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.”
Pro-forma ET’s EBITDA of $2,577M beat our forecast by 11% driven by a $200M beat at the legacy ETP businesses and a $60M beat at SUN (including a $25M one-timer). DCF was likewise 12% above our forecast, leading to coverage of 1.73x on the 7.6% annualized yield. EBITDA from legacy ETP was 11% ahead of consensus, making it one of the largest beats this earnings season alongside PAA and ENBL. ET announced a new 150 mbd frac which will come into service in 1Q20, and will build a new NGL pipe from the Permian to the 30” portion of Lone Star Express near Fort Worth. So the trend continues… companies are beating nicely and adding to growth backlogs. But when will stocks start responding positively with the AMZ having underperformed the SPX by 4% over the past 2 weeks?
We are discontinuing our coverage of Energy Transfer Partners (ETP) as the company was acquired last week by its sponsor. We reiterate our Outperform rated on the surviving company, Energy Transfer LP (ET), with a $22 target price.
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.
ETE filed an S-4 on the simplification merger with ETP this evening (8/14/18). The new company will be called Energy Transfer and listed under ticker “ET”. The disclosures imply a financial outlook that is well above consensus. While the initial pro-forma unit count of ~2,650M is slightly above our estimate, our analysis shows the pro-forma outlook embeds zero equity issuance over the 2019-21 period (see p. 2).
Investment thesis solidly on track. Energy Transfer has premium assets with numbers upside, while the simplification provides a catalyst for re-rating. Q2 results were very strong, beating consensus by 7% with strength across the board and despite a smaller uplift from Permian differentials than we expected. An S-4 with the pro-forma financial outlook is expected early next week. Strong Q2 results and a sooner than expected roll-up makes it likely the S-4 numbers will impress. ETE is our top pick in midstream.
We thought today’s (08/02/18) slides and investor call were very positive. Pro-forma retained cash flow expectations of $2.5B – $3.0B and 1.6x – 1.9x coverage imply an extremely strong financial outlook with DCF north of $2/unit (see Exhibit 1). Our Wolfe pro-forma outlook forecasts $2.2B of excess coverage in 2019-20 and 1.6x – 1.7x coverage.
Energy Transfer announced ETE will buy ETP in a unit for unit transaction at an 11% premium. Closing is expected in 4Q18 and requires approval from a majority of unaffiliated ETP holders. The press release is brief and we expect a lot more detail tomorrow in an 8-K filing and on the 10am ET call. We are surprised that ETE is paying a premium in the deal, which we had seen as an unlikely outcome.
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.
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