA should scale from 2021 levels with the annualizing of growth projects from 2021, the addition of recently sanctioned growth projects and return to more normalized levels within the marketing group (which was depressed in 2021 due to hedging losses).

b. Capex scales down from a range of $250-$325m from the 3-year period (2018-2020) to a more normalized range of $175m-$225M over the coming three-year period.

c. The result is that DCF, after being flat/down from the 2018-2020 period, will scale higher, and combined with a bump in the payout ratio, we should see an outsized bump in the dividend increase this February and perhaps the next two years as well (unless a new high-return project gets sanctioned).

d. With a 75% payout ratio, GEI would be able to bump its dividend by 8c/share/quarter.  This would result in a

$28.50 stock at a 6% yield. [Note that this payout ratio still leaves a decent amount of FCF for debt reduction].

3.                The cash flows are “safe” in that the vast majority are “take-or-pay” contracts or fee for service contracts (see above slide).  Note that these were “battle-tested” during the peak of the covid crisis.  There were no counterparty defaults when oil went to -$40/Bbl.  In fact, GEI was able to make an outsize gain in its marketing division during that period.

4.                This is a smaller collection of assets that could easily be absorbed by TRP or PBA or numerous venture players in the space.  Now that the transformation is complete and with the CEO’s stock options coming due in June, there is some speculation that a takeout could be more imminent (see VIC writeup from 2020, for example).  I am not counting on this for the stock to work, but it should provide some underpinning to the shares and could in fact play out, given the activity in the space.

Growth Drivers:

What is GEI getting for its annual $150M (projected) of growth capex over the next few years?  Simply put, about $25M in incremental EBITDA per year, as these projects are being completed at about 6x.  Examples:

a. Additional storage tanks (one is in process now).  They are targeting 2-4/year, but do not build these on "spec”. These are built only once they have a counterparty to contract for the volumes.  The biggest opportunity over the next several years is at their Edmonton terminal.  A new pipeline there should allow GEI to contract for about additional 4-5 tanks.  The pipeline will provide enough volume for 4M Bbls of storage.  GEI is on track to split these volumes with one competitor, providing enough demand for GEI to build 4-5 tanks at 400k-500k per tank. 

b. DRU.  First 50k bbl/day train is now in service. GEI has the ability to commission 4 more of these.  Skirts political issues that often arise with pipelines, like Keystone.  $150M in capex has resulted in $20-$25M in incremental Ebitda.  Lots of leverage, especially with DRU #3, #4 & #5 (#2 will have some offsets).

c. Miscellaneous other opportunities, including a biofuels blending facility (already contracted for with Suncor and being built) and a renewable diesel fuels facility at their Moose Jaw refinery, which would be a significant incremental add.

Some relevant quotes from the 3Q call & recent press releases that support the thesis above:

“Our payout of 72% remains near the bottom of our target range of 70% to 80%.”

“And given we're already in November, the extent we are successful in securing additional customers, the time line would definitely be in 2022. On the tankage front, we're very pleased to announce the sanction of a new tank at Edmonton during the quarter. With this tank, we welcome a new investment-grade energy customer to our Edmonton terminal.”

“We continue to be in discussions with other TMX shippers. We believe Gibson is very well positioned to support shippers on TMX and optimize producer netbacks and meet stream requirements for them.” [This is in reference to the additionla 4-5 tank opportunity mentioned above]

“[we are looking at] projects such as incremental DRU phases, expansions under the MSA with Suncor at Edmonton and potential renewable diesel facility.”

“Again, we feel we had another strong quarter and remain very well positioned going forward. Our infrastructure business remains solid with our run rate increasing with the start-up of the DRU. We continue to sanction new growth within our target 5.0 to 7x build multiple, and we remain focused on deploying $150 million to $200 million per year in capital.” 

“Given our funding position and solid balance sheet, we see the potential to return excess capital to shareholders in 2022, which we will continue to evaluate in the context of how capital deployment activities are proceeding.  To the extent we see a recovery in our Marketing segment, that would accelerate our ability to return capital to shareholders as we will continue to prioritize maintaining our enviable financial position."

Catalysts:

1.       Outsized dividend bump in February or a series of dividend bumps over the next few years

2.       Accelerated debt paydown due to increased free cash flow

3.       Rebound/normalization in marketing division profits

4.       New project announcements (tankage, DRUs, renewable diesel, etc.)

5.       Closing of valuation gap to peers/private market valuations

6.       Takeout

Catalyst

Catalysts:

• 1.       Outsized dividend bump in February or a series of dividend bumps over the next few years
• 2.       Accelerated debt paydown due to increased free cash flow
• 3.       Rebound/normalization in marketing division profits
• 4.       New project announcements (tankage, DRUs, renewable diesel, etc.)
• 5.       Closing of valuation gap to peers/private market valuations
  • 6.       Takeout