RBC Comments
February 16, 2022
Keyera Corp.
The market is likely to remain focused on KAPS
Our view: We believe Keyera's solid quarterly performance was overshadowed by concerns about the KAPS project's capital cost as inflation in general has been on the minds of most investors and the company's disclosure on modest cost pressures for the project are unlikely to help sentiment. We look to the upcoming virtual Investor Day (March 29) for commentary on its approach to deploying capital into new projects, building upon encouraging statements on the Q4/21 conference call as it relates to a stronger preference for locking in returns and mitigating risk versus Keyera's historical approach.
Key points:
KAPS: "modest" capital cost pressure. The company noted that the project was over 40% complete at the end of January and that construction remains on schedule for a Q1/23 start-up. Further, while the project has experienced "some modest cost pressures due to inflation," Keyera's current estimate is that capex is "not expected to materially exceed" the project sanction cost of $800 million (net to Keyera). While no specific figures were given, the statement on materiality was framed against the project's cost versus materiality to Keyera as a whole. If we had to guess, we believe management estimates that KAPS is tracking less than 5% over budget at this time.
Virtual Investor Day on March 29 – we hope to hear more about the evolution of the capital deployment framework. Historically, Keyera has been more willing than many of its peers to deploy capital into projects with a greater proportion of the expected return coming from uncontracted volumes (or future contracting of capacity) and/or commodity spread exposure. In recent quarters, Keyera has talked about wanting to strengthen its long-term take-or-pay contracted profile (e.g., by targeting projects in the Liquids Infrastructure segment where those types of contracts have been more prevalent). We felt the commentary on the Q4/21 conference call was another step in the right direction and we look to the Investor Day for the company to solidify this strategy.
Solid Q4/21 results with not much to pick on. Adjusted EBITDA was $294 million in Q4/21 versus our estimate of $273 million and consensus of $280 million (14 estimates, range of $271-298 million). DCF/share was $0.93 compared to our estimate of $0.84 and $0.60 in Q4/20. Both Gathering & Processing and Liquids Infrastructure posted solid quarters for both volume growth and financial results.
Modest increase to our 2023 estimates. For 2022, our EBITDA and DCF/share estimates are unchanged with higher Liquids Infrastructure contribution being offset by the timing of hedge realizations in Q4/21 that negatively impact our Q1/22 forecast. For 2023, our EBITDA forecast increases to $983 million (up from $969 million) primarily due to higher contribution from Liquids Infrastructure, building upon the run-rate for the segment observed as part of the Q4/21 results. The higher forecast EBITDA drives an increase in our 2023 DCF/share estimate to $3.00 (up from $2.94).
Three thoughts on the quarter
KAPS disclosures overshadow the solid Q4/21 results In our view, given that inflation has been a theme in the market, we believe the number one topic for investors heading into the quarterly results was an update on the capital cost for the KAPS project.
While the pipeline project has experienced "some modest cost pressures due to inflation", Keyera's current estimate to complete KAPS is that capex is "not expected to materially exceed" the project sanction cost of $800 million (net to Keyera). Although no specific figures were given, the statement on materiality was framed against the project's cost versus materiality to Keyera as a whole. If we had to guess, we believe management estimates that KAPS is tracking less than 5% over budget at this time. However, we think many investors may tread carefully until there is enhanced disclosure on costs for KAPS and/or we get much closer to the Q1/23 targeted in-service date.
We are hoping to hear more about its approach to new projects At the upcoming virtual Investor Day on March 29, we hope Keyera puts forward a definitive framework with respect to how it will approach investing in new projects.
Historically, Keyera has been more willing than many of its peers to deploy capital into projects with a greater proportion of the expected return coming from uncontracted volumes (or future contracting of capacity) and/or commodity spread exposure.
In recent quarters, Keyera has talked about wanting to strengthen its long-term take-or-pay contracted profile (e.g., by targeting projects in the Liquids Infrastructure segment where those types of contracts have been more prevalent). We felt that commentary on the Q4/21 conference call was another step in the right direction with management noting that it is looking to take less risk going forward and with that, it is looking for higher contracted returns in order for the company to deploy capital in the future.
We hope there will be additional commentary at the upcoming Investor Day and specifically, we believe a strategy that focuses on achieving 6-8x EBITDA build multiples for new projects solely based on long-term take-or-pay contracting when a final investment decision is made would be well-received by the market.
Solid volumes – will midstream stocks get a lift from producer drilling in 2022? In Gathering & Processing, net throughput was up 16% year-over-year and up 3% sequentially from Q3/21. Liquids Infrastructure net processing throughput was up 8% year-over-year and up 17% sequentially from Q3/21.
Higher volumes that fill excess capacity are capital efficient ways to increase EBITDA, but we believe the key to higher midstream valuations and growth rates will be if oil and gas producers ramp up their drilling programs in a manner that both fills excess capacity and results in select infrastructure projects moving forward underpinned by long-term take-or-pay contracts. To date, oil and gas producers in aggregate have exhibited tremendous discipline with respect to focusing on free cash flow generation, paying down debt and returning capital to shareholders (e.g., share buybacks, increased dividends).
Solid Q4/21 results with not much to pick on
In Q4/21, Adjusted EBITDA was $294 million versus our estimate of $273 million and consensus of $280 million (14 estimates, range of $271-298 million). DCF/share was $0.93 compared to our estimate of $0.84 and $0.60 in Q4/20.
· Gathering and Processing realized margin was $81 million compared to our estimate of $78 million and $77 million in Q4/20.
· Liquids Infrastructure realized margin was $110 million compared to our estimate of $103 million and $98 million in Q4/20.
· Marketing realized margin was $124 million compared to our estimate of $116 million and $11 million in Q4/20. Keyera noted that roughly $10 million of realized hedging gains related to propane inventory were booked in Q4/21 and that the positive impact of these gains being booked in Q4/21 will effectively reduce margins in Q1/22 when the physical product is sold.
Valuation
Our $34.00/share price target is based on applying the 15- year average valuation of 11x EBITDA to our forward EBITDA estimate adjusted for full-year contributions from certain assets (e.g., KAPS) that we do not expect to fully contribute to results in 2023. Our target multiple is also consistent with a blended contribution from Gathering & Processing (at 11x EBITDA), LiquidsInfrastructure (at 12x EBITDA), and Marketing (at 8x EBITDA). The risk-adjusted expected total return to our price target supports our Outperform rating for the shares.
Upside scenario
Our upside scenario of $40.00 is based on a 1x increase in EV/ EBITDA valuations, which would approximate the valuations we were using prior to the COVID-related market downturn. This scenario also includes roughly $3/share associated with upside from volumes at new facilities and the development of spare land in Fort Saskatchewan.
Downside scenario
Our downside scenario of $22.00 per share is based on a scenario where Marketing results are at the low end of the long-term “base realized margin” range and Gathering & Processing margins are similar to 2020 levels (i.e., no volume recovery as well as no upside from the optimization program). Further, this scenario does not include any value for KAPS.
Investment summary
We expect Keyera’s shares to outperform the peer group for the following key reasons:
• Poised to benefit from improving basin trends. We believe that Keyera remains poised to benefit from increased WCSB volumes and demand for midstream infrastructure, at its existing facilities as well as a rising tide of future demand driving additional contracting for KAPS. On top of the potential for improved throughput and fee-driven revenue, we also see the potential for Keyera to add long-term contracts, which could help lock-in future cash flows and reduce future volatility.
• Attractive financial setup. We forecast that Keyera’s debt/ EBITDA will remain at a manageable level through the construction of KAPS with a path to deleveraging back into the company’s targeted range once KAPS is complete and contributing to EBITDA. Excluding the major turnaround at AEF scheduled for 2022, we expect that the payout ratio will continue to be at or below 70% in 2023. Further, the company intends to finance its growth capex on a self funded basis for equity (i.e., no DRIP, ATM, or discrete equity).
• Potential catalysts: additional information on KAPS that gives the market confidence in the ability to achieve a 10– 15% return on capital; Marketing results that support the company’s guidance; delivering on the optimization and cost-reduction strategy; and new projects underpinned by long-term, take-or-pay contracts that can be financed on an equity self-funded basis.
Risks to rating and price target
The ability to realize the targeted optimization and overall cost savings; low spreads and fewer opportunities in the marketing business; a material reduction in throughput at the company’s gathering and processing facilities; an inability to stem the impact of volume declines through operating cost reductions; ineffective hedges; and projects not proceeding on a time frame or with economics in line with our expectations.