We are downgrading TransCanada to Peer Perform from Outperform. In our view TRP still has one of the best growth backlogs in the space - CAD$36B of defined projects and tens of billions in active development. It also has a utility-like business profile, with virtually all of its Canadian operations under cost of service constructs and much of the Columbia system under long term take or pay contracts. That said, we believe the stock could be hindered in 2019 as it comes closer to a decision on Keystone XL and there is greater certainty on the financing plan. See our detailed sector note here.
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Enbridge now our preferred Canadian midstream name. We are upgrading Enbridge to Outperform from Peer Perform and it is now our preferred Canadian midstream name. ENB executed very well in 2018: fully simplifying, repairing its balance sheet with significant asset sales, and getting Line 3 Replacement approved. It has become what we see as a prototypical large cap midstream model: high yield (7%), high growth (10% through 2020, 5%-7% sustainably thereafter), and no foreseeable need to access the equity markets. Finally, ENB is well positioned for Canadian crude takeaway given the uncertainty over TMX and KXL, and it appears headed to reduce volatility further under a long-term tariff agreement on the Mainline. We are boosting our target price to $37 from $36.
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.
While there weren’t any big announcements at TRP’s analyst day on Nov. 13 we thought the meeting was constructive. The messaging of 8%-10% growth through 2021 while minimizing equity and keeping leverage sub-5x was as we expected, though it was clear that TRP has a lot of growth momentum beyond 2021. We continue to see the stock as attractive on both earnings and EBITDA given the growth potential and low-risk locked in cash flows. Outperform.
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.”
TRP had a lot of good news on the Q3 call and it outperformed nearly 2% on the day reporting a solid beat on the quarter, $8B of secured growth project backlog additions, and talk of paring back equity. TRP will be holding an analyst day on 11/13 where we expect a lot more detail on the growth story and financing plan, but the bottom line remains that TRP has one of the largest and most visible growth outlooks that now runs well past 2021. We reiterate our Outperform rating.
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 continue to view TransCanada’s long term investment backlog as one of the highest quality and most visible in the midstream space. Its 10% EBITDA growth profile through 2020 is already one of the highest in the sector, and it also has a series of options to extend that growth further, all at a utility-like risk profile. Despite what we see as a premium growth story the stock barely trades at an average multiple – reiterate Outperform.
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.
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.
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