KMI’s Q4 results came in above market expectations primarily due to a 40% YoY decline in G&A, some of which was driven by greater capitalized overhead and timing-related items. DCF was further above our estimate on lower cash taxes and favorable interest income after the Trans Mountain sale. Pipeline volume data was strong and continues to come in above expectations. We found the call a little downbeat with more focus on some wrinkles like Ruby’s contract with PCG, rate settlement talks, and Elba delays. On a positive note, KMI did add a strong $500M of new projects to the growth backlog. We’d like to see continued progress on this front to help backfill for the ~$1.3B of projects that entered service in Q4 and the $1.2B Elba project which starts up shortly.
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KMI reports earnings AMC on Wednesday (1/16) and will hold an Analyst Day on 1/23. We forecast 4Q18 and FY ‘18 EBITDA of $1,933M and $7,540M, respectively. This is slightly above consensus. KMI previously indicated they expected to beat the $7.5B EBITDA budget.
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.
Moving to neutral view on PAA as the Capline opportunity, improved valuation, and lower leverage offset our concerns on fee-based growth. We are upgrading PAA and PAGP to Peer Perform from Underperform as we now see risk-reward as balanced. We still see PAA’s crude business as highly competitive and the 2019 fee-based EBITDA outlook as too optimistic. However, PAA now only trades at a small premium on our below consensus 2020 EBITDA estimate and the Capline reversal is a unique upside opportunity that’s not in our numbers and could provide a meaningful boost in 2021. While WTI oil collapsing to $50 is unhelpful, we think investor perceptions of PAA as a higher risk stock could evolve over the next year. PAA’s volume exposure is heavily tied to the Permian which should see sustained growth even if oil stays weak. Meanwhile, the balance sheet is completely fixed with 2019 leverage of 3.7x almost a full turn below peers and the 3rd lowest in our coverage among large caps.
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.”
Q3 results were solid with FY 2018 still on track to beat guidance despite the Trans Mountain sale, the LNG contract termination, and another Elba LNG delay. The company is showing some operational leverage to accelerating production which should carry through to 2019. KMI is finding more growth and the balance sheet has improved, although we’d still like to see more progress on both fronts. On the 501-G issue, KMI reiterated a $100M eventual impact from a lower tax allowance, but couldn’t give much clarity or assurance on the risk of challenges to potential overearning. This is likely to remain an overhang topic with most of KMI’s pipes filing their 501-G in early December.
KMI kicks off Q3 midstream earnings AMC on Wednesday. Last quarter, KMI’s Q2 beat alongside accelerating volumes ended up being a good indicator for the sector which subsequently saw great results. See our EBITDA walk for KMI on p. 4. Our 3Q18 EBITDA estimate of $1,825M is below $1,859M consensus. We see FY 2018 results above KMI’s guidance but with growth more skewed to Q4 from the start-up of the Elba and Broad Run projects.
We have worked with BNP Paribas to create a reference custom basket of 15 midstream stocks held in a C-corp structure or that file a form 1099 and are taxed as corporations. The basket can be accessed on Bloomberg (BNPBCCOR INDEX) and is customizable and tradeable – contact your Wolfe salesperson for details.
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.
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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