Kinder Morgan, Enbridge, Union Pacific: Do Rails Trump Pipelines?

Jacob is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Editor's Note: The initial article stated Phillips 66 signed a five-year contract with Union Pacific to deliver crude from the Bakken. That was incorrect; the contract was with Global Partners. This article has been amended.

A couple of high-profile project cancellations have raised questions over the attractiveness of crude oil and liquid petroleum pipeline companies such as Enbridge Energy (NYSE: EEP) and Kinder Morgan (NYSE: KMP), while making a strong case for rail haulage companies like Union Pacific (NYSE: UNP). Here is a closer look at all three.

Kinder Morgan announcement

Earlier this month, after major West Coast refiners said they were not interested in taking oil from Kinder Morgan's proposed Freedom pipeline, Kinder Morgan announced that it would not move forward with the project, which would ship oil from the Permian Basin shale play in Texas to refineries in Southern California. This comes as a major blow to the $2 billion project announced last October. The company is now forced to explore the higher-cost rail transport method. Understandably the announcement had a negative impact, though not very high, knocking off a couple of percentage points.

Kinder Morgan is a large company, and its stock is not driven by an announcement of a project getting slightly derailed, but this small speed bump does allow for good entry points in this high-growth stocks. Kinder Morgan has corrected from its 52 week high of $91.6 in April to $85 but has a target of $102 from Deutsche Bank. Kinder Morgan’s forward price earnings ratio of 29.6 is slightly on higher side but offers strong future prospects with an excellent dividend yield of 6%.

Similarly, Enbridge Energy faced a major setback for its $2.5 billion sandpiper pipeline project when the U.S. Federal Energy Regulatory Commission (FERC) rejected the company’s application for approval of a toll agreement. The 600 km pipeline would have linked the prolific Bakken Shale in North Dakota to a refining capacity in the U.S. Midwestern state of Minnesota. The FERC decision does not reject the project, but it has effectively pushed back the pipeline’s start-up target of early 2016, as Enbridge will now have to look into alternative ways of financing the project. Like Kinder Morgan, Enbridge is a big company with a market capitalization of $9.3 billion and remains unfazed by these small setbacks but the development has certainly taken some sheen off this stock, which has gained less than 5 % over the last quarter, thus underperforming the markets. The loss in stock price is compensated by the boost in dividend yield. At $29.60, it offers a yield of 7.3% while its fundamentals are still strong. A forward price-earnings ratio of 23.3 and a debt gearing of 1.37 indicate that the stock is in line with market valuations.

While the party lasts

On the other hand, stocks of railroad companies such as Union Pacific are surging, as it has become clear that they are the winners, at least in the short term. More than half the oil produced in the prolific Bakken Shale in North Dakota is transported through rails, as the pipeline capacity is just not there.

Union Pacific has surged 15% over the quarter. The company does not provide a break-down of its profits, but it is not difficult to see that better rates for transporting Bakken crude shipments is one factor behind the 10.9% growth in net profits during the latest quarter. In line with its improving finances, the stock has also advanced. Nevertheless, its forward price-earnings ratio of 14.5, coupled with a low gearing of just 0.5 means there is a lot more to come.

The Foolish bottom line

Rail shipping is more costly than using pipelines, but transporting crude oil by rail offers shippers and consumers more flexibility as the infrastructure is already in place. It is essentially a stopgap measure, but until enough pipeline capacity is installed, companies such as Global Partners stand to benefit. Given the significant cost benefits pipelines offer over railroad transportation, there is no denying that prospects of pipeline companies are bright. However, the long-drawn requirements of pipelines such as 20-year contracts swing the short-term balance in favor of railroad companies.

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Jacob Wolinsky has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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