Pipeline stocks have been very profitable for long-term investors.
In 1995, shares of Enbridge (TSX:ENB)(NYSE:ENB) were under $4. Today, they’re above $40.
Inter Pipeline Ltd (TSX:IPL) traded at $6 in 2008. Shares have more than doubled since then.
None of these returns even include dividends, which often add 5% to 8% every year in gains. If you bought for the long term, these stocks would have handily beaten the market.
As we’ll see, it’s not a bad option to buy a little bit of every pipeline stock on the market. But some companies have clearly done better than others. Plus, they all have different niches. Valued at $85 billion, Enbridge is going to take a much different approach than Inter Pipeline, which is worth just $6 billion.
This is a great place to pick stocks that beat the market. But if you want to maximize your returns, which stocks should you own?
Here are the facts
It’s critical to review why these companies outperform the market in the first place. Then, the choice of investment should be clear.
Pipelines typically transport oil and natural gas. Trucking is slow and expensive. Plus, you need to build a road system to the drilling location, which could be very remote. Trains suffer the same drawbacks, primarily danger, speed, and expense.
While pipelines are expensive to construct, sometimes exceeding $5 million per kilometer, they’re extremely cheap to service and maintain. Plus, they’re much safer and faster than rail or road. When available, pipelines are the number one choice for fossil fuel producers.
As mentioned, however, these are costly to build. They also take years to get online due to regulatory restrictions. These factors limit industry supply. That’s bad for producers who rely on available capacity, but it’s great news for operators, who are granted extreme pricing power.
Consider Enbridge’s recent infrastructure addition. The firm wanted customers to commit to decade-long contracts!
Notably, these contracts are almost always volume-based. That means these businesses are insulated from gyrations in the commodity market.
In 2014, for example, oil prices were cut in half. Enbridge stock, meanwhile, grew in value. But Inter Pipeline stock lost one-third of its value. This gap in performance should be clear to anyone that understands each company’s business model.
Buy Enbridge or Inter Pipeline?
Why did ENB stock outperform during the oil bear market of 2014? The answer lies at the heart of how each company is positioned.
Enbridge is the largest pipeline operator in North America. It’s basically a pure-play. More than 95% of its cash flow comes from low-volatility sources directly tied to its pipeline operations.
Despite its name, Inter Pipeline is less of a pipeline play. Only 13% of its cash flow comes from traditional oil pipelines. Another 29% comes from processing and storage. The remaining 58% involved transportation infrastructure for oil sands projects.
Oil sands projects are structurally higher cost. When oil prices fall, their viability comes into question. That’s why IPL stock fell in 2014. The market was worried about the strength of its customer base.
Enbridge is clearly better positioned for the years ahead that given it’s actually a pure-play pipeline business. If you want to take advantage of these stocks, ditch IPL for ENB.
