Attractive valuation, but with late cycle multiple compression risks. Midstream stocks offer low double digit total return (dividend + growth), which is attractive at this point in the cycle especially for a relatively low risk business. Relative EV/EBITDA multiples are slightly below the SPX and UTY, and P/E is now in line with the market. We saw a 10-20% compression of EBITDA and cash flow multiples in 2018. The risk is market multiple compression in 2019, which has an amplified effect on equity values for a levered sector.
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Q3 results were even better than we expected. None of our covered companies missed with a median EBITDA beat for the quarter of 5%. More importantly, the median DCF / share growth in Q3 was 18%!! This figure excludes companies involved in M&A and is more reflective of true growth in the business – see p. 2. While this pace of growth clearly won’t last forever, what other sector is paying a 7-8% yield and growing cash flow per share by almost 20%? The fundamental picture is very strong, balance sheets are improving, and equity needs have been dramatically reduced. EPD’s CEO Teague stated this is “the strongest business climate we have seen in recent memory.”
Cheniere outperformed 275bp on Thursday (11/08/18) after reporting a Q3 beat but more importantly announced higher run-rate guidance, a new long-term contract with Poland, and steps forward on Sabine 6. This good news more than offset any concern on 2019 guidance that was below consensus. In our view the much-improved long-term outlook is a big positive, there is still more expansion potential in Sabine 6 and at Corpus, and the new contract highlights that Cheniere is not wholly dependent on China for growth from here. We reiterate our Outperform rating.
We are forecasting Q3 EBITDA growth of nearly 15% vs. last year, with median DCF per share rising by 15% YoY as well. Fundamentally, the sector continues to benefit from positive dynamics as production volumes accelerate across most key basins, new projects come into service, and wide locational price differentials highlight the need for new infrastructure investment. The Q3 fundamentals are similar to Q2 which saw strong results and the AMZ outperform the market by 8% over the course of earnings season. However, unlike Q2 we see consensus as largely there; we have a roughly even split of beats and misses vs. consensus. So it’s less clear to us if Q3 will again be a positive catalyst or more neutral near term. Ultimately, we believe that as the companies continue to show above-average growth, simplify, and get to sustainable leverage, investor support for the sector will increase.
We have worked with BNP Paribas to create a reference custom basket of 15 midstream stocks held in a C-corp structure or that file a form 1099 and are taxed as corporations. The basket can be accessed on Bloomberg (BNPBCCOR INDEX) and is customizable and tradeable – contact your Wolfe salesperson for details.
We hope everyone had an enjoyable summer. To help get back in the swing of things and with the fall conference season ahead of us, we are publishing a midstream-focused question bank for a number of our covered companies (see table on right). Key industry topics are discussed below with a detailed listing of questions for individual companies in the body of this report.
Cheniere has been the exception among LNG players - projects on time and on budget, execution on expansion FIDs (to date the only one in the US), and a productive marketing arm. Cheniere looks cheap to us on the locked up cash flows from the 8 trains operating and under construction, and we continue to see growing odds of more expansion - Sabine 6 and more capacity at Corpus. Outperform.
Last night (7/18/2018) FERC issued a final rulemaking on how to handle tax reform in regulated gas pipeline rates as well as a clarification of the policy statement that eliminated the tax allowance for MLPs. These stemmed from initial orders in mid-March. While FERC did not change the fundamental position that MLPs (in a vacuum) still can’t collect an income tax allowance it appears that under the final rule natural gas MLPs that are consolidated by a parent corporation can claim that they are taxpayers. Bottom line, this appears to be a significant change from the initial ruling in March for a number of pipeline MLPs that are consolidated by C-corps.
Cheniere held an impromptu mini analyst day and formally updated run-rate EBITDA and cash flow guidance in light of last week’s FID of Corpus Christi 3. EBITDA guidance for 8 trains is now $4.3-$4.6B vs. $4.2-$4.7B previously. Cash flow is better than expected, at $2.0-$2.3B vs. $1.8-$2.2B previously mainly due to lower expected interest expense and lower minority interest. Sabine 5 and Corpus 1-2 also look ahead of schedule. Cheniere remains one of our best midstream ideas, with significant growth and cash flow coming from 20 year locked up contracts and option upsides from LNG marketing and the potential for additional expansions over time. Outperform.
With U.S. production increasing fast, several big simplification announcements, and oil prices much improved, the fundamental tone was positive at MLPA. Turnout was reportedly higher than last year even with each of the large C-corps still sitting out of the event. That said, FERC and structure were clear overhangs. On FERC, we heard more questions than answers. Structure / simplification was discussed at nearly all our meetings and often overwhelmed the conversation. We think continued (and speedy) resolution around FERC / structural issues should help bring investor focus back to a strong fundamental set up, but there will be uncertainty in the meantime.
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