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Permian crude differentials have significantly compressed after the August start-ups up EPIC’s interim crude pipeline and PAA’s Cactus II. In response, pipelines are already beginning to lower their walk-up tariffs as the Permian transitions into a more overbuilt environment and the battle for volumes heats up. In this week’s report, we discuss the Permian in greater detail and which companies in our coverage have benefitted the most from these wide crude differentials over the past 4 quarters.
As we say goodbye to summer and head into conference season, we devote this week’s Midstream of Consciousness to reference materials for investors to help with company meetings. Inside the report we have updated questions to ask management and summary financial information for a number of large cap midstream companies, including ENB, EPD, KMI, LNG, OKE, PAA, and WMB.
This week we hosted a virtual NDR with EPD CFO Randy Fowler and head of Fundamentals, Tony Chovanec, and also had the opportunity to meet with KMI President Kim Dang and TRGP CFO Jennifer Kneale. It’s hot in Texas in August, but the companies seemed fairly cool and comfortable in their plans and financial outlooks even in a more volatile energy and macro tape. Key focus areas in each of our meetings included capital allocation, the implications of slowing E&P production growth, and an update on key growth projects. See company-specific takeaways below and in more detail in the body of the report.
As midstream investors shift their focus to 2020, there have been a lot of questions regarding production growth and what volumes will look like into next year. In this week’s report, we break down the Wolfe Energy team’s recently updated production model, which expects incremental production to decelerate some over the next year and a half. At the basin-level, the Permian is expected to provide the bulk of the growth, though volumes may underwhelm the slew of takeaway projects near completion and recently announced. In response to lower production growth, we expect midstream capital spend to decrease materially into 2020, which should help midstream screen much more favorably in terms of positive FCF yields next year. We show our projections for capex and FCF outlooks for 2020 vs. 2019 for our coverage in the report.
We move to No Rating after Pembina’s announcement to buy KML . We are moving to No Rating on KML from Peer Perform given that the stock is no longer trading on fundamentals due to the announced acquisition of the company by Pembina Pipeline Corporation. For our thoughts on the deal, please see our KMI note.
Surprise exit from Canada at good value. KMI will sell KML and the Cochin pipeline to Pembina (PPL CN) for $2.2-$2.3B of proceeds net of tax leakage, while also removing $550M of preferred equity from the balance sheet. The assets would have contributed $260M of 2020 EBITDA, implying almost 11x EV/EBITDA after the tax impact. We see it as about neutral to DCF/share assuming $1.2B of debt paydown (4.5x EBITDA from assets sold) and the rest of the proceeds going to buybacks (see p.5). However, the sale was a positive surprise three months after the KML strategic review concluded with no news. Mgmt. was patient and ended up getting a good outcome for shareholders that simplifies the KMI structure and greatly boosts financial flexibility in 2020.
Market volatility increased this past week and interest rates collapsed. The 10-year treasury yield has now fallen 113 bps YTD, while the 30-year dipped below 2% for the first time ever. In this week’s report, we take a look at the current interest rate environment and how midstream’s market leading dividends could present a viable alternative for yield-starved investors in search of higher returns. That said, August performance to date has not proven this to be the case with midstream again performing just like any other energy sub-sector, and safety names significantly outperforming within the group. Separately, we also discuss the results from our Q2 poll which showed less bullish views on midstream than a quarter ago.
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