For the second straight year, FERC tried to steal the spotlight from the NCAA on the first day of March Madness, but this year the consequences were not nearly as drastic for midstream companies. FERC opened an NOI for the ROE rate setting process for oil and gas pipeline companies. Among other questions, FERC has asked for stakeholders’ opinions on the validity of the current two-stage DCF methodology and whether or not to incorporate CAPM, risk premium, and expected earnings models. As FERC awaits feedback, investors are contemplating the possible outcomes. Could the expanded approach impact ROEs significantly? When would the proposed changes come into effect?
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We’re hearing a more cautious tone on the group overall after a strong start to the year. Q4 earnings were mixed and mega project risks are front and center on investors’ minds. The C-corps keep outperforming the MLPs and most dedicated midstream investors aren’t sure why. Perhaps we’re seeing new generalist buyers? We’re also hearing consistent debates on a number of key stocks from investors. Please open the full report for details.
We thought results in Q4 were solid with an average EBITDA beat of 3%. DCF/share growth of 8% YoY in Q4 was down from the breakneck double digit growth seen in Q2 (13%) and Q3 (18%), but is clearly still attractive total return when combined with safe 7% yields. Our updated forecasts still call for 5% DCF/share growth in 2019, preserving a low double digit total return investment proposition. That said, the group now seems more dependent on a valuation call near-term given more uncertainty over the pace of production growth and concerns over high levels of competition and a cyclical shift toward potential overbuild.
4Q18 EBITDA beat consensus by 5% and would have been an 11% beat excluding a one-time crude inventory change. 2019 EBITDA guidance of $10.6B - $10.8B was maintained and ET gave more color on commodity sensitivity and spread assumptions that seem sufficiently conservative to us. A simple annualization of 4Q18 EBITDA (which included a negative $150M one-time item) would put ET in the middle of the 2019 guidance range. While spread-based margins may moderate from robust Q4 levels, ET will benefit from the start-up of ME 2, frac 6, Bakken expansion, and Bayou Bridge. 2019 consensus before the print was below ET’s guidance, whereas we think ET can even beat guidance.
ET reported 4Q18 EBITDA of $2.67B which was 3% above our forecast and 5% above consensus. This was the 7th straight quarterly EBITDA beat. DCF of $1.52B was further above our expectation on lower maintenance capex. ET had 1.90x coverage of its 7.9% distribution yield in Q4. This is very impressive, especially in comparison to ET’s peer TRGP who reported earlier today with 0.91x coverage of a similar 8.1% yield. While TRGP certainly has more visible multi-year growth than ET, we see more value in ET stock based on today’s cash flow profiles. Importantly, ET reiterated 2019 EBITDA guidance of $10.6B - $10.8B and 2019 growth capex of $5B.
On Friday (02/08/19), the PA Department of Environmental Protection (DEP) suspended all reviews of clean water applications for ET projects. They cite non-compliance with orders to stabilize the Revolution construction site after a landslide caused a gas gathering pipeline to explode in September. PA Governor Wolf issued his own statement supporting the action and stating “there has been a failure by Energy Transfer and its subsidiaries to respect our laws and our communities”. He also called upon the PUC to require a “remaining life study” of the older ME 1 NGL pipeline – an action favored by opponents of Mariner. There have been a number of incidents during construction of key ET projects such as DAPL, Rover, ME 2, and Bayou Bridge over the past few years.
Our EBITDA estimates for Q4 are close to consensus overall and we forecast DCF/share growth of 8% on average (5% median). While not as robust as the wild 18% YoY growth in DCF/sh reported in Q3, we see continued momentum in Q4 from strong volume growth and new infrastructure investment despite some modest commodity pressures. As we wrote in our year ahead report, the group offers an attractive value proposition with 7% yields plus mid single digit growth, while a larger exposure to production volumes than commodity prices should differentiate midstream results vs. broader energy in 2019.
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.
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?
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