RBC Comments This Morning
December 20, 2022
Keyera Corp.
Strengthening its core
Our view: In our view, the Keyera Fort Saskatchewan (KFS) terminal has been at the centre of much of the company's business and with that, we like the transaction to acquire an incremental 21% working interest in KFS to bring its total stake to 98%. Based on the initial year EBITDA, Keyera appears to have paid a full price, but we believe tight fractionation capacity (i.e., rising frac fees) and Keyera's ability to integrate the acquired capacity into its Marketing business provide attractive upside.
Key points:
Greater ownership interest in its core asset. The transaction increases Keyera's capacity by over 25% for the assets at KFS, which include fractionation, storage and its pipeline connections to Keyera's Edmonton Terminal. The effective capacity expansion does not require a multi-year build, and also comes without needing to construct new infrastructure in an inflationary environment, which is something that Keyera's shareholders would be more than aware of (i.e., KAPS).
Ability to integrate the spare frac capacity with spare KAPS capacity. With the increased access to natural gas liquids (NGL) fractionation capacity (i.e., +14,000 b/d) as part of the transaction, the company has the ability to pair that capacity with unutilized KAPS capacity as a bundled service offering. Given the tight market for frac capacity expressed by numerous midstreamers, we believe that Keyera's ability to immediately market frac capacity could become a strategic advantage.
Keyera is guiding to 3% DCF/share accretion. Keyera noted that it expects the transaction to result in average annual accretion of roughly 3%. In the near-term, we expect tax synergies to drive most of the accretion with the medium to longer-term accretion coming from tight fractionation markets resulting in higher fees, revenue synergies given Keyera's ability to bundle its service offering, and upside via the Marketing segment.
Equity issue appears to be driven by conservatism. While we acknowledge that some have questioned whether the $200 million base equity issuance was necessary given the relatively low balance sheet leverage, we note that the current management team has consistently stressed its commitment to the 2.5-3.0x debt/EBITDA range. Without the equity issuance, we project that debt/EBITDA would have slightly eclipsed 3.0x in 2023.
Bumping up our estimates to reflect the transaction. Reflecting EBITDA and tax synergies from the acquired assets net of the financing impact (i.e., higher interest expense and shares outstanding), we have increased our 2023 and 2024 DCF/share estimates to $3.12 and $3.32, respectively (up from $3.08 and $3.24, respectively).
Valuation
Our $36.00/share price target is based on applying an 11.0-11.5x EV/EBITDA valuation to our forward EBITDA estimate adjusted for a full-year contribution (post ramp-up) from certain assets (e.g., KAPS, Wapiti). Our target multiple is also consistent with a blended contribution from Gathering & Processing (at 11.5x EBITDA), Liquids Infrastructure (at 12.5x EBITDA), and Marketing (at 8.5x EBITDA). The risk[1]adjusted expected total return to our price target supports our Outperform rating for the shares.
Upside scenario
Our upside scenario of $42.00 is based on a 1x increase in EV/EBITDA valuations, which would bring the valuation close to the average valuation for midstream stocks over the past 10 years leading into the onset of COVID. This scenario also includes roughly $3/share associated with upside from volumes at new facilities and the development of spare land in Fort Saskatchewan.
Downside scenario
Our downside scenario of $23.00 per share is based on a scenario where Marketing results are at the low-end of the long-term “base realized margin” range and Gathering & Processing margins are similar to 2020 levels (i.e., cyclical trough).
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 and within, or below, Keyera’s targeted 2.5–3.0x debt/EBITDA range (credit facility calculation). Despite the major turnaround at AEF in 2022, we expect that the payout ratio will continue to be at or below 70% through 2024. 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; 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
KAPS delays and/or material cost overruns; 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.