Reports of line fill starting shortly on PAA’s Cactus II crude pipeline and EPIC filing interim tariffs for crude service on their pipeline have put more focus on marketing businesses as Permian crude spreads likely narrow. In the report we give estimates of key companies’ exposure to narrowing Permian crude differentials. Separately, while current NGL prices remain very weak, the forward curve is showing steepening contango which should create opportunities for NGL storage assets. We show storage capacity and discuss the opportunity for key NGL players within our coverage such as EPD, ET, OKE and TRGP.
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We’ve been on the road meeting with clients in TX, CA, NY, and the Southeast, as well as at the MEIC conference. We discuss detailed feedback from investors on each of the stocks in the full report. Looking back at May performance, it felt like a rough month in the market. The S&P 500 fell 6.6%, oil by 16.3%, and the E&Ps by 17.3%. Typically this would be a bad sign for midstream...but the group finally traded defensively in May, or utility-like we might say with only a 2% decline. Perhaps this was just dividend support as bond yields fell, or maybe midstream finally de-linked from broader energy which would be encouraging.
In this week’s report we discuss the stronger than expected Q1 earnings, which resulted in an average EBITDA beat of over 5% for companies in our coverage and average YoY DCF/sh growth of ~10%. Investor focus was on commodity pricing, particularly with regards to NGLs, and mega project risk given recent struggles with MVP, L3R, and KXL. We also dive into recent M&A trends in midstream after the announced acquisitions of BPL and ANDX, and what this means for valuations moving forward. Please see the full report for details.
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.”
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.
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