Thoughts on Valuation – Moving Target to $29 Scotia BankOUR TAKE: Positive. We recently hosted members of AltaGas' senior management team for investor meetings. The meetings highlighted the numerous reasons we like the shares, including: (1) improving returns from existing assets; (2) significant visibility into 8%-10% annual utility rate base growth; (3) torque to increasing energy activity in western Canada; (4) a self- funding model; and (5) attractive relative valuation. AltaGas continues to be our favourite utility name. We increase our target price to $29 from $25 as we now believe the company deserves a valuation at least in line with its peers' (see p. 2). We believe that further valuation expansion could be driven by additional clarity on its growth outlook and continued strengthening of the balance sheet. At 10.9% 2023E free cash flow yield, AltaGas is trading like a midstream company (in fact, at a discount to its midstream peers, which are trading at an average of 10.1%). At 14.4x 2023E P/E, we view AltaGas as a way for investors to get exposure to high-growth utility assets at a discounted valuation (the other Canadian utilities are trading in the 17x-19x range). KEY POINTS Key focus of management is improving returns from existing assets. This should drive earnings growth without any incremental capital. It has made significant progress in improving the earned ROE at WGL to our estimate of 9.1% in 2021 versus ~6% in 2019. Looking forward, new rates in Washington as well as a continued focus on accelerated pipeline replacement programs (ARP) should drive further earnings growth. Its midstream business has significant unused capacity or low-cost expansion potential. Increasing activity in northeast BC could improve volumes and returns. Thoughts on assets sales and corporate structure. A common question centered around AltaGas' long-term strategy of holding both Canadian midstream and U.S. utility assets in the same structure. Management is of the view that its diversified business mix has served the company well. However, in the future if the market were not properly pricing its assets, the company would look at options to maximize shareholder value. Our belief is that management wants to make further progress on its plan to improve returns on existing assets and further de-lever the balance sheet (should take until at least 2021) before evaluating any scenario (such as a sale, spin-out, or sell-down of the midstream business). Regarding asset sales, management once again highlighted the Mountain Valley Pipeline (MVP) as a non-core asset that could be monetized once it is de-risked (i.e., close to entering service). Regarding Blythe, the company believes there is a high likelihood of further contract extensions at the asset in the medium term, which could could improve its valuation. The company also noted that for the right valuation and use of proceeds it could divest its Alaskan utilities as they do not have the same growth as the rest of AltaGas' business.
Thoughts on Valuation – Moving Target to $29 Strong start to 2021. AltaGas has been the best performer in our utility coverage, with the shares up 38% year-to-date. We see a number of factors driving this including: (1) strong operating results including revising up its 2021 guidance (link), (2) continued improvement of the balance sheet driven by cash flow growth and asset sales (link), (3) strength in midstream valuations, and (4) gas utilities (LDC) valuation improving relative to their electric peers. As a reminder, until 2020, gas LDC often traded at a premium valuation, in part due to their strong growth profiles. However, with concerns regarding terminal value, this premium fell to a discount. However, recently, there has been relative strength in gas LDC valuations as investors are less concerned about terminal value as well as some recent strong valuations for transactions (Centerpoint at 38x and Noverco at 29x).