For the second straight year, FERC tried to steal the spotlight from the NCAA on the first day of March Madness, but this year the consequences were not nearly as drastic for midstream companies. FERC opened an NOI for the ROE rate setting process for oil and gas pipeline companies. Among other questions, FERC has asked for stakeholders’ opinions on the validity of the current two-stage DCF methodology and whether or not to incorporate CAPM, risk premium, and expected earnings models. As FERC awaits feedback, investors are contemplating the possible outcomes. Could the expanded approach impact ROEs significantly? When would the proposed changes come into effect?
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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.
2018 EBITDA was just below our estimate mainly on one-time items related to the separation. ETRN and EQM continue to build out new growth including the upsized MVP Southgate and additional contracted gathering investment. Despite this EQM and ETRN both trade nearly 2 turns below the midstream group on EBITDA; we believe that the market is heavily discounting the risk on MVP. Outperform.
Last week we hosted investor meetings with Equitrans Midstream CEO Tom Karam. ETRN is about 2 months out from its spin from EQT and Karam is optimistic on the long-term opportunities to grow the company. He is initially focused on finishing Mountain Valley Pipeline and completing the IDR swap with EQM. Longer term the focus will be on keeping leverage low, growing the business across the existing footprint and considering other ways to achieve scale.
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.
On Friday (11/30/18), Equitrans announced the simplification of its MLPs. It will acquire EQGP for $20 (a 17.5% premium from the 11/29 close) and has proposed to swap its EQM IDRs for 95M LP units. This will leave EQM as the surviving MLP, surprising consensus (and us), which believed that an EQM rollup into EQGP was more likely. EQM fell 5.5% on the day, given the expectation that it would be rolled up and on the potential dilution from the IDR swap. ETRN, which is a net beneficiary of the transaction, fell 3%, and EQGP rose 17.5% to reflect the takeout value. Bottom line, we still believe the overall complex is attractive.
Equitrans Midstream was spun out of EQT on 11/13. It is a C-corp that solely owns interests in EQM Midstream (EQM; OP, $66 TP) and EQGP (OP, $20 TP). Via these interests, ETRN has stakes in high-growth transmission and G&P assets in the Appalachian basin that are highly contracted. At the midpoint of 2019 dividend guidance, ETRN has an 8.8% yield with visibility on 8%-10% dividend growth through 2021. Our $25 TP is based on our targets for EQM and EQGP discounted 5% for tax risk and spin flowback.