Midstream Comments G&M The second-quarter financial results for Canadian midstream energy companies exhibited signs of continued recovery, according to Canaccord Genuity analyst John Bereznicki.
However, he warned of the emerge of “modest” headwinds which could linger for the foreseeable future, including “power cost inflation, realized risk management losses, a strengthening Canadian dollar, outsized integrity spending, extreme weather and rising LTIP costs.”
In a research note released Thursday, Mr. Bereznicki also emphasized producer cashflow is “surging, but caution remains.”
“Notwithstanding the recent (Delta-driven) pullback in global oil prices, our E&P team estimates WCSB producer cashflow outside the oil sands will increase 105 per cent on a year-over-year basis in 2021,” he said. “Analysis by our E&P colleagues also suggests that over the past seven years, domestic producers outside the oil sands have deployed an average of 100 per cent to 120 per cent of cashflow on capital spending. In 2021, we expect these same producers to spend only 70 per cent of cashflow on average (50 per cent on a weighted basis) against a much stronger fundamental backdrop.
“We believe this financial caution is reflective of: 1) a desire by producers to ‘bullet proof’ their balance sheets following the oil price collapse in 2020; 2) a recognition that investors are not rewarding producers for production growth; and 3) the continued transition of the E&P sector to a self-funded model as equity investors shun the space. We nonetheless note that through the Q2/21 earnings season several WCSB producers increased their capital budgets modestly. Should WTI remain above US$65/bbl, we believe producers will be increasingly willing to further expand their budgets in 2H21.”
Ignoring recent declines, Mr. Bereznicki noted domestic midstream equities are up thus far in 2021 by an average of 30 per cent.
He added: “As equity values recover, we believe there is generally decreasing motivation for midstream companies to devote free cashflow to NCIB activity. As midstream balance sheets strengthen, counterparty risk declines and interest rates remain low, we also believe that debt reduction will generally become less of a priority. Not surprisingly, we believe discussion of organic and inorganic growth opportunities was increasingly prevalent through the second quarter earnings season. In our view, contracted organic growth opportunities that offer rapid payback, high-quality counterparties and ESG-positive attributes are most likely to be well received by investors.”
The analyst made a series of target price adjustments to stocks in his coverage universe. They are:
- AltaGas Ltd. (
, “buy”) to $32 from $30. The average is $28.83. - Gibson Energy Inc. (
, “buy”) to $27 from $28. Average: $24.92. - Inter Pipeline Ltd. (
, “hold”) to $20 from $20.50. Average: $19.70. - Tidewater Midstream and Infrastructure Ltd. (
, “buy”) to $1.70 from $1.60. Average: $1.67.
“Since late last year domestic midstream EBITDA valuation multiples have steadily recovered from a pandemic-induced double-bottom in 2020,” he said. “Over this same period, forward cashflow multiples for the domestic E&P and OFS sectors have continued to decline. In our view this relative midstream divergence is a function of at least three factors: 1) as E&P counterparty risk and midstream payout ratios have fallen, equities have transitioned from commodity plays to yield-driven investments; 2) recent energy transition infrastructure announcements may be providing investors with increased comfort in the longer-term value of midstream assets; and 3) the pending acquisition of IPL by Brookfield may be creating at least modest valuation tailwinds for the space.