Scotia Bank Take On AltagasOUR TAKE: Slight Positive. AltaGas' shares were soft following its results, which we attribute to weakness in the general utility market as well as recent outperformance. Overall we have a favourable view of the quarter and believe it highlights a number of the themes from our recent upgrade to Sector Outperform (High-Quality Utility Trading at a Midstream Multiple – Upgrading to Sector Outperform). Specifically, its utilities see strong rate base growth of 8%-10% out to 2024 and its efforts to reduce costs to improve its ROE are tracking ahead of management's plan. The positioning of its midstream business has also improved over the last few weeks as competing propane export terminals and PDH/PP plants have been deferred. In our recent virtual marketing we note that AltaGas was an idea that saw significant traction. In terms of valuation, we see AltaGas trading at a 13.0x 2021E PE, well below its utility peers' average of 18.5x, and at a 13.3% free cash flow yield, it trades at a slight discount to the midstream average of 13.2%. We expect this valuation differential to narrow as the market gets more comfortable with the 2020 outlook and the balance sheet is further strengthened. KEY POINTS Midstream business well positioned for a choppy environment. Even with COVID-19, AltaGas' Ridley Island Propane Export Terminal (RIPET) was able to move 35 kbpd and generate favourable margins. In April the terminal moved 45 kbpd with a target of 50 kbpd thereafter. We also note that AltaGas' midstream assets are well positioned in an environment that favours gas over condensate exposure. The market is concerned about AltaGas' exposure to Painted Pony (~4% of EBITDA); however, we note that its assets are well positioned for an environment where gas prices are rallying and condensate volumes could be shut-in due to a lack of storage (link). Overall AltaGas is our favourite infrastructure way to play the recent "dry gas" rally. Longer term, though, we would not be surprised to see AltaGas sell some or all of these assets. Upside through the utilities. With AltaGas we believe investors get exposure to high growth utilities at a discounted valuation. The 8%-10% rate base CAGR out to 2024 would be above the rest of the utilities we cover. Also in 2019 we estimate the WGL utilities generated a 7.0%-7.5% ROE, which is well below its allowed ROE of 9.2%-9.7%. We expect AltaGas to narrow this gap through new rates received in 2019 as well as new Washington rates in 2021. The utilities are also reducing costs to improve their returns. The $6m reduction in leak remediation costs in Q1/20 would be tracking ahead of management's plan, which is a positive.
Q1/20 Recap: Utilities Outperform, Driving EBITDA Beat AltaGas' Q1/20 EBITDA of $499m was ahead of our estimate of $487m and consensus of $494m (range $454m-$520m). The beat versus our EBITDA estimate was largely driven by a greater-thanexpected Utilities contribution, partially offset by a softer Midstream contribution. Cash flow was also ahead of our expectation, with FFOPS of $1.50 versus our estimate of $1.46. EPS of $0.79 came in below our $0.89 estimate but was slightly above consensus of $0.76 (range $0.64-$0.89). The EPS miss versus our estimate was largely due to higher taxes. Utilities EBITDA for the quarter of $369m was ahead of our $339m estimate. The segment benefited from new rates at Maryland, Virginia, and SEMCO. The company also saw a $6m reduction in leak remediation at WGL, which is a positive development. With a rate base growth outlook of 8%-10% per year out to 2024 as well as improving ROEs, we see significant earnings growth at AltaGas’ utilities. For context we estimate that WGL earned a 7.0%-7.5% ROE in 2019, which we see improving to ~9% in 2021. This still would be below management's targeted ROE of 9.4%, which implies some upside to our estimates. Gas (Midstream) reported EBITDA of $120m, below our $132m estimate and up 13% y/y. The key driver of the Gas EBITDA miss was lower Petrogas equity earnings of $9m in the quarter versus $22m in Q1/19, as well as lower-than-expected WGL marketing results. The underperformance at Petrogas was the result of softer crude oil marketing margins and some realized hedging losses. The Ridley Island Propane Export Terminal (RIPET) added $33m of EBITDA in the quarter after adjusting for some hedge losses. This was in line with our $33m estimate and slightly below the $36m posted in Q4/19. RIPET loaded two ships per month in the quarter and exported 35 kbpd of propane; we see this ramping up to 50 kbpd by year-end. The company continues to see strong demand for its propane exports despite the impact of COVID-19. With the recent deferral of Pembina's PDH/PP and Prince Rupert Export Terminal Expansion we see the competitive position of RIPET being improved.