Full RBC Comments .. their "what if" wish list
Seems like a big "what if" dream but RBC makes many valid points. RBC put a lot of work into this "what if" dream.. Sorry I was unable to paste in all the charts.
Pembina Pipeline Corporation
Playing Let's Make a Deal
Our view: With Pembina's desire to acquire some portion of Inter Pipeline's
natural gas liquids (NGL) assets including the Heartland Petrochemical
Complex (HPC), we set out what a deal could look like, potential financing
options and the pro forma metrics including where Pembina would sit
within its financial guardrails. In short, we believe the strategic and financial
merits could be compelling, but it is unclear whether a deal will come
together and we suspect any deal may not occur until 2022. We think a
50/50 joint venture could be an attractive outcome for both parties.
Key points:
Where there's a will, there's a way. Based on prior disclosures, it is clear to
us that Pembina only coveted certain Inter Pipeline (IPL) assets and on the
other side, BIP previously messaged an interest in only acquiring "certain
lower risk, lower return assets", which we believe relates to IPL's oil sands
pipelines. In our view, the key question at this point is whether BIP and
Pembina can agree on valuation, particularly with BIP being in the driver's
seat although Pembina possesses the $350 million (pre-tax) break fee.
Investor feedback has been positive on the industrial logic; any deal might
take some time to come together. We believe that Pembina's investors
are broadly supportive of the strategic rationale for combining IPL's NGL
assets and HPC with Pembina's footprint. Timing wise, we believe that
BIP needs to close its plan of arrangement to squeeze out IPL's remaining
shareholders before turning its attention to a potential deal. As such, we
believe a deal involving multiple assets might not occur until 2022.
Pembina's guardrails provide a framework to assess a transaction. The
two most relevant financial guardrails are: (1) maintaining an 80% feebased
contribution to adjusted EBITDA (Pembina expects to be at 90%
in 2021); and (2) maintaining a strong BBB credit rating. We believe that
Pembina could easily fit an acquisition of HPC (partial or all) within its
EBITDA guardrail with an acquisition of HPC and all of the NGL assets being
tight, although doable. Further, we believe Pembina could deliver AFFO/
share accretion while keeping its credit metrics unchanged.
Transaction size depends on the asset package, but could range from
roughly $2-7 billion. The low-end of the range (i.e., $2.5 billion) would
represent the acquisition of a 50% interest in HPC at IPL's estimated
construction cost. The high-end of the range incorporates 100% of HPC and
the NGL assets including the Redwater and Cochrane facilities. Our analysis
includes other plausible scenarios including Pembina entering into a 50/50
joint venture for IPL's NGL assets and HPC.
Despite strong underlying fundamentals, we see a potential modest
equity overhang. We believe the potential for a sizable equity issuance
to fund a potential transaction could be a modest overhang for the stock
despite the positive underlying fundamentals with respect to growing
WCSB gas and NGL volumes, robust commodity prices and improving
commodity spreads (please click here for a report on WCSB activity).
We think a deal to split the assets could make a lot of sense
In our view, there are a number of reasons that both Pembina and Brookfield Infrastructure
should explore a transaction to split the IPL assets. Some of our thoughts on a potential
transaction are as follows:
· Both parties have expressed an interest in certain assets of IPL. Notwithstanding that
both parties bid for all of IPL, BIP previously indicated an interest in acquiring "certain
lower risk, lower return assets" that we believe centre on IPL's oil sands pipelines.
Pembina disclosed that its initial focus was on specific assets versus an en bloc acquisition
and we believe that Pembina can generate attractive commercial synergies from owning
the NGL and HPC assets (e.g., IPL's Redwater fractionator sits on the same site as
Pembina's Redwater facility, so with full control, Pembina could optimize logistics.
· BIP is in the driver's seat, but we think there are incentives to do a deal. Being on the
path to owning 100% of IPL puts BIP in the driver's seat in any process to divest some of
IPL's assets. However, we believe there are reasons that BIP should consider divesting
some of IPL's assets, including: (1) based on investor feedback, we think investors want
BIP to own fewer midstream assets as public markets provide numerous options to invest
in midstream directly; and (2) BIP's assets possess minimal direct commodity exposure
whereas the vast majority of IPL's NGL assets are directly commodity-exposed.
· Timing wise, we think at the end of the year or early 2022 is the most likely scenario if a
transaction comes together. BIP is in the process of squeezing out IPL's minority
shareholders and we do not think the announcement of any deal to split the assets would
occur until BIP has control of 100% of IPL's shares. Further, BIP noted that it will be "very
commercial" with respect to how it looks to maximize value and reduce risk in its business,
which we partly interpret as the partnership likely running some sort of an auction process
notwithstanding Pembina being a logical acquiror. We do not think an auction needs to
take a long time as we believe most interested parties would have already been through
IPL's data room as part of the company's strategic review.
The asset package could take various forms
Our analysis focuses on three groups of assets that we believe would be of most interest to
Pembina, namely: (1) the Heartland Petrochemical Complex (HPC) that is currently under
construction with a targeted in-service date in 2022; (2) the offgas assets that include the
Pioneer plants in Fort McMurray, the Redwater olefinic fractionator and related storage, and
the Boreal pipeline system that connects the Pioneer plants to Redwater; and (3) the Cochrane
straddle plant. As detailed in our report, the acquisition scenarios that we evaluate include:
· 50% or 100% of HPC: Given Pembina was previously looking to build its own
polypropylene plant with its Kuwaiti partners, we believe Pembina would be interested in
a partial or full interest in HPC.
· 50% of the NGL assets and HPC: This scenario would keep the acquisition size fairly
manageable (we estimate something in the range of $3.65 billion) and allow Pembina to
realize commercial synergies across all of the assets. Further, by retaining 50% of the
assets, BIP could also participate in those commercial synergies (previously estimated by
Pembina to be in the range of $50 million annually for IPL's entire business), and
potentially benefit from more than $1 billion of capital project opportunities that Pembina
had outlined as levering off the combination of IPL's assets with its own footprint.
· 100% of the NGL assets and HPC: This would be the cleanest exit for BIP, but also create
the largest financing requirement for Pembina as we estimate a transaction size could be
over $7 billion. Acquiring all of the assets would provide an opportunity for Pembina to
realize significant targeted synergies.
100% of the offgas assets and 50% of the rest: We put forward this option as it helps both
companies achieve some different goals. For BIP, it results in a material reduction in direct
commodity exposure as the offgas assets appear to have little in the way of fee-based
cash flow, while still allowing BIP to participate in HPC, which could become a strategic
part of the footprint down the road via an integration with its gas processing plants. For
Pembina, the transaction is a more manageable size, and the acquisition of 100% of the
offgas assets allows for full control of the synergies on the broader Redwater site.
Pembina's guardrails will be a constraining factor
The company's long-standing financial guardrails are likely to be a driving factor with respect
to its desired form of a transaction. Specifically, we note two of its guardrails that should be
material considerations, namely: (1) maintaining an 80% fee-based contribution to adjusted
EBITDA (Pembina expects to be at 90% in 2021); and (2) maintaining a strong BBB credit rating
(Pembina expects to be at 18% FFO/debt in 2021 and we project debt/EBITDA to be roughly
4x). With these constraints in mind, we highlight the following:
· HPC's contracting helps keep Pembina within its guardrails. At its recent investor day
(please click here), BIP confirmed IPL's previous disclosure that 68% of HPC's capacity is
secured under take-or-pay contracts (nine-year weighted life) with nine customers.
· Most potential transactions should fit within Pembina's fee-based guardrail with room
to spare. As shown in Exhibit 1, most of the various acquisition scenarios would result in
pro forma fee-based EBITDA in the 83-87% range, which would exceed Pembina's
guardrail of keeping fee-based EBITDA at 80% or higher.
· Acquiring all of the NGL assets and HPC would be a tight squeeze. While it appears that
Pembina could acquire 100% of HPC, the offgas facilities and Cochrane and stay within its
80% fee-based EBITDA guardrail, we believe it would be a tight squeeze, particularly taking
into account the potential for higher commodity spreads for the base business in 2022.
Strategic and accretive, but a potential financing overhang
Based on our analysis in Exhibit 2, we project that the various transactions could result in
roughly 3-7% AFFO/share accretion using fairly conservative assumptions including:
· an acquisition valuation of 10x EBITDA, which we believe would be the high-end of fair
value for the assets;
· synergies ranging from $10-50 million, which compares to the $150-200 million of
synergies that Pembina set out as part of its bid to acquire all of IPL with our assumption
being lower partly as a significant portion of those synergies came from lower G&A, which
would now be for the benefit of BIP;
· unchanged leverage metrics (i.e., no temporary increase in leverage via a bridge loan or
other financing); and
· cash taxes at a 23% effective rate despite the likelihood that Pembina could realize a
stepped up tax basis for the acquired assets.
In keeping the leverage metrics unchanged, our acquisition scenarios all assume a common
equity issuance at $40/share that ranges from roughly $1 billion at the low-end (for 50% of
HPC) to approximately $3.5 billion if Pembina were to acquire 100% of Cochrane, the offgas
facilities and HPC as shown in Exhibit 2.
From a sensitivity point of view, a 1x change in the EV/EBITDA valuation would change the
AFFO/share accretion by 1-3% depending on the scenario with a $1/share change in the equity issue price having a negligible impact on AFFO/share accretion (i.e., less than 0.5%). Further, a transaction would still be accretive if Pembina realized no synergies as part of a deal.
Valuation
Our $48.00/share price target is based on an EV/EBITDA
multiple of 11.5x and includes no upside from the mothballed
growth initiatives. For much of the last 15 years, Pembina’s
shares have traded within a range of roughly 10–13x EBITDA.
We believe a valuation at the mid-point of the range
is appropriate given the improving market fundamentals,
particularly in Western Canada. We believe that the relative
risk-adjusted expected total return to our price target
supports our Outperform rating on the shares.
Upside scenario
Our $55.00 per share upside scenario is based on a 1x
premium to our base valuation (resulting in EV/EBITDA being
at the upper-end of the 15-year range) plus roughly $1.00/
share for deferred projects that have been mothballed in the
current environment but could move forward in the future.
The EV/EBITDA valuation is modestly higher than the group
average, reflecting the high proportion of cash flow derived
from the NGL pipeline and terminal infrastructure, primarily
under take-or-pay contracts.
Investment summary
We expect Pembina’s shares to outperform its peers for the
following key reasons:
• Growing WCSB volumes should drive higher EBITDA.
Whether it be uncontracted capacity or within its contract
structures that blend minimum take-or-pay levels with feefor-
service upside as volumes grow, we expect Pembina
to benefit from growing gas and liquids volumes in the
Western Canada Sedimentary Basin (WCSB), particularly
with its assets levered to the Montney, Duvernay and Deep
Basin.
• We expect growing volumes to also drive new projects
underpinned by take-or-pay contracts. We expect growing
volumes to result in contracted infrastructure opportunities,
evidenced by the re-activation of the Phase IX expansion,
some of which could be announced by the end of 2021.
New projects could include previously mothballed initiatives
including the Phase VIII pipeline expansion or the Prince
Rupert Terminal expansion.
• Solid base of business with a commodity kicker. Although
the hedge book was prudent risk management for 2021, it
has resulted in a substantial reduction from margins based
on spot commodity prices. However, hedge disclosures as
part of the Q2/21 results lead us to believe that hedging
losses booked in 2021 should reverse in 2022 assuming
constant commodity prices/spreads.
• Potential catalysts. Improved investor sentiment towards
energy and midstream stocks; additional volumes for the
conventional pipeline system; government programs that
strengthen oil and gas producing customers; increased
Montney producer activity on the back of the sanctioning of
the third-party LNG Canada project.
Risks to rating and price target
Risks to our price target and rating include: (1) the impact of
COVID-19 and a weak market for energy including lower-thanexpected
throughput on the pipeline systems, (2) regulatory
intervention, (3) the ability to complete new projects on time
and on budget, (4) operational issues, (5) reduced margins in
the midstream and marketing segment, and (6) acquisitions,
investments and/or projects that fail to gain the confidence of
investors.