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Wide-Moat Firms We Like in Midstream Energy

Stephen Ellis
Jeremy Glaser

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. I'm here today with Stephen Ellis. He is an equity strategist here at Morningstar. He recently did a deep dive into the competitive advantages of midstream energy and pipeline companies. He is here to talk about what he found.

Stephen, thanks for joining me.

Stephen Ellis: Thank you for having me.

Glaser: Let's start by looking at this pipeline business as a whole, this midstream energy business as a whole. Do we see a lot of moats in this area? Is this a place that's kind of ripe for competitive advantage?

Ellis: Yes, we do actually. It's really been one of the moatiest industries that we cover and long been the example of efficient scale moat source, look at one of the five major moat sources we use to evaluate competitive advantage here at Morningstar. Just thinking about efficient scale we really try to look for a couple of factors to evaluate efficient scale moat source, one being does it serve a mature market. U.S. pipelines typically serve, they start out most of the time serving growing basins of production, but over time those basins peak and decline. But generally, what that means is overall the U.S. energy market has very stable, very mature demand for oil in particular. Generally, these basins are pretty mature and very stable sources of production over time.

Another thing that we look at, for example, would be this commodity market. Generally, if we think about a pipeline serving from point A to point B, they differ obviously in terms of different types of oil, different types of pressures. At the end of the day the pipeline firms do compete on one price and that is generally what we think about when we think about commodity market as well.

Glaser: Let's look at what would differentiate some of these companies from each other. Just owning a pipeline isn't going to give you a moat. What really gives what we think are the highest quality pipelines that edge?

Ellis: When we were doing this report, it was really focused on two factors: asset quality and contract quality. Asset quality, you really have to go down and not think about – and think about just, well, obviously, a lot of these firms own pipelines, but they also earn a lot of their earnings as well from other assets like gathering and processing, petrochemical assets, export assets, refined product systems and even different types of pipeline within hydrocarbon. So we have oil, gas, and NGLs. But you also have demand pull and supply push pipelines. We look at asset quality and there is a wide spectrum of quality within there. We also look at contract quality in terms of evaluating commodity price exposure. We obviously do not want very much commodity price exposure. But we also like to see long-term contracts--10, 15, 20 years with primarily take or pay.

Glaser: When you look at the sector as a whole right now, are there any values, are there any of these high-quality companies trading at a discount?

Ellis: I would highlight perhaps three or four names. First one I would highlight would be Enbridge. We think Enbridge is a wide-moat pipeline firm. It's trading at a pretty substantial discount because of concerns over Line 3 pipeline expansion. Some of the other firms I would highlight would be Spectra Energy Partners. It's another wide-moat firm. It's trading more like commodity-sensitive MLP firm versus more like the utility, where the long-range longest pipelines tend to be not commodity price-sensitive and very high quality natural gas pipelines. Maybe two other firms I would highlight would be Enterprise Products Partners and Plains All American Pipeline and GP. These pipelines are generally exposed to NGLs and oil, and we don't think investors necessarily appreciate the expansion and earnings they can get from in terms of higher volumes.

Glaser: Stephen, thanks for the report and for giving us the recap of it today.

Ellis: Thank you.

Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.