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.”
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.
On Wednesday (11/22), the FERC issued an order on MMP’s petition that FERC affirm the legality of having marketing affiliates ship on crude oil pipelines held within the same integrated company. FERC determined that having marketing affiliates is permissible. However, FERC also found that transactions where marketing businesses deliberately incur losses in order to increase volumes and revenues on affiliate pipelines owned by the same integrated company are not compliant with the Interstate Commerce Act (ICA). FERC cited Supreme Court precedent and how such transactions effectively lead to certain shippers receiving preferential rates under common carrier pipelines relative to rates paid by others.
The merger of Sunoco Logistics Partners (SXL) with Energy Transfer Partners (ETP) closed on April 28. ETP became a wholly owned subsidiary of SXL, which changed its name to Energy Transfer Partners, L.P. and ticker to “ETP.” As such, we are withdrawing coverage of SXL while maintaining our coverage of the pro-forma entity which trades under the ETP ticker.
Investors should no longer rely on previously published research, opinions, estimates, or price targets.
SXL committed to move forward on up to a 300 MBPD Permian Express oil pipe expansion through YE 2018 and a 250 MBPD expansion of the recently approved ME 2 NGL pipeline. Adding to growth backlogs is differentiated in midstream these days and reflective of SXL’s attractive position in the growing Permian / Appalachian basins. This was a positive update. Our only concern is the lack of details on contracts for ME 2 and delay in finding a JV partner which would help affirm good returns on the project. We think the long-term NGL supply is there, but near term returns are less certain.
Will MLPs trade with energy (oil) or income sectors (bonds)? Oil prices and rates have both been going up. We think MLPs continue to trade more with energy (oil) than rates in 2017, just as they have post election. MLPs are a risk-on income sector – that’s a good thing for portfolio diversification. MLPs may be due for a catch-up trade vs. the XLE based on history after two years of underperformance.
This is the second edition of our new weekly research product. We intend to be flexible on content with a focus on a few key issues each week in a concise format – feedback is welcomed. We initiated coverage on the Midstream sector in early October with a Market Weight rating (link), and now cover 13 midstream equities in addition to our utilities / power coverage. We’ve been encouraged by the level of interest from midstream investors and the constructive feedback – please keep it coming.
We initiated on SXL in early October with an Underperform rating on the basis the equity was expensive given the risks and distribution growth could disappoint. We see the ETP deal and recent SXL weakness as having improved the valuation and risk-reward profile. Put simply, SXL is using its higher multiple equity to buy the cheaper ETP for no premium. The pro-forma valuation is now a discount to our large cap comp group on 2018 EV/EBITDA (11.5x vs. 12x) with an above average yield (9% vs. 6%) and ample coverage of 1.1x in 2017 – see our pro-forma analysis on page 4. SXL’s distribution growth outlook is also better with the deal. We see the risk-reward skew as now more balanced and upgrade to Peer Perform.
We are introducing a new weekly research product. We intend to be flexible on content with a focus on a few key issues each week in a concise format – feedback is welcomed. We initiated coverage on the Midstream sector in early October with a Market Weight rating (link), and now cover 13 midstream equities in addition to our utilities / power coverage. We’ve been encouraged by the level of interest from midstream investors and the constructive feedback – please keep it coming.
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