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.
We thought the tone at last week’s MEIC conference was positive. Companies are executing on their plans and continuing to grow. Investor focus is on growth opportunities within existing business platforms, capital discipline, and some newer areas like M&A, ESG, and water infrastructure. Equity needs, leverage, coverage, and structural questions have generally faded as big topics from a year or two ago. There is some concern, however, the sector will transition back to an overbuilt environment with investors wanting to understand the implications. See our detailed recap of key industry themes and company takeaways in the full report.
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.
This week we highlight three midstream treasure hunts – NGLs searching for demand, Waha gas in desperate need for a pipeline, and investors seeking capital discipline. Starting with NGLs, midstream investors watching oil steadily grind higher may not realize NGLs have lagged badly with pricing at 1-year lows relative to oil. We discuss our latest thoughts and potential for NGLs to recover later this year. Next we turn to Permian gas where pricing the past two weeks has only increased our concern that the basin will remain heavily constrained for a while with big downside risk to pricing. Lastly, we give updated thoughts on Permian crude takeaway in light of the MMP announcement. See the full report and charts for more.
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.”
We are terminating coverage of Williams Partners following the closing of its acquisition by Williams Companies (WMB) on August 10. We continue to have research coverage on WMB.
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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