Enbridge Hopes to Pacify Opponents of Its Northern Gateway Pipeline

By Ari Charney • June 18, 2013 • Canadian Edge Weekly

As we noted in a recent issue of Maple Leaf Memo, pipeline companies are being forced to learn how to navigate issues well beyond their core expertise. Indeed, the number of constituencies involved in approving a massive pipeline project means that companies have to undertake some serious cultural diplomacy, particularly in the key coastal province of British Columbia, where First Nations, environmental groups, and labor unions wield considerable clout.

And Canadian pipeline company Enbridge Inc (NYSE: ENB, TSX: ENB) may have just learned an important lesson in cultural sensitivity.

Late last month, British Columbia officially declared its opposition to Enbridge’s Northern Gateway pipeline due to concerns about how the company would prevent and handle possible spills and other environmental disasters, both logistically and financially. However, this move is likely just another part of a complex negotiation to extract concessions from Enbridge.

The project is currently undergoing final review for approval, with all sides delivering oral arguments before a three-member Joint Review Panel that includes representatives from the National Energy Board and the Canadian Environmental Assessment Agency.

According to the Financial Post, the company’s final remarks before the panel included a dramatic plea that the project be approved for the sake of the Canadian economy, with Enbridge lawyer Richard Neufeld rhetorically asking, “You want to see an economic ‘black swan’ for Canada?” before detailing a worst-case scenario should Canada continue to rely on US demand.

Still, British Columbia has left open the possibility of changing its mind if Enbridge can meet five key conditions, including “world leading” marine and land oil spill prevention, response and recovery systems.

Enbridge’s management team understands that they’ll have to address BC’s environmental concerns and appears more than willing to do so, though one executive said that these conditions can’t be fully met until the end of the review panel process.

But management’s conciliatory tone was in stark contrast to their lawyer, who asserted that no amount of additional information on the project could hope to pacify environmental groups opposed to it. The groups arrayed against the project argue that what Enbridge has provided thus far has been largely conceptual, lacking the detail necessary to determine if the company can truly operate in accordance with the high standards it’s promising.

However, the federal government is naturally interested in seeing this project come to fruition in order to boost exports, so it’s also working with all parties to make it happen.

Indeed, the Canadian government and energy producers alike are hoping to reduce the country’s dependence on the US by building the infrastructure necessary to ship landlocked energy products overseas, with Asia as a prime destination for these commodities. And Enbridge’s proposed 731-mile Northern Gateway pipeline will be one of the main avenues for moving inland crude to coastal export facilities.

The CAD6 billion pipeline is expected to transport an average of 520,000 barrels of crude oil per day from the oil sands in central Alberta to the west coast in British Columbia. That amount would account for one-third of oil sands production, based on 2011 numbers.

The final hearings conclude in two weeks, and the panel has until the year’s end to make a recommendation to the federal government, which presumably means there will still be ample time for all parties to achieve some sort of compromise.

The bottom line is that although BC’s formal opposition is certainly a setback for the project at this late juncture, we expect both Enbridge and the federal government will do what it takes to appease the provincial government.

The Roundup

Ag Growth International Inc (TSX: AFN, OTC: AGGRF) reported first-quarter earnings per share (EPS) that beat analyst estimates by 62.5 percent, though it still fell short of expectations on its top line by 12.8 percent. Nevertheless, the shares surged 11.1 percent in response during the trading session that immediately followed the earnings release.

Given the pummeling this leading grain-handling and storage equipment manufacturer’s profits have taken as the result of last year’s historic drought, we’re betting a more normal harvest this year and next, at the very least, will make this stock a “reversion to the mean” story. Barring any weather-related disasters, therefore, we’re expecting Ag Growth’s shares to continue their rebound toward levels that preceded last year’s selloff.

In fact, the US Department of Agriculture predicts a record corn crop this year, totaling 14 billion bushels, which would break the current record of 13.1 billion bushels set back in 2009. If those levels are achieved, that would represent a 30 percent increase from last year’s harvest. According to management, the corn crop is the primary demand driver for the company’s portable grain handling equipment.

However, the company’s near-term earnings could still be affected by delays to planting in the western Corn Belt, due to rain and unseasonably cool temperatures. That late start for some plantings also means higher risk from the warmer temperatures and drier conditions forecast for July during key growth stages. Additionally, management has already stated that last year’s drought will dampen second-quarter results, as scheduled deliveries of grain-handling equipment are currently lower than last year.

So despite record projections for this year’s corn crop, last year’s severe drought has continued to weigh heavily on Ag Growth’s shares, which dropped from a high of CAD41.71 in late March of 2012, before ultimately bottoming at CAD27.80 in early November. The stock has been hit by further downward volatility in recent months, falling as low as CAD30.14 in early May. Shares are currently up 26.6 percent from the aforementioned 52-week low last November, but are still 10.1 percent below their 52-week high.

Drilling down into Ag Growth’s earnings report, and we see further evidence of the drought’s sustained impact on operations. Sales dropped 17.2 percent, to CAD59.9 million, compared to a year ago, while profits plunged 35.9 percent, to CAD3.4 million.

Sales were down in all three geographic segments, though the 17 percent drop in revenue from the US, which accounts for 62 percent of overall sales, hurt the most. Sales in Canada, which account for almost 28 percent of overall revenue, were down 14 percent, while overseas operations (10 percent of total revenue) dropped 27 percent.

Management attributed much of this performance to the timing of customer commitments, in terms of deliveries, as well as the buying pattern of a key Canadian distributor, which normally begins building inventory in the first quarter. The company expects second-quarter purchasing activity will reflect continued hangover from last year’s drought, and anticipates that adjusted EBITDA (earnings before interest, taxation, depreciation and amortization) will fall below last year’s result, though not by nearly as much as the first quarter did relative to its comparable period.

But Ag Growth’s performance should be significantly higher during the second half of the year, especially once the new crop season is firmly underway. Indeed, management says the company’s current order backlog is higher than its pre-drought backlog in 2012.

Longer term, management is definitely focused on expanding Ag Growth’s overseas operations, where its order backlog is up 72 percent from a year ago. About half of the sales in this segment are derived from the Commonwealth of Independent States, otherwise known as the former Soviet Union.

The company recently won its largest-ever contract, from a customer in the Ukraine, a CAD42 million agreement for CAD28 million in commercial grain-handling and storage equipment, along with CAD14 million in related services.

Interestingly, management’s comments during its earnings call were surprisingly candid. Despite the obvious impact of the severity of the drought, late last year management started to wonder whether there was something awry with operations that went beyond its assumptions.

As such, it had an outside firm assess its market share and customer satisfaction across its product categories. The results confirmed that its franchise is intact. In fact, management learned that the company holds a commanding 47 percent share of the market in portable augurs, among other equipment, while achieving high marks for brand preference and performance across its product portfolio.

On Bay Street, the mix of analyst sentiment currently stands at four “buys,” six “holds,” and one “sell.” Following the company’s earnings report, TD Securities upgraded the stock to a “buy,” while Laurentian Bank Securities downgraded it to a “hold.” Meanwhile, Alta Corp Capital initiated coverage of the stock with an initial rating of “outperform,” which is equivalent to a “buy.” The 12-month consensus price target is CAD35.60, which is 1.2 percent above the current share price.

Despite such a modest price target, analysts are forecasting full-year 2013 sales and EPS to rise 5.6 percent and 23.5 percent, respectively, versus last year’s dismal performance. And next year, sales and EPS are projected to jump 12.1 percent and 34.4 percent, respectively.

Based on Ag Growth’s funds from operations (FFO), which measures operating cash flow before the deduction of certain non-cash expenses, the company’s first-quarter payout ratio was 72.8 percent (CAD7.5 million in total dividends paid out compared to CAD10.3 million in FFO).    

At quarter-end, Ag Growth had no cash or cash equivalents on its balance sheet, though that’s been the case for five of the past eight quarters. Long-term debt currently stands at CAD145.9 million. The company has access to CAD58.9 million from its bank credit facility to fund short-term exigencies, if necessary. As for upcoming debt repayments, the company has CAD115 million in convertible debentures coming due at the end of 2014.

Shares of Ag Growth currently yield 6.9 percent and rate a buy below USD40 in the Aggressive Portfolio.

Here’s where to find our analyses for Portfolio Holdings that have reported earnings for the first quarter of 2013:

Conservative Holdings

  • AltaGas Ltd (TSX: ALA, OTC: ATGFF)–May Portfolio Update
  • Artis REIT (TSX: AX-U, OTC: ARESF)–June “In Focus”
  • Bird Construction Inc (TSX: BDT, OTC: BIRDF)–June 4 Maple Leaf Memo
  • Brookfield Real Estate Services Inc (TSX: BRE, OTC: BREUF)–May 7 Maple Leaf Memo
  • Brookfield Renewable Energy Partners LP (TSX: BEP-U, OTC: BRPFF)–June “Best Buys”
  • Canadian Apartment Properties REIT (TSX: CAR, OTC: CDPYF)–June “In Focus”
  • Cineplex Inc (TSX: CGX, OTC: CPXGF)–May 9 (confirmed)
  • Davis + Henderson Income Corp (TSX: DH, OTC: DHIFF)–May 7 (confirmed)
  • Dundee REIT (TSX: D-U, OTC: DRETF)–June “In Focus”
  • EnerCare Inc (TSX: ECI, OTC: CSUWF)–May 14 (confirmed)
  • Innergex Renewable Energy Inc (TSX: INE, OTC: INGXF)–May 14 (confirmed)
  • Keyera Corp (TSX: KEY, OTC: KEYUF)–May 7 (confirmed)
  • Northern Property REIT (TSX: NPR, OTC: NPRUF)–June “In Focus”
  • Pembina Pipeline Corp (TSX: PPL, NYSE: PBA)–May 9 (confirmed)
  • RioCan REIT (TSX: REI, OTC: RIOCF)–May 7 Maple Leaf Memo
  • Shaw Communications Inc (TSX: SJR/A, NYSE: SJR)–May Portfolio Update
  • Student Transportation Inc (TSX: STB, NSDQ: STB)–May 10 (confirmed)
  • TransForce Inc (TSX: TFI, OTC: TFIFF)–May Portfolio Update

Aggressive Holdings

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