Veresen Inc. T.VSN.DB.B

Scotia on Alliance Upside for Veresen

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Scotia Equity Research

March 14, 2017

Veresen Inc.

Alliance Provides Optionality and Upside

OUR TAKE

The Alliance pipeline is assessing the feasibility of increasing its capacity by 30% (~500 MMcf/d). The pipeline will be looking for expressions of interest for additional natural gas transportation service with an anticipated start date of November 1, 2020. Though not binding, this is another indication of the significant demand for the pipeline. We note its firm capacity is sold out through 2018, and it has been very successful in securing seasonal firm service and interruptible volumes. While there are many unknowns, we expect that any expansion would be very accretive to cash flow. Veresen remains our top pick; our Sector Outperform rating and $16 target price are unchanged.

KEY POINTS

30% increase to Alliance's capacity possible. The Alliance pipeline announced a non-binding request for expressions of interest for additional natural gas transportation service on its system. The pipeline could increase capacity by up to approximately 500 MMcf/d (30%) to 2.1 Bcf/d from 1.6 Bcf/d currently. The expansion would include adding compression stations along its pipeline system, which would not require a long outage. While details are limited we estimate a project cost of $0.8-1.5b. Following a feasibility study, if Alliance determines that sufficient interest exists, it could commence a binding open season as early as Fall 2017. We note that this is in addition to the small upstream debottlenecking and gathering system expansions (50-100 MMcf/d) that the company has previously spoken to.

Alliance is under-levered. Alliance has roughly $1.4b of debt outstanding which it is amortizing by $130m per year (100% basis). With a 2.1x debt to 2017E EBITDA ratio, declining to ~1.5x in 2020, and a recent debt-to-capitalization of ~50% declining to ~30%, we see the pipeline as under-levered. This presents an opportunity (1) to pull additional cash from Alliance or (2) for the pipeline to lever up to largely finance the potential investment related to additional compression facilities.

Alliance refinancing or expansion is a positive catalyst. The free cash flow that Veresen presents to the market is fundamentally different than that of its peers, and understates Alliance's cash-generating ability. This is because free cash flow as Veresen presents it is after debt amortization at the Alliance pipeline. We believe that investors should adjust for this when looking at Veresen's free cash flow yield and see the company trading at an adjusted ~10% free cash flow yield. We have for some time spoken of the possibility of pulling additional cash from Alliance. A large expansion would push this out in favour of what is likely a highly accretive project. We view both scenarios as positive for shareholders.