Description

Gibson is a short. The view, explained in greater detail below, is driven by a view of:

1. Weakening economics and limited growth in their core asset.
2. Growth capital in areas where they are in a clear disadvantaged competitive position.
3. Track record of value destruction.
4. Lofty valuation.

We all know how to source analyst research and read company filings, so I will try to keep this as direct and brief to the core of the argument as I can. That said, a bit of background may be helpful. Gibson used to be an oil levered Canadian energy centric services and infrastructure conglomerate of some sorts on a small scale, but recently has divested assets focusing down today to:

1. Hardisty Terminals: 10 million barrels of existing oil storage and 2.5 million barrels of oil storage under construction, which is approximately sixty percent of expected 2020 EBITDA.
2. US Infrastructure: Five percent of 2020 estimated EBITDA but over half of expected future growth capital. The Pyote Gathering System is the toe hold management believes they’ll be able to leverage into a core infrastructure position connecting into the Wink Hub.
3. Edmonton Terminals: Approximately 1.7 million barrels of existing terminals storage representing approximately ten percent of 2020 EBITDA.
4. Marketing: Mid-cycle the company estimates this division will generate approximately fifteen percent of 2020 EBITDA, but is volatile. Management doesn’t have enough confidence in this division to include it in dividend decisions.
5. Other Infrastructure: Moose Jaw refinery (produces asphaltic and lighter distillate products generally sold into specialized markets) & Viking pipeline (transports oil from the Alberta Viking into the Hardisty Terminal) largely make up this division, which is estimated to be approximately ten percent of 2020 EBITDA.

Weakening economics and limited growth in their core asset

Demand for increased tankage at Hardisty is driven to a large extent by counterparties looking to take advantage of speculative arbitrage opportunities believed to exist due to volatile and wide differentials, not actual volume driven demand growth. This, along with Gibson’s management’s priority of beating expectations on new growth capital, likely means a weakened negotiating position overall (counterparties know Gibson’s needs to make an announcement by x date) on top of what already was a weakening basis for new tank demand (speculative arbitrage counterparties) and weakening position for negotiating terms on new and renewal contracts (fewer and less motivated counterparties).

If you repeat a lie often enough it becomes … There still is a misconception being messaged when understanding the nature of cash flows and difference between infrastructure fee-for-service and take-or-pay arrangements. I couldn’t find this in company filings but did in analyst research, that by 2020 they expect EBITDA to be “~80% take-or-pay or stable-fee-based-service,” and within that mix sixty percent of segment EBITDA will be take-or-pay (about forty percent of which is with third-parties). That’s a big difference between ~80% management focuses on and what’s reality. Most retail investors and even some institutional investors don’t recognize it and this is on purpose. Looking back at the original prospectus Hardisty arrangements were explained as “fixed monthly fees, plus additional usage fees based on throughput” and “fee-based storage and terminalling service.” This language has largely gone away explaining terminals. They try to convince retail investors, and pressure the sell side to great effect to replicate the message, that their capital plans and overall risk profile is take-or-pay in nature and comparable to TransCanada, Enbridge, Inter Pipeline, Keyera and Pembina. This is misleading and intellectually dishonest.

When you factor eroding contract terms into the equation, terminals is essentially a no growth or shrinking asset from an equity holder’s perspective. For example, take Gibson’s numbers for total market size of tankage under a oil volume growth scenario of half a million barrels. This is approximately inline with CAPP’s forecast for the oil sands, which is often overly optimistic, over the next decade. They assume this type of volume growth implies an incremental four to six million barrels of tankage demand or eight to twelve days of new supply, implying ten to fifteen incremental 400,000-barrel tanks or 1.0-1.5 tanks per year. One tank per year or less than three percent of Gibson’s existing & under construction terminals. Said another way, the growth implied on Gibson’s terminal assets is equivalent to something which is maybe comparable to inflation expectations. Factor in likely weaker contract negotiating position of terminals go-forward, and from an equity holder’s perspective this asset’s value is likely to be shrinking at some small percentage. 

Growth capital in areas where they are in a clear disadvantaged competitive position

The future growth engine for Gibson’s is marketed to investors in the Permian, a place for which a Canadian company of Gibson’s small relative size, this late to the game with their track record, has convinced very few of the merits. It’s just hard to envision them winning and earning an appropriate risk adjusted return. Contract term, risk, counterparty etc. is worse than their Hardisty position, meaning this growth spending is dilutive to their core business (management expects the US will be approximately fifteen percent of total cash flow in 5-years at the $100 million per year capital level). Gibson’s estimates up to $100 million capital in 2020 and beyond, but no one will be surprised estimates are shown to be too low.

Track record of value destruction

Gibson has been reshaping the portfolio through divestiture over recent years under watchful pressure from certain shareholders, improving the balance sheet largely by selling ‘non-core’ assets, some of which the current board and CFO had acquired not long-ago (e.g. OMNI). Nothing unique in the oil patch and better lately, but the track-record is clear that the company has shown a propensity to chase the flavor of the day inorganically. It has been a tough market, but since going public they have been value destructive acquirors. The historical financial performance of the company is what you’d expect, profits of a few “not even an idiot could mess this up” type assets distributed to projects that drove large losses and an outsized dividend. Over the past three fiscal years (2016-2018) net income has cumulatively been negative, while dividends declared were over $550 million and negative retained earnings stood at $1.25 billion year-end 2018. The chairman, whom owns a material number of shares, has historically set up the public companies which he’s involved where a lion’s share of cash flow is put towards dividends, funded by public investors largely through new issuance. The dividend stands today at approximately seventy five percent of estimated DCF per share and two times EPS.

Another thing worth mentioning is the decision makers in the company are former investment bankers. Bankers like financial engineering and have a watchful eye to the public market pressures of the day. It’s reasonable to think, given the lack of growth in Canadian terminal’s and disadvantaged organic options in the Permian, there is an awareness that the clock is ticking to the day this becomes very apparent and their cost of equity changes to reflect it. A large US based acquisition is very much a possibility.

Lofty valuation

There’s many ways to cut this, and all arrive at the same answer, so I’ll try my best to choose the simplest. Consensus has approximately $425 million EBITDA for 2020 coming out the recent investor day. This implies a multiple of approximately eleven times on today’s enterprise value. This is, plus or minus a turn, inline with the average of TransCanada, Enbridge, Inter Pipeline, Keyera and Pembina. I’ve been following these names for a long time, and although I haven’t explicitly run the historical numbers, I can not remember a time where Gibson has been trading this close. This is absurd. Outside of fundamental reasons already discussed, Gibson is not a core position for anyone that can help it in a down market and will underperform. In an upside case the company has sold off any assets that provide leverage to increasing crude prices. When I run a DCF and take a look at multiples relative to peers, I conservatively believe the stock should be trading below $15 per share or approximately thirty five percent downside.

Catalyst

Lack of ability to prove economics of spending and competitive position in Permian.

Acquisitions in new markets explained through accretion, but truly dilute the company's core assets, are outside of their core competencies and are high risk.