Post by
hawk35 on Nov 06, 2023 6:20pm
RBC Full Comments after Conference Call
November 5, 2023
Pembina Pipeline Corporation
Focusing the story on what matters
Our view: Pembina's shares are our favoured way to play growing WCSB gas and natural gas liquids (NGL) production given the company's integrated footprint of gas processing, NGL pipeline, and fractionation/terminalling assets. The conference call commentary highlighted Pembina's ability to deliver growth, while still generating free cash flow, which we think is attractive to North American midstream investors. Last, between the conference call commentary as it relates to potential timelines being a ways away and our prior work that any funding need may be minimal, we believe Trans Mountain will become a back burner topic.
Key points:
Our best stock idea. Pembina's Q3/23 disclosures reinforced key aspects of our positive thesis, including our view that: (1) Pembina is well-positioned to benefit from growing Western Canada Sedimentary Basin (WCSB) natural gas and NGL production, evidenced by new contracts signed during the quarter; (2) the company's focus on free cash flow generation as well as keeping leverage below 4x debt/EBITDA will attract a broad range of international midstream investors; and (3) the topic of Trans Mountain has held back the stock and management's conference call commentary helps push this topic to the back burner.
New contracts for Peace and a contract extension at Redwater. Pembina disclosed that it signed roughly 25,000 b/d of new Peace Pipeline contracts with a weighted average term of 5.5 years, while extending by five years an existing 25,000 b/d contract at Redwater that was set to expire in 2027.
Increased guidance and record quarterly EBITDA. Following the release of record quarterly EBITDA of $1.021 billion in Q3/23, Pembina set out its new 2023 EBITDA guidance range of $3.75-3.85 billion (previously $3.55-3.75 billion), which represents a roughly 4% increase from the mid-point of the prior guidance range to the mid-point of the new guidance range.
Trans Mountain: Let's give them nothing to talk about. Pembina noted that neither the company nor its joint venture will be eligible to participate in the first phase of the Canadian government's Trans Mountain divestment process. As it relates to a subsequent phase, Pembina stated that the process is "still undefined", while also highlighting an increasing list of uncertainties and outstanding issues that will need to be resolved before the company would be able to evaluate a potential acquisition.
Adjusting our estimates; introducing our 2025 forecast. Our new 2023 EBITDA and AFFO/share estimates are $3.804 billion and $4.73, respectively (up from $3.685 billion and $4.70, respectively) and for 2024, our new EBITDA and AFFO/share estimates are $3.941 billion and $5.02 (from $3.930 billion and $5.10, respectively). Finally, we are introducing our 2025 estimates for EBITDA and AFFO/share of $4.032 billion and $5.20, respectively, which represent continued growth in WCSB volumes.
Lots of positive messages
Solid operating performance and positive business updates
· New contracts for Peace and a contract extension at Redwater. Pembina disclosed that it signed new Peace Pipeline contracts for roughly 25,000 b/d with a weighted average term of 5.5 years. Further, the company extended to 2032 an existing 25,000 b/d contract at Redwater that was set to expire in 2027.
· Standing out from the crowd with a decline in the anticipated capital cost for Phase VIII. Despite many third-party pipeline projects in Western Canada realizing major cost overruns, Pembina stands out for its pipeline construction performance. For the Phase VIII expansion on the Peace Pipeline, the company now expects the capital cost will be $475 million (down from $530 million) with the project remaining on schedule. Pembina attributed the reduction in costs to project management and execution, favourable weather conditions and “productive contractor relationships”.
· Nipisi Pipeline reactivated at the beginning of October. Pembina reactivated the roughly 100,000 b/d Nipisi Pipeline to serve customers in the Clearwater oil play. The reactivation is supported by long-term agreements with an anchor customer, and Pembina highlighted that it continues to talk with other potential customers regarding potential additional long-term commitments.
Strong results and increased 2023 guidance
· Record quarterly EBITDA that was well-ahead of our estimate and consensus. In Q3/23, Pembina's EBITDA was $1.021 billion versus our forecast of $929 million and consensus of $923 million (10 estimates; $896-944 million). AFFO/share was $1.20 in Q3/23 compared to our forecast of $1.19 with higher-than-expected EBITDA being mostly offset by lower[1]than-forecast cash distributions from Alliance and Aux Sable and non-cash income included in EBITDA. For a table showing the quarterly results versus our forecast, please see Exhibit 1.
· Guidance for 2023 increased by roughly 4%. The new EBITDA guidance range is $3.75- 3.85 billion (previously $3.55-3.75 billion), which represents a roughly 4% increase from the mid-point of the prior guidance range to the mid-point of the new guidance range. The new EBITDA guidance range implies Q4/23 EBITDA of $959 million to $1.059 billion, which compares to our Q4/23 EBITDA estimate of $1.013 billion and consensus heading into the quarterly results of $978 million (nine estimates; range of $950 million to $1.005 billion).
Pushing the topic of Trans Mountain to the back burner
· The timing could be a year from now, if not longer. Pembina noted that neither the company nor its joint venture will be eligible to participate in the first phase of the Canadian government's Trans Mountain divestment process. As it relates to a subsequent phase, Pembina stated that the process is "still undefined" and that a divestment might not occur until the end of 2024 at the earliest. We also note that with the next federal election set to occur no later than 2025, there is a possibility that the government holds off on a sale until after an election.
· Pembina strikes a cautious tone with respect to the many outstanding issues. Pembina highlighted "outstanding regulatory, construction and tolling issues that pose further schedule, cost and divestment timing uncertainty". Last, the company stated that it requires clarity on the many outstanding issues before it can appropriately evaluate its next steps.
· If Pembina gets involved, we expect a transaction to be attractive. Despite most investors expressing optimism with respect to Pembina's base business, we believe the stock has been held back by the market’s concerns about a large equity issuance if Pembina decides to acquire a stake in the Trans Mountain pipeline. However, we believe that the market may have overlooked Pembina's existing messaging, which has largely framed out what an acquisition might look like. Based on our analysis, we think Pembina might need less common equity than some may be anticipating based on balance sheet capacity and a transaction could generate at least mid-single digit AFFO/share accretion.
Target/Upside/Downside Scenarios
Pembina Pipeline Corporation
Valuation
Our $58.00/share price target is based on an EV/EBITDA multiple of 11.5x 2025E. For much of the last 15 years, Pembina’s shares have traded within a range of roughly 10– 13x EBITDA (although its peak valuation was in the range of 20x). With improving market fundamentals, new growth projects, and a stronger focus on capital allocation versus the past, we believe there is support for the stock trading in the upper half of its historical valuation range. We believe that the relative risk-adjusted expected total return to our price target supports our Outperform rating on the shares.
Upside scenario
Our $65.00 per share upside scenario is based on a 1.0x premium to our base valuation (resulting in EV/EBITDA being at the high-end of the 15-year range) and new projects that could include the Prince Rupert Terminal expansion or Cedar LNG.
Downside scenario
Our downside scenario of $38.00 is based on applying the low[1]end of the valuation range that the stock has traded at over the past 15-years (i.e., 10x EBITDA) to our forward EBITDA adjusted for a Marketing contribution that is at the low-end of the five-year range.
Investment summary
We expect Pembina’s shares to outperform its peers for the following key reasons:
• Well-positioned to benefit from higher WCSB production. Whether it be uncontracted capacity or within its contract structures that blend minimum take-or-pay levels with fee[1]for-service upside as volumes grow, we expect Pembina to benefit from growing gas and liquids volumes in the Western Canada Sedimentary Basin (WCSB). Further, growing volumes could result in contracted infrastructure opportunities including NGL fractionation expansion and/or pipeline expansion projects.
• Free cash flow generation after all capex and dividend payments provides a range of capital allocation opportunities. In 2022, the company prioritized share buybacks with the strategy going forward focused on creating balance sheet optionality by reducing leverage. Lower debt levels should position the company to pursue a wide-range of growth initiatives on an equity self-funded basis.
• Solid base of business with a commodity kicker. Pembina's guardrails target over 80% of EBITDA coming from fee[1]based revenues, primarily underpinned by take-or-pay or cost-of-service contracts, which underpin the dividend. As upside optionality, Pembina's Marketing division can benefit from leveraging its asset base to take advantage of various commodity spreads.
• Potential catalysts. Improved investor sentiment toward energy and midstream stocks; additional volumes for the conventional pipeline system; government programs that strengthen oil and gas producing customers; increased Montney producer activity on the back of the sanctioning of the third-party LNG Canada project.
Risks to rating and price target
Risks to our price target and rating include: (1) a weak market for energy including lower-than-expected throughput on the pipeline systems; (2) regulatory intervention; (3) the ability to complete new projects on time and on budget; (4) operational issues; (5) reduced margins in the midstream and marketing segment; and (6) acquisitions, investments and/or projects that fail to gain the confidence of investors.