November 13, 2020
Topaz Energy Corp.
New hybrid on the block: Initiating coverage at Sector Perform
Our view: We initiate coverage of Topaz Energy with a Sector Perform rating and a $16 price target derived from an equal weighting of our FCF discount model and a sum-of-the-parts relative valuation. Our neutral stance is primarily valuation-driven; we have a favourable view of the hybrid model, given backing by resilient and high-quality counterparties.
Key points:
Unique royalty/infrastructure model enhances cash flow stability.
Topaz’s portfolio consists of a GORR on the majority of Tourmaline’s 2.9 million net acre land base, a 77k net acre Clearwater GORR, working interests in four facilities backed by long-term take-or-pay commitments, and a contracted interest in a portion of Tourmaline’s third-party revenues (Exhibits 13–20). The infrastructure tilt provides cash flow stability but requires proportional cost-sharing, which is likely to become more material as the assets age and limit commodity upside relative to peers.
Only royalty player offering near-pure natural gas exposure. Topaz’s revenue stream is heavily gas-weighted, making it the only royalty company offering near-pure natural gas exposure. We view this favourably in the current environment given our view that the fundamentals of Canadian natural gas are better than at any point in the last several years, though we believe pricing upside is likely capped long-term.
Dropdown potential offers clear path to additional revenue streams. We expect Topaz to shop outside the Tourmaline umbrella, though we believe infrastructure dropdowns de-risk the growth potential of the portfolio. In our view, this provides a clear advantage relative to Canadian royalty peers that are much more tied to broader basin trends and have limited visibility. In addition, it is likely that Topaz will be incorporated into Tourmaline’s acquisition strategy, creating new GORR and infrastructure participation.
Clean balance sheet provides room to finance near-term growth, and backfill decreased GORR revenue in 2022. At closing of Jupiter/Modern (note here), we forecast that Topaz will have $120 million in cash on its balance sheet, combined with an undrawn $125 million credit facility. Management plans to deploy available cash for acquisitions near-term; assuming a 9x EBITDA metric, Topaz will need to spend about $100 million to backfill reduced GORR revenue in 2022.
Premium valuation sufficiently factors in growth potential. Topaz is currently trading at 12.2x 2022E EV/DACF, which compares to royalty/ midstream peers at 7.1x/7.9x, respectively. In our view, a premium multiple is justified by visibility on near-term growth, high-quality counterparties, and a clean balance sheet, though we believe the current spread sufficiently accounts for these factors.
Thanks to 'retiredcf'.