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.
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On Friday (3/1/19), Enbridge announced that it now expects Line 3 Replacement to be completed in 2H-2020 rather than late this year. This stems from Minnesota’s notification to ENB that it would take until November to issue the remaining state permits. Getting the US Army Corps permit would take 30-60 days following the state permit issuance. This would mean construction will not likely start until January-February, and taking into account weather, a late Q3-early Q4 completion appears reasonable. This is obviously a disappointment for Enbridge. Even though we don’t think that most investors were baking in an on-time completion (we had been assuming Q1-20), this does push out the timing of ENB’s key near term growth project.
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.
Enbridge closed out a year of significant progress on simplification, balance sheet strengthening, solid growth, and a reorientation to a self-funded model. The outlook is unchanged from the December analyst day - strong growth into 2021 and then 5%-7% growth thereafter, fully internally funded while keeping leverage low. We believe this is a highly attractive midstream business model, particularly coupled with ENB's quality, largely regulated asset base. We remain Outperform.
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.
Upgrading Enbridge to Outperform from Peer Perform. Enbridge has arguably done as good a job as any other company in the space realigning its balance sheet and financing plan to reflect the new realities of the capital markets. ENB sold over CAD$7B in assets in 2018 and moved its leverage to below 5x several years ahead of plan. Beyond that the company also moved to simplify its (very) complicated structure by rolling up its sponsored vehicles. ENB now has a nearly 7% yield, clarity on 10% annual growth through 2020, and 5%-7% growth longer term - all without the need to issue equity via block or even DRIP. We believe this profile is what most large cap midstream companies should look like. Finally, we like the defensive characteristics of the company as well - most of its assets are long term contracted or utility like, and it should do relatively better in periods of volatility (also, at 15x 2020 EPS, it is less expensive than a utility). See our detailed sector note here.
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.
Terminating coverage of EEP on ENB rollup completion . On December 17, unitholders of Enbridge Energy Partners approved its acquisition by Enbridge and the transaction closed on December 20
We think that Enbridge did a good job at the analyst day highlighting a low-risk, self-funded model with visibility on growth in out years. After the excitement over the last few years on digesting Spectra and addressing the balance sheet, the focus can now be on execution on a better-scaled growth plan and a simpler structure. We remain Peer Perform as the stock trades at a (warranted) premium to the midstream peers but we believe ENB’s defensive nature has more appeal in this environment.
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