RBC Comments Today
February 24, 2020
Inter Pipeline Ltd.
Anticipation building for key announcements in
H1/20
Our view: Our thesis that material upside in the stock is likely to be capped
until the longer-term story plays out (i.e., in 2022 when Heartland is
online) remains unchanged. In the nearer term, we believe that the stock
may come under modest pressure if longer-term focused investors take a
step back to wait for what could be significant updates in H1/20 on funding
and Heartland costs.
Key points:
European bulk liquid storage sale process update expected by the end
of H1/20. There were no material updates on the process as part of the
Q4/19 results, although management noted that it expects the process to
be concluded “within the first half of 2020”. The company also stated that
“should a full or partial transaction be completed, proceeds would be used
to reduce debt and finance our capital expenditure program, including the
Heartland Petrochemical Complex.” We currently value the segment at
11x EBITDA, so unless there is a significant upside surprise in valuation,
we see the biggest benefit from a sale being improved investor sentiment
with respect to funding and capital optimization.
Funding update following the conclusion of the European bulk liquid
storage sale process. We expect the company to provide an update on
its funding plan following the conclusion of the European sales process.
Inter Pipeline noted that a “successful” sale should allow it to turn off the
premium DRIP ahead of schedule. For this reason, we see the outcome
of the sales process as being a key driver of the share price given what it
means for funding, especially if only a portion of the European assets are
sold or if the company elects to not sell the assets at all.
Heartland cost update likely to be disclosed concurrent with Q1/20
results in May. While the current message is that the Heartland
Petrochemical Complex (HPC) construction “continues to track according
to budgetary and schedule targets”, management noted that it is
undertaking a “full bottom-up refresh” of the polypropylene capital cost
estimate and that it expects to provide an update when it reports Q1/20
results in May. Directionally, Inter Pipeline stated that there could be a
“modest increase” in costs but noted that it does not expect any revisions
to materially impact the overall project economics.
Modestly reducing estimates. We reduce our 2020 and 2021 FFO/share
estimates to $2.13 and $2.17 (from $2.20 and $2.27), respectively. The
primary changes to our estimates are driven by a modestly lower forecast
realized frac spread closer to current pricing, higher financing charges
more consistent with Q4/19 levels, and higher cash taxes as our prior
estimate was too aggressive.
Price target/base case
Our $24.00 per share price target represents 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, a 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.
Upside scenario
Our upside scenario of $34.00 assumes that the Heartland
project is completed on-time and on-budget with commercial
terms and EBITDA in-line with management's guidance.
Furthermore, our upside scenario includes a 1x EV/EBITDA
valuation expansion reflective of lower long-term interest
rates and/or an improvement in oil-related sentiment.
Downside scenario
Our downside scenario of $14.00 assumes that EV/EBITDA
valuations contract by 1x, possibly due to higher 10-year
GOC bond yields and/or a prolonged downturn in NGL prices
resulting in weak frac spreads at Cochrane in addition to no
EBITDA for the NGL/olefins business.
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 until
much closer to HPC’s in-service date.
• Is there takeover upside? Given the length of time from
the August 2019 disclosure by Inter Pipeline with respect
to an unsolicited approach by a unnamed party, we would
caution against a thesis that primarily involves upside from
a takeover. Given the board's reluctance to engage last
year, we believe that if a future approach were to occur,
it may have to be unsolicited and many parties may shy
away from making unsolicited offers as: (1) the party may
not be willing to take on the stigma of a hostile bid; and
(2) presumably the party sees value in HPC, and with the
project under construction, management being distracted
with the bid could jeopardize the timing and cost of the HPC
construction.
• Potential catalysts: a potential takeover bid being launched;
the sale of the bulk liquid storage business for an attractive
valuation (i.e., above our 11x EBITDA valuation); securing
funding for Heartland resulting in an ability to turn off
the DRIP; 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: the resolution of the potential takeover bid
situation, an inability to sell the bulk liquid storage business
at a reasonable valuation, material decline in throughput
on the conventional oil-gathering 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 ability to secure new oil pipeline projects; 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.