Complete RBC Comments From Investor Day
March 29, 2022
Keyera Corp.
Investor Day: Laying out the road map
Our view: Keyera did a good job detailing what investors can expect when it comes to capital allocation and, specifically, the reiteration of its commitments to maintain leverage in the 2.5-3.0x net debt/EBITDA range as well as its aim to fund growth without accessing external equity. Although investors may continue to take a somewhat cautious approach to the construction of the KAPS project given the current inflationary environment, we believe investors comfortable with the project will look to the stock as an attractive way to play upside from potential growth in Western Canada Sedimentary Basin volumes in the coming years.
Key points:
Staying in its lane. We positively view Keyera reiterating its commitment to keep leverage low (and achieving its net debt/EBITDA target of 2.5-3.0x by the end of 2023), while funding its growth aspirations without accessing external equity. With sanctioned capital projectsled by KAPS underpinning management's targeted 6-7% EBITDA CAGR from 2022-2025, we believe the market will also start to focus on the next wave of growth (e.g., KAPS Zone 4, Pipestone gas plant expansion, fractionation expansion at KFS). After it places KAPS into service, Keyera anticipates balancing growth with returning capital to shareholders (i.e., we expect a modest dividend increase in 2023).
KAPS - increased contracting and a refined capital cost estimate; buying the other half seems like a luxury rather than a necessity. Keyera noted that it hasincreased the level of contracting for the project, which may also allow it to underpin the sanctioning of the Zone 4 extension (Pipestone to Gordondale) later this year. In line with its prior disclosures, Keyera expects costs to come in above its prior $800 million (net) estimate with a new disclosure that it anticipates costs being "within 10%" of that estimate. In addressing the potential sale of the 50% stake by its joint venture partner, Keyera noted its control over KAPS, and that any acquisition would have to fit within its financial framework.
Marketing outlook is modestly ahead of our expectations. Keyera rolled out its 2022 guidance range of $250-280 million for realized Marketing margin (we were at $242 million heading into the event). Further, the company increased its long-term "base" realized Marketing margin guidance to $250-280 million (up from $180-220 million) covering the period from 2023-2025.
Increasing our estimates as well as our price target to $35.00 (up from $34.00). Based on higher forecast realized Marketing margin, our 2022 and 2023 EBITDA estimates are now $936 million and $1.019 billion, respectively (up from $907 million and $983 million, respectively). For 2022 and 2023, our DCF/share estimates increase to $2.62 and $3.14, respectively (up from $2.52 and $3.00, respectiely). Our new price target reflects the increase in our 2023 estimates, while keeping our valuation multiple (11x EV/EBITDA) unchanged.
Investor Day largely focuses on the financial framework for strategic growth
From our point of view, key takeaways from Keyera's Investor Day include topics that are also further detailed in the following sections:
· Financial targets provide a framework for what to expect when it comes to undertaking new investments. Keyera provided financial targets including net debt/EBITDA, corporate return on invested capital, and fee-for-service as a component of realized margin. Further, the company provided a year-by-year road map for its key financial priorities.
· Keyera expects sanctioned growth, higher volumes and operational enhancements to drive a 6-7% EBITDA CAGR with upside from unsanctioned projects. On top of its 6-7% targeted EBITDA CAGR, the company outlined a number of growth initiatives, including several levering off of its KAPS project that is under construction, which could both increase the growth rate and extend growth past 2025.
· Increased contracting for KAPS and updated costs. The company announced that it has secured incremental contracting for KAPS from both existing and new customers, while also floating the potential for an extension of the project (i.e., Zone 4). In line with its prior disclosures, Keyera expects costs to come in above its prior $800 million (net) estimate, with a new disclosure that it anticipates costs being "within 10%" of that estimate.
· Marketing guidance drives upside from our prior forecast. Keyera provided realized Marketing margin guidance for 2022 of $250-280 million as well as increasing its long[1]term "base" Marketing margin guidance to $250-280 million (up from $180-220 million). Financial framework provides year-by-year approach
· 2022 – the focus is on completing KAPS: Keyera's capital allocation priority this year is the construction and funding of the KAPS project. Keyera continues to note that net debt/EBITDA will temporarily trend above its long-term target range.
· 2023 – bringing leverage into its target range: As shown in Exhibit 1, the company will look to balance its capital allocation priorities between reducing leverage (i.e., Keyera expects net debt/EBITDA to decline into its 2.5-3.0x target range by the end of the year), increasing cash returns to shareholders (we forecast a slight dividend increase in 2023) and modest growth capital.
· 2024 and 2025 – balance between growth and returning capital to shareholders. The company sees the potential to spend roughly $300 million in annual growth capital, while also increasing cash returns to shareholders.
Upside to visible growth from currently unsanctioned projects
· Keyera expects to deliver a 6-7% EBITDA CAGR from 2022-2025 driven by sanctioned projects. Assuming constant Marketing realized margin of $250 million, Keyera expects its sanctioned project portfolio (please see Exhibit 4), led by the KAPS project, combined with improved returns for existing assets (e.g., continued ramp up at Wapiti; filling existing capacity) can drive a 6-7% EBITDA CAGR from 2022-2025.
· Upside to the growth target from unsanctioned projects. The company set out a number of projects that have not yet been sanctioned that it believes could contribute to future growth, both through 2025 and beyond. In particular, we highlight KAPS Zone 4 as well as a fractionation expansion at Keyera Fort Saskatchewan (KFS) as being somewhat nearer term potential projects (i.e., KAPS Zone 4 could be sanctioned later this year) and ones that lever off of the construction of KAPS (please see Exhibit 5).
· Longer-term upside from potential projects driven by the energy transition. Keyera highlighted its land position in Alberta's Industrial Heartland that underpins its Low[1]Carbon Hub Strategy, which focuses on offering low-carbon solutions to customers between Edmonton and Fort Saskatchewan. The strategy will provide an opportunity to decarbonize the company's Alberta EnviroFuels (AEF) and Keyera Fort Saskatchewan sites, while also offering third-parties a range of services that could include low-carbon feedstocks, hydrogen transportation and storage, and connectivity to carbon transportation and storage hubs.
KAPS updates feature increased contracting and a refined capital cost estimate
Keyera's KAPS project remains a highly strategic asset that links the company's existing gathering and processing footprint with its natural gas liquids (NGL) fractionator at the Keyera Fort Saskatchewan site (with butane being available for Alberta EnviroFuels), while also delivering condensate into Keyera's system that moves product for oil sands customers.
· Increased contracting from a combination of existing shippers (e.g., step-up rights) and new customers. Keyera noted that it has increased the level of contracting for Zones 1-3 and the yet to be sanctioned Zone 4 (Pipestone to Gordondale), while further stating that it is in "advanced negotiations with numerous parties" to secure additional contracts. However, we note that Keyera did not provide a specific quantitative update to its previously disclosed contracting level (i.e., roughly 70% contracted).
· Potential decision on sanctioning Zone 4 later this year. Keyera highlighted that it has secured volumes for its Zone 4 extension and it anticipates that it will soon contract the majority of the volumes needed to sanction the project. The company expects a sanctioning decision for Zone 4 later this year.
· Capital costs refined. In line with its prior disclosures, Keyera expects costs to come in above its prior $800 million (net) estimate with a new disclosure that it anticipates costs being "within 10%" of that estimate. With 65% of the project now complete, "the majority" of the remaining 35% of KAPS relates to construction activities for which signed contracts are in place with contractors who are currently performing work on the project. Given the cost increase for KAPS, Keyera now expects its 2022 growth capital to be in a range of $620-660 million (up from $570-610 million).
Marketing guidance drives upside to our estimates
· 2022 Marketing guidance drives an increase in our financial forecast. Keyera rolled out its 2022 Marketing segment guidance for realized margin of $250-280 million (our forecast for 2022 heading into the event was $242 million; we have revised our 2022 forecast to $271 million). Component wise, Keyera highlighted that 2022 realized Marketing margin should benefit from low-cost butane in Q1/22 and strong commodity prices net of its risk management program, partially offset by a planned six-week turnaround at AEF and increased butane costs starting in Q2/22 following the NGL contracting season that runs from April 2022-March 2023.
· Increased long-term "base" Marketing guidance drives upside in our cash flow forecast. The company updated its long-term 'base" guidance for realized Marketing margin to a new range of $250-280 million (up from $180-220 million) covering the period from 2023- 2025. Keyera noted that the new range reflects: (1) its success in accessing higher value iso-octane markets in the U.S. (Rockies and Midwest) for AEF, while also reducing transportation costs; (2) higher go-forward commodity price assumptions including a US$65-75 per barrel WTI crude oil assumption; and (3) higher contribution from recently completed U.S. assets (e.g., Galena Park and Wildhorse). Of note, Keyera stated that it views the new "base" range as being achievable "with a high degree of confidence".
Increasing our estimates to reflect higher Marketing margins
For 2022, we have increased our EBITDA and DCF/share estimates to $936 million and $2.62, respectively (up from $907 million and $2.52, respectively) to reflect an almost $30 million increase in our realized Marketing margin estimate to $271 million (versus management's guidance for a range of $250-280 million).
For 2023, while there is less visibility with respect to the Marketing segment drivers and therefore we are generally loathe to increase our forecast just because management puts out higher guidance, we note that Keyera specifically has historically been very conservative when it comes to its long-term "base" Marketing realized margin range. For example, relative to the prior "base" guidance range of $180-220 million, the actual realized Marketing margin in 2019, 2020 and 2021 were $373 million, $295 million and $323 million, respectively. Reflecting a Marketing segment forecast for realized margin of $280 million (up from $244 million), our new EBITDA and DCF/share estimates for 2023 are $1.019 billion and $3.14, respectively (up from $983 million and $3.00, respectively).
Valuation
Our $35.00/share price target is based on applying the 15- year average valuation of 11x EBITDA to our forward EBITDA estimate adjusted for full-year contributions from certain assets (e.g., KAPS) that we do not expect to fully contribute to results in 2023. Our target multiple is also consistent with a blended contribution from Gathering & Processing (at 11x EBITDA), LiquidsInfrastructure (at 12x EBITDA), and Marketing (at 8x EBITDA). The risk-adjusted expected total return to our price target supports our Outperform rating for the shares.
Upside scenario
Our upside scenario of $41.00 is based on a 1x increase in EV/ EBITDA valuations, which would approximate the valuations we were using prior to the COVID-related market downturn. This scenario also includes roughly $3/share associated with upside from volumes at new facilities and the development of spare land in Fort Saskatchewan.
Investment summary
We expect Keyera’s shares to outperform the peer group for the following key reasons:
• Poised to benefit from improving basin trends. We believe that Keyera remains poised to benefit from increased WCSB volumes and demand for midstream infrastructure, at its existing facilities as well as a rising tide of future demand driving additional contracting for KAPS. On top of the potential for improved throughput and fee-driven revenue, we also see the potential for Keyera to add long-term contracts, which could help lock-in future cash flows and reduce future volatility.
• Attractive financial setup. We forecast that Keyera’s debt/ EBITDA will remain at a manageable level through the construction of KAPS with a path to deleveraging back into the company’s targeted range once KAPS is complete and contributing to EBITDA. Excluding the major turnaround at AEF scheduled for 2022, we expect that the payout ratio will continue to be at or below 70% in 2023. Further, the company intends to finance its growth capex on a self funded basis for equity (i.e., no DRIP, ATM, or discrete equity).
• Potential catalysts: additional information on KAPS that gives the market confidence in the ability to achieve a 10– 15% return on capital; Marketing results that support the company’s guidance; delivering on the optimization and cost-reduction strategy; and new projects underpinned by long-term, take-or-pay contracts that can be financed on an equity self-funded basis.
Risks to rating and price target
The ability to realize the targeted optimization and overall cost savings; low spreads and fewer opportunities in the marketing business; a material reduction in throughput at the company’s gathering and processing facilities; an inability to stem the impact of volume declines through operating cost reductions; ineffective hedges; and projects not proceeding on a time frame or with economics in line with our expectations.