Is This Beaten-Down 5.5% Yielder Now a Buy?

Before the oil market downturn, Plains All American Pipeline (NYSE: PAA) was a high-powered growth stock. Over the five-year period from 2009 to 2014, the oil pipeline company delivered a nearly 300% total annual return -- more than double that of the S&P 500 -- fueled by rapidly expanding oil production in North America that drove the need for new oil-related infrastructure. However, the collapse of oil prices since late 2014 has had a significant impact on Plains by causing the volumes flowing on its pipelines to fall, which has adversely affected earnings and put a strain on its balance sheet. As a result, the company struggled to obtain financing for its growth projects and has lost more than 50% of its value over the past three years, forcing it to reduce its distribution to investors twice.

That steep slide in the company's market value, however, looks like a compelling opportunity for long-term investors to jump aboard. That's because even with those payout cuts, Plains still yields an attractive 5.5%. Add in the visible improvements on the horizon to both its balance sheet and growth prospects, and Plains could deliver an enticing blend of income and growth in the coming years.

Ripping the Band-Aid off

Plains has tried to address its financial situation several times over the past few years. Early last year, for example, the company issued $1.6 billion of preferred shares to satisfy its equity financing needs for the year, address concerns about the sustainability of its distribution, and strengthen its balance sheet. A few months later the company completed a simplification transaction with its general partner Plains GP Holdings (NYSE: PAGP) that was supposed to improve its cost of capital by strengthening its distribution coverage and credit profile.

However, neither transaction went far enough to improve its financial situation, which is why the company announced an even more significant move last month. Plains chose to slash its investor payout by 45% because that would free up $1.1 billion of cash flow over the next six quarters. That excess cash, when combined with several in-process asset sales and other moves, puts it on pace to reduce total debt from $11.2 billion to $9.7 billion by early 2019. Furthermore, it would provide the company with the capital to finance several high-return projects it has in development, positioning it to increase the payout by a rapid rate after it hits its leverage target.

Going back to growth mode

Plains All American Pipeline's earnings peaked in 2013 and have steadily declined since that time, going from $2.3 billion to an expected $2.1 billion this year. That said, the company anticipates a significant improvement in its financial results next year, with its current guidance forecasting a 19% increase at the midpoint. Fueling that growth is a combination of recent acquisitions and high-return growth projects.

On the acquisition front, Plains made a big splash earlier this year when it acquired the Alpha Crude Connector System in the red-hot Permian Basin from Concho Resources (NYSE: CXO). The company paid $1.25 billion for the system, which is under a long-term contract with Concho. Furthermore, the cash infusion gives Concho additional capital to drill more wells, which should provide Plains with incremental opportunities to expand the system. Meanwhile, Plains also signed a joint venture agreement with Noble Midstream Partners (NYSE: NBLX) to acquire an oil pipeline in the Permian. Noble then connected that line with Plains' system in the region, which should provide additional future opportunities.

In addition to buying those expandable assets, Plains also has several organic growth projects underway, the bulk of which are in the rapidly growing Permian Basin. Overall, the company plans to invest $1.2 billion into projects that should enter service over the next two years. Plains estimates that these projects, when combined with the embedded growth of its existing system, should add $300 million in fee-based earnings next year, with additional upside in 2019 and beyond.

It could be a bumpy road, but the upside is there

Plains All American Pipeline's financial situation had eroded to the point where it needed to do something drastic to get back on solid ground. While the oil pipeline company isn't there just yet, it has a clear path to reach its destination in less than two years. There could be more volatility in the near term, but for investors with an iron stomach, Plains could be quite the buy given its dirt cheap-valuation and potential to deliver significant upside when combining its attractive 5.5% yield with the possibility for compelling capital gains and distribution growth.

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Matthew DiLallo has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.