Scotia Bank Take On AltagasMidstream Spin-Out Possible...But Work To Be Done in 2021 OUR TAKE: Positive. Q3/20 reinforces our view of AltaGas as our favourite utility. It continues to improve returns at its utilities, which when coupled with 8%-10% annual rate base growth, should drive strong utility earnings growth. The improvement in utility returns is trending ahead of our estimates and as such we move up our estimates slightly. Management noted that it would look at options to maximize value (i.e., a split of the company), but first more work needs to be done to execute the company's strategy. We believe AltaGas' shares are not properly reflecting the value of its utility assets. At 14.6% 2021E free cash flow yield, AltaGas is trading like a midstream company (its peers are trading at an average of 14.4%). At 11.6x 2021E P/E, we view AltaGas as a way for investors to get exposure to high-growth utility assets at a discounted valuation (the other Canadian utilities are trading in the 18x-19x range). KEY POINTS Open to strategic options...but work to be done first. The long-term structure of AltaGas was a focus of the call given investor preference for pure-play utilities and the recent announcements of Dominion and DTE spinning off their midstream assets. Management noted that it would be open to all options to maximize value, however it believes that further execution of its existing strategy is in the best interest of shareholders. We agree with this stance and believe that improving returns on its midstream and utility assets, as well as further improvement of the balance sheet, should be a focus for 2021. At its midstream business we see the focus in 2021 being: 1) improving volumes at RIPET including a potential expansion; 2) integrating the Petrogas assets; and 3) ramping up volumes from existing and new customers. The balance sheet continues to improve and we expect this to accelerate in 2021 aided by growing EBITDA as well as potential asset sales (MVP, Blythe, non-core midstream). Longer term, we would not be surprised to see a sale or spin-out of the midstream business, which would make AltaGas a more utility-focused company. Utilities: moving up ROEs. With new rates in Maryland and Virginia, as well as a focus on improving costs, management sees WGL's achieved 2020 ROE increasing 150 bp-180 bp y/y. Overall it appears that WGL is reining in operating costs more quickly than we expected due to lower leak costs as well as improving worker productivity. We expect these benefits to be sustainable and they are currently trending ahead of our forecasts. As such, we increase our WGL achieved ROE to 8.6% in 2020. In 2021 we see further ROE improvement to 9.0% due to new Washington rates as well as further cost improvements. This would be modestly below its 9.5% allowed return and as such, there could be further upside to our estimates.
Q3/20 Recap: Strong Utilities More Than Offsets Midstream Softness AltaGas' utility assets (which are core to our Sector Outperform thesis) performed very well during Q3, though this was partially offset by a slightly softer Midstream contribution. Overall, results were well ahead of our expectations. AltaGas' Q3 EBITDA of $213m was above our estimate of $174m and consensus of $173m (range $167m-$180m). Adjusted EPS of $0.04 was ahead of our ($0.10) estimate largely due to the higher EBITDA. Included in Q3/20 was a non-recurring benefit that added $21m to EBITDA and $0.06 to EPS; if we normalize for this (EBITDA of $192m and EPS of -$0.02) results still would have been well ahead of our estimates. Strong utilities growth is core to our Outperform thesis. Utilities EBITDA for Q3 (seasonally, the weakest quarter) of $80m was well ahead of our $37m estimate. The large beat includes a $21m pension benefit which is non-recurring, but if we adjust for this ($59m EBITDA for the quarter) the utilities were still stronger than expected. The segment benefited from new rates at Maryland, Virginia, and SEMCO and continued improvement on operating costs which we believe will drive ROE higher. With a rate base growth outlook of 8%-10% per year out to 2024, as well as improving ROEs, we see significant earnings growth potential at its utilities. For context, we estimate that WGL earned a 7.0%-7.5% ROE in 2019, which we see improving to 9% in 2021. This would still be below management's targeted ROE of 9.4%, which implies some upside to our estimates. Some RIPET softness. The Ridley Island Propane Export Terminal (RIPET) loaded seven and a half ships during the quarter (Exhibit 3) and generated $23m of EBITDA, which was below our $32m estimate. Volumes of ~43 kbpd were in line with our estimate and we note that the facility is seeing some rail and logistics headwinds, but still expects to exit the year at 50 kbpd. Average RIPET margins of $5.85/bbl were below our estimate of $8.25/bbl estimate and LTM of ~$10/bbl. So far in Q4, two ships have departed from RIPET and a third is expected at anchorage in the next few days. We assume 7.5 ships are loaded in Q4. Midstream Q3/20 EBITDA of $114m was below our $126m estimate due to the lower-than-expected RIPET contribution. We also note that its Townsend and North Pine assets added a new customer described as a "global LNG player".
2020 guidance looking very achievable. Management continues to see 2020 EBITDA of $1,275m- $1,325m and EPS of $1.20- $1.30. We increase our 2020 EBITDA and EPS estimates to reflect the betterthan-expected Q3 (Exhibit 6). Our full-year EBITDA estimate is in line with the midpoint of the guidance range and above consensus of $1,288m (range $1,247m-$1,323m). However our new 2020 EPS estimate of $1.35 is above management’s guidance range given the strong performance year-to-date (with Q1-Q3 results, AltaGas has already achieved 68% of the top end of its guidance range, and we are heading into a seasonally strong quarter).