Inter Pipeline bid highlights bright spot in Canada's oil sector

A recent unsolicited bid for Inter Pipeline Ltd. has highlighted the potential of Canada's midstream companies to offer insulation from volatile oil prices.

Inter Pipeline, Pembina Pipeline Corp and Keyera Corp own key infrastructure such as gathering pipelines, gas-processing plants and storage tanks that are in high demand, and reported record second quarter profits.

They are sometimes overlooked, however, because of the wider energy sector's problems of congested export channels and low prices. Inter Pipeline shares jumped 14 per cent in two days last week after a newspaper reported the bid, leading some investors to say that their full value has gone unrecognized.

"The entire energy infrastructure space is significantly undervalued and under-appreciated," said Rob Thummel, senior portfolio manager at Tortoise Capital, one of Inter Pipeline's biggest shareholders. "They own and operate critical assets and generate fee-based cash flows that are essential."

Inter Pipeline, with a $10 billion ($7.5 billion US) market value, confirmed on Aug. 9 that it received an unsolicited takeover bid, but said it was not in talks to sell.

Interest in buying midstream assets has been "very active" in an otherwise slow energy M&A climate, said Stephanie Stimpson, a partner at Torys law firm, whose practice advises energy companies on mergers and acquisitions. Private equity investors and pension funds have been drawn to past deals by reliable returns.

"It's a successful and profitable sector right now," she said.

Companies like Inter Pipeline and Pembina ensure steady cash flow through long-term contracts, helping limit risk when crude prices tumble, said Nate Heywood, an AltaCorp Capital analyst.

Shares of Inter Pipeline, Keyera, Pembina and Gibson Energy Inc have all gained 20 per cent or more this year. By contrast, the Toronto Stock Exchange energy index is down about 12 per cent this year as investors fret about obstacles to expanding oil export pipelines and the Alberta government's mandatory curtailment orders to prop up prices.

Shares out-perform

Shares of Canadian midstream companies have outperformed their U.S. counterparts this year due to a history of paying consistent dividends, said Stacey Morris, director of research at Alerian, an index provider that tracks the performance of U.S. and Canadian midstream firms.

However, they are still impacted by wider concerns about Canadian oil and gas.

"When we go out and pitch Canadian energy names to private equity, they always say no despite the valuation," said a source involved in oil sector M&A. "With everything the sector is suffering from, they don't see it as the right time to get involved."

Inter Pipeline is also positioned to benefit from the broader energy sector's particular problems of congested pipelines and low-valued gas, Chief Financial Officer Brent Heagy said in an interview.

It is building a $3.5-billion petrochemical complex in Alberta to make plastic from the province's cheap, over-supplied propane.

"Sometimes there's opportunity when everybody sees difficulty," Heagy said, adding that ultimately constrained export pipelines limit growth for all players.

Heagy declined to comment on the takeover bid for Inter Pipeline or whether other offers have emerged.

Pembina declined to comment and Keyera did not respond.

Gibson Energy, another Calgary-based midstream company, has focused on expanding crude oil storage in recent years, as western Canadian crude inventories hit record highs in April.

The company believes the Canadian markets reward companies that are weighted towards long-term stable cash flows, have strong balance sheets and are able to consistently grow cash flow and dividends, Mark Chyc-Cies, Gibson's vice president of Strategy, Planning and Investor Relations told Reuters in an interview.