After more than 100 years of owning royalty coal properties, PVR has shifted gears to become a natural gas pipeline company. The move seems to make sense, but it comes with notable risks.
PVR has owned and leased out coal properties since the late 1800s. That's a long time to be in one line of business. With coal under increasing pressure from environmentalists and increased supplies of natural gas, management decided it was time to branch out. With new drilling methods unlocking supplies of gas, PVR chose to build a pipeline business.
Although owning and building pipelines is very different from owning land that others mine, it still has the same toll taker business model. That said, a change like this comes with many risks. Investors need to understand what the new PVR is facing if they are going to bet that the limited partnership's hefty dividend yield can survive the change.
Natural gas pipelines
Owning a coal property is pretty low maintenance. The lessee does all the work. Owning a pipeline requires a lot more effort. Notably, PVR has to actually manage and maintain its pipelines.
While pipelines are pretty low maintenance, too, the move by industry giant Enterprise Products Partners to reverse the direction of the Seaway pipeline is an example of astute asset management. That shift allowed the company to take advantage of the desire to move a glut of oil in one market to an area with available refining capacity.
Similarly, Enterprise has suffered pipeline spills and closures related to weather events. Such issues require swift action and usually can't be predicted. While Enterprise has years of experience dealing with such routine problems, PVR doesn't. It can hire experienced employees, but that doesn't mean the company is ready for an unforeseen event or prepared to make a big strategic shift that will enhance its business. There's a reason why Enterprise shares are priced at a premium and PVR shares aren't.
Then there is the issue of finding customers. In the coal business, PVR only has to find a miner. Pipeline operators need to find multiple drillers to link to their pipes. Of course its pipelines also have to be in areas with growing supplies, or finding customers will be increasingly difficult. Once customers are found, PVR also needs to be astute at building pipelines—another skill set that is new to the company.
Demand and location
Even though PVR's pipeline business is largely fee based, it is still linked to a commodity. That means that price changes could materially alter the amount of product that flows through its pipelines. That, in turn, could reduce revenue.
The locations of its pipes are also key. Some fields and regions are simply better than others, so it is important to be in the right areas. It looks to be well situated today, but that isn't a guarantee that output in its current locations remains strong. Should production fall, it can't just move its pipes.
The legacy coal assets are also linked to commodity prices. The impact of weak demand and low prices, despite the leasing model, has been a material drag on the top line. Being a toll taker is a safer business model than drilling for gas or mining coal, but it doesn't remove the risks of commodity price moves.
Pipelines and coal are both highly regulated industries. There's good reason for this, but the impact of changes can be material on the entire industry. For example, increasingly stringent regulation of coal fired power plants has helped push electric utilities to switch to natural gas, thus reducing demand for and the price of coal.
The new drilling methods being used to extract once hard to get oil and natural gas are being blamed for ground water contamination. The government is examining those claims and looking at regulation of the practice. That could pose serious challenges to the industry and weaken demand for pipeline capacity.
Another example of regulatory complexity is TransCanada's ongoing attempts to gain approval for its Keystone XL Pipeline project. The approval process has gone all the way to the desk of the president. While just about everyone wants the pipeline to be built, the inability to get it done has often left TransCanada's shares trading on news rather than the company's impressive fundamentals—with or without Keystone. This has opened up some buying opportunities, making the stock worth watching.
A big yield
Clearly there's a reason why PVR has an above market yield. While the yield may offset the risks the company faces for more aggressive types, conservative investors should probably stick to established industry leaders like Enterprise and TransCanada. The dividends are lower, but the risks are better defined.
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