The following infographic speaks volumes:
The United States has transitioned from coal as its primary baseload power source to embracing natural gas. Natural gas stands as the number one primary source for baseload energy, and this trend is projected to persist for at least a decade or more.
The largest producer in our portfolio is the lowest cost natural gas producer in the Northeastern United States. This region supplies the baseload natural gas power that much of the eastern United States depends on (especially the states highlighted in blue on the infographic).
Our natural gas producer’s cost advantage stems from its ownership of midstream assets, which includes pipelines – the conduits for transporting molecules out of the area. By having control over both upstream (production) and midstream (pipelines) assets, no other producer in the vicinity can match their low-cost production from the wellhead to the final sale. This represents a significant and enduring competitive advantage.
This cost advantage has been convincingly demonstrated over the past several months. Despite a sharp drop in natural gas prices over the last six months, our producer experienced minimal disruption. While natural gas prices are yet to recover, our natural gas producer is approaching its recent high and remains well above our cost basis.
This resilience stems from their cost advantage, which ensures strong cash flow in nearly any environment. Additionally, we hold the company at a substantial discount to its intrinsic value. Notably, their pipeline assets alone are worth more than their market capitalization. An example is the Mountain Valley Pipeline (MVP), a forthcoming pipeline that has faced years of construction delays, and was initially budgeted at $3.7 billion.
MVP’s costs have now surged to $6.6 billion for a 300-mile pipeline. In comparison, our company owns more pipeline miles than MVP (and also controls upstream production), yet our market capitalization is less than half of MVP’s pipeline expenses alone, even before the project becomes operational.
Essentially, our natural gas producer represents an undervalued hard asset investment with substantial free cash flow generation – a highly favorable scenario, particularly within an inflationary environment.
Meanwhile, our producer has already bought back 30% of its outstanding shares since late 2020. Recently, they approved an additional $1 billion for share buybacks, which equates to 40% of outstanding shares at current prices.
I’m withholding the name in this communication because the primary focus is not the company itself, but rather its low-cost competitive advantage and commitment to shareholder returns, which can result in tremendous returns even in prosaic industries.
For instance, NVR (no position), operating in the capital-intensive and slow-moving homebuilding industry, achieved remarkable success, yielding over 20,000% gains in the last couple of decades. This success resulted from becoming a low-cost producer and leveraging local scale, as well as a unique land premium strategy.
Our natural gas producer shares similar long-term prospects, a replicable strategy, and a formidable competitive advantage. Our investment portfolio also includes other comparable companies, which have low-cost business models with proven and repeatable formulas.
Consider United States refiners, which require a significant portion of heavy crude. Due to insufficient domestic production of heavy crude for refining diesel and gas, we import over a million barrels a day from Canada. Canadian oil sands producers, benefiting from 20 to 30-year reserves in inventory, will have reduced capital expenditures and heightened free cash flow going forward.
Given current market valuations, these companies offer attractive opportunities for shareholders due to their elevated free cash flow yields. With substantial capital spending largely behind them, top-quality oil sands producers are prioritizing shareholder returns, including substantial dividends and sizable share buybacks. I see steady and rewarding returns from select oil sands producers in the upcoming years.
In essence, businesses with substantial competitive advantages, repeatable strategies, and tangible assets hold a significant place in our investment portfolio. These portfolio holdings should offer investors peace of mind and possess the potential to yield tremendous returns, driven by the prevailing secular trends that favor them in a big way.