Comments from RBC this morning
March 30, 2020
Inter Pipeline Ltd.
The first cut is the deepest
Our view: We believe the 72% dividend cut and DRIP suspension help
alleviate concerns about the payout ratio and share dilution from the DRIP,
while providing a modest improvement in net cash flow/liquidity/funding.
Nevertheless, we believe the market will continue to take a "wait and see"
approach to the stock with respect to a potential HPC partner, the optics
of high leverage and any credit rating agency actions.
Key points:
The solution to dilution - cutting the dividend by 72%; suspending the
DRIP. Inter Pipeline announced a 72% reduction in the dividend to a new
annualized rate of $0.48/share. The first new monthly dividend will be
paid on, or about, May 15. The company also suspended the dividend
reinvestment plan (DRIP), including the premium DRIP, effective with the
payment of the dividend in May.
European bulk liquid storage sale process suspended. The company
noted that it was at an "advanced stage" of the process, but it decided
to suspend sale activities given the COVID-19 situation, while stating that
it "may revisit this process at a later date." On the business performance
front, Inter Pipeline highlighted that strong contango pricing has benefited
its European storage operations with utilization rates of roughly 95%.
Looking for a partner at HPC to take a "material interest." The company
highlighted that it started a process in late 2019 to secure a partner
and that the process "remains active and ongoing." While the company
noted that there are interested parties, it acknowledged that the pace of
progress will inevitably be slowed by the impacts of COVID-19.
We believe the HPC partner process will be key to the share price.
Quantitatively, a partner would help bring funding for the project, which
potentially would benefit Inter Pipeline's leverage and cash flow credit
metrics. We see even more qualitative benefits, including the potential
to bring in a well-regarded petrochemical operator, the reduction of
overall corporate exposure to HPC and assuming a valuation that is
close to book value, the read-through with respect to a partner having
vetted confidential information that has not been disclosed to the public
(e.g., the amount of contracting; tracking of construction costs). Last, we
highlight the recent announcement of a PDH/PP project in Saudi Arabia,
which on one hand highlights the economics of polypropylene, but on the
other hand represents an incremental source of global supply.
Bumping up our estimates. Reflecting lower interest expense (cash
savings from the dividend cut) and the complete elimination of the
DRIP, our new 2020 and 2021 FFO/share estimates are $1.86 and $2.15,
respectively (up from $1.85 and $2.09, respectively).
Price target/base case
Our $9.00 per share price target is based on the prior trough
valuation of roughly 7.5x EBITDA applied to our 2021E EBITDA
plus an adjustment for the Heartland construction work inprogress.
Given the current weak market environment that
is also pressuring companies with above average leverage
and large capital projects (like Inter Pipeline), we believe a
trough valuation is appropriate at this time. However, like
other WCSB-focused midstream stocks, we see significantly
higher long-term value in the shares, which is reflected in our
"Upside Scenario" that is based on our price target from before
the March 2020 market downturn.
Upside scenario
Our upside scenario of $24.00 is based on our pre-downturn
value, which incorporated a a roughly 12x multiple of our
2021E EBITDA. The selected multiple is derived by valuing
the major businesses separately. Specifically, we use multiples
that are consistent with what we use for similar assets owned
by peers, including a 13x EBITDA valuation for the oil sands
pipelines, an 11x EBITDA valuation for the bulk liquid storage
assets, an 11x EBITDA valuation for the conventional pipelines
and a 10x EBITDA multiple for the NGL processing assets.
For Heartland, our valuation attributes value equal to the
construction work in-progress.
Downside scenario
Our downside scenario of $3.00 is based on the recent trough
valuation for the shares (i.e., 6x EBITDA) applied to our 2021E
EBITDA adjusted downwards for no NGL processing operating
margin improvement from our 2020 estimate.
Investment summary
We expect Inter Pipeline’s shares to perform in line with its
peers for the following reasons:
• Upside from Heartland is a ways away. With the long
construction period (i.e., late-2021 planned in-service) for
the $3.5 billion Heartland Petrochemical Complex (HPC) as
well as limited details on actual contracting levels, we think
that the market is taking a wait-and-see approach with
respect to a potential partnership as well as adding value for
the project in the share price until much closer to HPC’s inservice
date.
• We believe the HPC partner process will be key to the share
price. Quantitatively, a partner would help bring funding for
the project, which potentially would benefit Inter Pipeline's
leverage and cash flow credit metrics. We see even more
qualitative benefits, including the potential to bring in
a well-regarded petrochemical operator, the reduction of
overall corporate exposure to HPC and assuming a valuation
that is close to book value, the read-through with respect
to a partner having vetted confidential information that
has not been disclosed to the public (e.g., the amount of
contracting; construction costs).
• Potential catalysts: securing a potential partner for HPC; a
potential takeover bid being launched; additional contracts
for the PDH-PP project; new contract announcements
related to the utilization of spare capacity on the Polaris and
Cold Lake pipelines and/or the Mid-Saskatchewan system;
further expansion of other pipelines; a spike in NGL prices/
frac spreads.
• Key risks: actions needed to defend the credit rating;
material decline in throughput on the conventional oilgathering
system where the impact cannot be offset
through toll management; a prolonged decline in frac
spreads or crude oil midstream margins; the ability to
commission new projects on time and on budget; the
inability to secure additional contracts for the PDH-PP
projects; capital cost overruns and acquisitions or new
projects that fail to gain the confidence of investors.