Reversing the Flow
Tired of watching pipeline problems ruin your portfolio? Try this small-cap company with big-time upside
Jody Chudley is the author of The Punchcard Portfolio, a value-oriented newsletter with a focus on Canadian oil and gas stocks
by Jody Chudley
Has any topic been more front and centre in the Canadian business press than pipelines over the past couple of years? Whether it be Keystone XL, the Northern Gateway or some other pipeline route designed to get Canadian oil to market, rarely a day passes without several news articles related to pipelines being published. Personally, I don’t get all the fuss over the major pipelines such as Keystone XL and Northern Gateway. Huge quantities of pipeline are being laid across North America every single day without any attention being paid to them or their environmental impact.
This may not make environmentalists very happy, but pipelines are here to stay – and then some. The boom in oil sands and tight oil production in North America means pipelines are going to be of increasing importance going forward, and the politicians know this. More importantly, I don’t think they are going to try and stop the unconventional energy revolution that is sweeping North America. This oil boom is providing enormous economic stimulus to both Canada and the U.S. at a time when the economies of both countries desperately need it.
That said, with both the high profile controversy associated with Keystone XL and the 2010 Deepwater Horizon disaster in the Gulf of Mexico still very much on the public mind, you can bank on politicians holding energy companies and pipeline operators to a higher standard when it comes to their environmental responsibilities. Pipeline safety therefore is going to be of crucial importance to the energy companies and pipeline operators.
They have some work to do. I was surprised when I did some digging into what the common pipeline leak detection methods are today, and discovered that the most widely used method of monitoring pipelines can only detect leaks that amount to one per cent or more of the total pipeline flow.
Worse still, that’s the best practice. Many companies still pay people to walk pipeline routes carrying a device that monitors for leaks, or use trained dogs to detect problems. That’s why the majority of pipeline leaks are detected not by companies monitoring them but by third parties such as passersby or farmers who have pipelines running through their lands. The public doesn’t seem like it’s willing to tolerate that any longer, which means something is going to have to change. Enter Synodon Inc., a company that trades on the TSX Venture Exchange that has a remote sensing technology that can measure very small ground level concentrations of escaped gas from an aircraft that flies overhead. The technology is called “realSens,” and it is mounted on a helicopter that then flies (the pilot is guided by GPS) over the pipeline that’s being monitored.
The technology actually dates back to the 1990s, when the Canadian Space Agency was attempting to develop something that could detect carbon monoxide from orbit. Synodon bought the technology from the Canadian Space Agency and has moved it forward. As I understand it, the technology is like a big infrared camera that uses reflected light to detect tiny colour changes in the infrared spectrum. Those colour changes are caused by various gases, with each different gas creating a different colour pattern.
Now, evaluating a technology such as realSens is not my area of expertise, but I don’t need to be much of an expert to figure out three things about Synodon and its product. First, this technology seems to be considerably better than the current methods being used to detect pipeline leaks. Second, detecting pipeline leaks is a huge and growing market. And third, if this superior technology were to obtain even a small share of the market for pipeline leak detection in North America, Synodon shareholders would be very happy. That’s because there are over four million kilometres of pipeline in the U.S. alone. According to Synodon, the leak detection market that it is targeting is worth $1.6 billion. The company has an enterprise value of less than $30 million, which will increase if it can gain even a small percentage of that market – and the stock price with it. For example, if it captures one per cent of the market, its annual revenues would be approximately $16 million, while if it captured just five per cent its revenues would be $80 million. Synodon’s most recent financial statements show that its gross margins are around 50 per cent, which means it could generate a gross annual profit of $40 million – more than its current enterprise value – if it captured just five per cent of the market. It’s not hard to see the upside here.
There’s more upside too, since it’s not like Synodon is legally barred from capturing more than five per cent of the market. Ultimately, it depends on whether their technology is the best. How will you know if that’s the case? By watching to see if Synodon gets any return business. After all, while lots of companies will give a new technology a try, there is only one reason to come back for more, and that is because the technology is a cost-effective improvement on what was being used previously.
And if the technology is a step up for one user, chances are it is a step up for many more.
I’ll be keeping my eye on Synodon and the behavior of its customers. If customers keep coming back for more, it will be a signal that this little company is going to get a whole lot bigger. Yes, it’s a high-risk investment, but it could also be one that comes with a high reward.