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Copano Energy's Growth Opportunities


The main driver for growth is Copano's exposure to gas-rich, fast-growing areas of the Texas Gulf Coast as well as eastern Oklahoma.

Oil prices may be peaking for the summer around $70 per barrel, but that doesn't have to mean the end of your energy investments. One of the more compelling opportunities in the sector right now continues to be in the transportation and storage corner of the business, the home of some very high-yielding master limited partnerships.

I've been highlighting Copano Energy (CPNO) since August of last year to clients, and it's just dipped down into what looks like a nice new entry point. I know that a lot of the MLPs look alike, but let me explain what sets this one apart.

Copano specializes in gathering and transporting natural gas from drilling sites in the Southeast and Southwest to the U.S.' inter-state pipeline network, with an intermediate stop at processing plants where water and natural gas liquids like ethane, propane, butane and natural gasoline are removed.

It operates some 5,000 miles of pipeline and five natural gas processing facilities that can handle more than 800 million cubic feet of gas per day. For scale, this is approximately equivalent to 1.3% of the average daily demand for natural gas in the United States. Starting with 23 miles of pipeline in 1992, the company has grown rapidly through some 40 acquisitions throughout Texas and Oklahoma.

As you probably know, master limited partnerships are unique corporate structures that are not required to pay corporate-level taxes. These companies are largely limited to natural resources industries and must pay out a majority of their earnings as a required quarterly distribution to its owners. Since the MLP structure is uniquely suited for the financial stability of pipeline operators, which have limited growth rates, the "units" of ownership behave much like fixed income securities. Given this, it's not surprising that Copano's units have been a bit flaccid lately.

However, Copano is unique in that it has a number of growth opportunities that sets it apart from its stodgier peers. In fact, I am looking for its distributable cash flows to average nearly 20% growth over the next two years, to roughly $130 million in 2008.

The main driver for growth is the company's exposure to gas-rich, fast-growing areas of the Texas Gulf Coast as well as eastern Oklahoma. An expansion of drilling among its customers, in other words, is driving pipeline and storage acquisitions at Copano. It is currently completing an $80 million expansion to its Paden natural gas processing plant in Oklahoma, which will boost production levels by 40% to 100 million cubic feet of natural gas per day. Copano is also boosting gas inlet capacity at its flagship Houston Central Processing plant. All told, some $51 million worth of capital expansion projects are in the works.

Due to Copano's decision to not have a general partner control the company, these projects enjoy a low cost of capital. Not only does this provide much stronger returns on investment, but it allows the company to efficiently operate as an active acquirer. Normally, MLPs are controlled by general partners who take a 50% share of net income after required distributions have been paid out. These general partners are a common occurrence amongst MLPs, and hinder growth potential by limiting internal financing opportunities.

Copano is also placing great emphasis on hedging out its price risk to natural gas and natural gas liquids. So far, the company has mitigated up to 80% of its exposure through 2011, which will provide stability to its financial results. Combine this with a solid balance sheet, and I am looking for a cash distribution of $2.22 next year.

The bottom line is that you don't really need to worry about the vagaries of the price of natural gas with an MLP like this – only that gas transmission volumes maintain their slow, steady upward pace. My 12-month price target for CPNO is $50, which is a 20% move from here. Add the 4% dividend yield, and we're in business. I'd look to set a protective stop at $38.50 in case something goes wrong.
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