ARC Resources Ltd T.ARX

TD Notes

[retiredcf]

Gas Supply Tight; Valuation, Implied Pricing & CF Sensitivities TD Investment Conclusion

North American natural-gas supply/demand balance remains historically tight as we approach winter heating season. This has resulted in continued strength in spot and future natural-gas prices. In this note, we:

• Put current (and forward) strip pricing in context of historical levels

• Outline the supply/demand balance in the U.S.

• Depict U.S. storage on an absolute basis and also relative to demand

• Outline the gas price currently being discounted by the equities

• Outline robust FCF yields using much lower than current HH pricing (US$3.00/ mcf)

• Finally, offer CF sensitivities of the group to both HH and AECO basis.

  Key Takeaways

• Although most focus on absolute storage levels trending below the five-year average, demand over this period has grown significantly. Given the combination of recently stagnated production, demand growth, and low storage levels, the U.S. inventories are at record-lows as measured in days of demand.

• Although natural-gas prices and natural-gas equities have performed well YTD, on average the sector is pricing in ~US$2.50/mcf HH — with the larger producers pricing in closer to US$3.00/mcf. In our view, the recent move in share prices reflect much lower-than-current natural-gas prices.

• Given improvements in cost structures and sustaining capital, even at US$3.00/ mcf HH natural gas, the sector is trading at very attractive FCF yields of ~23% based on market cap or ~14% based on EV.

• Unlike in previous cycles, leverage has largely disappeared from the capital structures of higher-quality producers. We forecast median YE-2022 D/CF of 0.7x for the Canadian gas producers and 1.8x for the U.S. gas producers at US$3.00/ mcf HH in 2022. This is below the rule-of-thumb sector leverage targets of ~2x D/CF in previous cycles. In our view, this indicates that these companies are better equipped to absorb commodity price volatility and/or return more CF to shareholders via dividends/buybacks than we currently model.