RBC Maintains Outperform and $48.00 Target PriceDecember 8, 2021
Pembina Pipeline Corporation
Improving the capital allocation messaging
Our view: Pembina's business update served up improved capital
allocation messaging (up to a $200 million share buyback in H1/22), 2022
EBITDA guidance that is consistent with consensus and generally positive
updates for the business overall. While there was no real clarity on the
reasons behind the CEO transition, the company highlighted a 6-12 month
timeline as a good estimate to announce a new CEO.
Key points:
Solid capital allocation messaging guides to share buybacks, while
keeping leverage in check. Pembina announced that it expects operating
cash flow to exceed dividend payments and capex. As such, the company
anticipates allocating up to the first $200 million of excess cash flow to
share buybacks in H1/22. As 2022 progresses, Pembina noted that it will
evaluate the merits of dividend growth relative to other capital allocation
opportunities. Last, the company stated that it expects debt/adjusted
EBITDA to be between 3.4-3.6x.
EBITDA guidance seems reasonable (and typical of Pembina's historically
conservative approach). Pembina's adjusted EBITDA guidance for 2022
is $3.35-3.55 billion. This range is consistent with our expectations as
published earlier this week, and compares to our estimate for 2022 of
$3.587 billion (unchanged) and consensus of $3.488 billion (17 estimates;
range of $3.305-3.610 billion).
Positive project and asset updates. Pembina provided the following
positive updates: (1) Peace Phase VII is tracking under budget and ahead
of schedule with its capital cost now at $665 million (down 14% from
$775 million) with an in-service date of mid-2022; (2) Alliance successfully
recontracted 76% of the capacity that was set to expire in October 2022
for an average length of almost four years commencing in November
2022; and (3) it is making progress on negotiations with a B.C. Montney
producer for a new long-term, take-or-pay contract for transportation
and fractionation services, while recently signing a new transportation
agreement with another Montney producer on a take-or-pay basis.
M&A: reactive not proactive, but still on the table. Unlike some of its
peers that have ruled out large acquisitions (at least ones that require
issuing equity), Pembina remains open to potential acquisitions. However,
the company described its approach at this point as "reactive" in nature.
Modestly reducing our AFFO/share estimates. While we have left our
EBITDA estimates unchanged, we have reduced our 2022 and 2023 AFFO/
share estimates to primarily reflect the guidance for higher cash taxes in
2022 that we assume will also continue into 2023 at somewhat similar
levels, partially offset by the modest accretion from an assumed $100
million share buyback in H1/22. Our new 2022 and 2023 AFFO/share
estimates are $4.51 and $4.79, respectively (down from $4.62 and $4.85,
respectively).
Guidance largely consistent with consensus; we think it could be conservative
Adjusted EBITDA guidance of $3.35-3.55 billion is in line with consensus. This range is
consistent with our previously-published expectations for what Pembina might set out,
and compares to our estimate for 2022 heading into the release of $3.587 billion (which
remains unchanged) and consensus of $3.488 billion (17 estimates; range of $3.305-3.610
billion). Key sensitivities to the guidance range include:
o AECO gas prices: $0.50/GJ change equates to +/-$39 million in EBITDA;
o Propane prices: US$0.10/gallon change equates to +/-$38 million in EBITDA;
o FX rates: a $0.05 USD/CAD change equates to +/-$37 million in EBITDA; and
o Share price: a $5/share change equates to +/-$11 million in EBITDA.
Pembina has a history of putting out conservative guidance. Pembina noted it is very
confident in achieving at least the low-end of the guidance range. We highlight that
Pembina has historically put out conservative guidance, and in many years the company
has increased its guidance (range and/or messaging) as the year progresses. Versus the
guidance, our forecast incorporates a stronger Marketing performance, which we believe
could come about if frac spreads remain near current levels partially offset by lower NGL
margins, as well as a buffer that we think that Pembina factored into its guidance range.
Cash tax guidance of $325-375 million. The guidance is modestly higher than the $286
million of cash taxes that were previously incorporated into our forecast for 2022, and we
have revised our AFFO/share estimates to reflect higher cash taxes.
Capex guidance of $655 million includes only sanctioned spending. This compares to our
estimate heading into the release of $737 million and we note that Pembina newly
announced solid cost performance on Peace Phase VII spending (i.e., now tracking to
under $110 million below budget). Management stated that the capital budget could grow
as the year progresses (we specifically point to pending investment decisions on the Prince
Rupert Terminal Expansion, a deep cut facility at Hythe, and the Peace Phase VIII
expansion), with every item in the current budget having already received board approval
(i.e., there is no “placeholder” capital). Of note, the capital plan includes $125 million of
non-recoverable sustaining capex. Please see Exhibit 1 for more information.
We positively view the capital allocation messaging for 2022
Substantial free cash flow generation creates options for return of capital and we
positively view the messaging around buying back its stock. As shown in Exhibit 2, the
company expects its operating cash flow to more than cover its dividends and capex in
2022. As such, Pembina expects to allocate up to the first $200 million of excess cash flow
(i.e., free cash flow less dividends) to share buybacks in H1/22. We positively view the
allocation of available cash flow to share buybacks as well as there being a specific time
frame (i.e., H1/22) where action on this front will become apparent to the market (e.g.,
regulatory reports; quarterly financial reporting).
Favouring buybacks, but a dividend increase is still on the table in 2022 (although we
are now not projecting an increase until 2023). Management stated that the potential
for a dividend increase is still on the table as the company looks out to its Q1/22 results
release in May (i.e., the Board of Directors’ typical timing for reviewing dividend policy)
and noted that it will evaluate the merits of dividend growth relative to other capital
allocation opportunities. On this front, it elaborated by saying that it does not believe
dividend growth is necessarily being rewarded by the market, especially in the context of
the company’s current dividend yield of roughly 6.6%. In our forecast, we have removed
our assumption for a roughly 5% increase in the dividend in 2022 as we believe there will
be greater market receptivity to share buybacks.
The balance sheet and funding plan are in good shape. Pembina expects its operating
cash flow to exceed dividend payments and capex in 2022, as depicted in Exhibit 2, and
anticipates that debt/adjusted EBITDA will range between 3.4-3.6x. Further, the company
expects that it will remain well within its financial guardrails, as shown in Exhibit 3.
M&A not a primary focus, but remains on the table. While management seemed open
to M&A in certain circumstances, noting that it would be “reactive” if opportunities were
to emerge, we do not think that M&A is a primary focus for the company given its $4
billion of organic projects under development. Further, based on management’s
comments as part of its presentation, we do not expect Pembina to pursue M&A to
accelerate as shift in the business mix, particularly as it relates to low-carbon
opportunities and the energy transition.
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.
Downside scenario
Our downside scenario of $31.00 is based on the pre-COVID
trough valuation for the stock (i.e., 9x EBITDA) applied to our
forward EBITDA.
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.
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 Q3/21 results lead us to believe that hedging
losses booked in 2021 should largely 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.