RBC Increases Target Price to $38.00
May 9, 2023
Keyera Corp.
Time to take the shiny new car out for a spin
Outperform
TSX: KEY; CAD 32.10
Price Target CAD 38.00 ↑ 36.0
Our view: With KAPS being placed into service, Keyera is "reaching a cash flow inflection point", and we positively view the company's capital allocation messaging. We like Keyera's leverage to growing WCSB gas and NGL volumes with the path to share price appreciation likely being linked to Keyera's follow through on capital allocation, including: (1) maintaining a strong balance sheet; (2) pursuing "smaller size" projects with returns in Keyera's target range being fully underpinned by long-term, take-or[1]pay contracting; and (3) returning capital to shareholders via a growing dividend and possibly share buybacks.
Key points:
Keyera now positioned to show what it can do, both operationally and financially. With KAPS essentially complete, Keyera has an integrated footprint that it can leverage to capture growing Western Canada Sedimentary Basin (WCSB) gas and natural gas liquids (NGL) production, and we believe the market will be looking to see what revenue synergies and high-return projects the company can capture. On the financial front, with management expressing that Keyera is "reaching a cash flow inflection point", we think investors are expecting a follow through on capital allocation messaging.
KAPS is now in service with no change in costs. Keyera noted that construction of its KAPS project is now complete with the condensate line having shipped its first volumes in April 2023. Linefill is underway for the natural gas liquids portion of the system, and Keyera expects to place that part of KAPS into service in June. The company stated that its latest cost estimate remains at $1 billion (net to Keyera).
Strong Marketing guidance for 2023. Citing lower butane feedstock supply costs and continued strong iso-octane premiums, Keyera expects its Marketing realized margin in 2023 to be in a range of $330-370 million (versus its long-term "base" guidance of $250-280 million). For 2023, our revised forecast for realized Marketing margin is $360 million (up from $307 million). For 2024, we have increased our Marketing estimate to $336 million (up from $300 million), which is consistent with the average realized margin over the past five-years.
Increased estimates drive our price target up to $38.00/share (up from $36.00/share). Primarily reflecting the stronger-than-expected Q1/23 results, trends observed during the quarter and the increased Marketing guidance provided by the company, we have increased our DCF/share estimates to $3.26 and $3.35, respectively (up from $3.13 and $3.29, respectively) with the increase in both years largely due to higher forecast EBITDA. Our new $38.00/share price target (up from $36.00) is driven by our increased estimates with no change to our EV/EBITDA valuation framework.
KAPS completion is the “cash flow inflection point”
With the $1 billion (net) KAPS project effectively complete, Keyera’s focus can now shift to realizing the operational upside associated with its integrated footprint. Financially, exiting a capex-intensive period allows Keyera to reach a “cash flow inflection point”, which provides the company with the ability to balance increasing the return of capital to shareholders (e.g., dividend growth; share buybacks) with capital investment (i.e., growth projects).
Following the completion of KAPS, the company expects to focus on smaller scale projects that complement its existing footprint. Management emphasized that future investment decisions would be viewed on a standalone basis (e.g., KAPS Zone 4), and that it will look to underpin returns within its target range by securing long-term, take-or-pay contracts. Specifically, Keyera noted that it will adjust its future capital programs so that it can keep net debt/EBITDA within its 2.5-3.0x target range.
KAPS is effectively finished; no material updates on contracting
· KAPS is now in service with no change in costs. Keyera noted that the condensate line has shipped its first volumes (April 2023). Linefill is underway for the natural gas liquids portion of the system, and Keyera expects to place that part of KAPS into service in June. The company stated that its latest cost estimate remains at $1 billion (net to Keyera).
· No material update on contracting, but optimistic on the outlook. The company remains positive that contracting discussions are heading in the right direction, and it expects to benefit from growing natural gas and natural gas liquids volumes in Western Canada. Further, Keyera sees upside from being able to provide an integrated service offering to its customers with KAPS connecting several of its gas processing facilities to its downstream storage and fractionation capacity at Keyera Fort Saskatchewan (KFS)
The existing business is performing very well
· Strong Marketing guidance announced for 2023. The company now expects realized margin for Marketing in 2023 to be in the $330-370 million range (versus its long-term “base” guidance of $250-280 million), while citing lower butane feedstock supply costs and continued strength of iso-octane premiums as key drivers behind its expectation for strong results this year.
· No change in other guidance items. The company re-affirmed its capex and cash tax guidance ranges of $200-240 million of growth capital, $75-85 million of maintenance capital, and no cash taxes in 2023. · Positive capital allocation messages. Following another strong quarter, Keyera ended Q1/23 with net debt/EBITDA of 2.6x (covenant calculation), which is at the lower-end of its targeted 2.5-3.0x range. Looking past KAPS coming online, the company highlighted that its focus is to revisit its annual dividend growth policy, with share buybacks and reinvesting in the base business competing for discretionary capital.
· Wildfires: Keyera does not expect a material impact. The company noted that it shut-in six gas plants between May 4 and May 5, being Brazeau River, Pembina North, Zeta Creek, Cynthia, Nordegg and Wapiti. At this time, Keyera stated that it does not expect the outages to have a material financial impact, while also noting on the conference call that Wapiti is now almost back to operating at rates before it was shut down.
· Strong results across the board. In Q1/23, adjusted EBITDA was $292 million compared to our estimate of $267 million and consensus of $263 million (12 estimates; range of $226-277 million). On a cash flow basis, DCF/share was $0.99 versus our forecast of $0.91 with the main variance being higher-than-expected EBITDA.
Valuation
Our $38.00/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 $43.00 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. With KAPS largely complete, Keyera ended Q1/23 with net debt/EBITDA of 2.6x, which is at the low-end of its targeted 2.5–3.0x net debt/EBITDA range (credit facility calculation). 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 an equity self-funded basis (i.e., no DRIP, ATM, or discrete equity).
• Potential catalysts. Additional contracts for KAPS; 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