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.
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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.”
MMP reported Q3 EBITDA that was 3% above consensus and raised 2018 guidance slightly – the third increase this year. The beat vs. our forecast was mainly in the crude segment on higher volumes and margins from pipelines / terminals. Much of the call was focused on new early stage development projects, including oil pipelines from Cushing to Houston and from Houston to Corpus, as well as a crude export terminal at Corpus. Recent growth investment has leaned more toward refined products, but MMP seems to see more opportunities forming in crude again now. Regardless, progress on this front would increase visibility on the post 2020 growth outlook which we would view positively.
MMP has an incumbent refined products business with high barriers to entry, an excellent track record of financial discipline, and is well positioned for rising U.S. exports. We forecast strong growth through 2020. However, longer term MMP’s core refined products business offers a less clear growth story than peers more levered to rising NGL / crude production. At a macro level, MMP stock could see support if financial markets remain volatile and we get a flight to safety. But we would need to argue for a ~25% premium to large cap peers on EV/EBITDA to recommend the stock here, which we think is too much even for a very high quality name like MMP. Peer Perform.