RBC Maintains $37.00 Target Price
August 5, 2022
Keyera Corp.
KAPS overshadows a solid quarter
Our view: Based on the weak share price performance, the market appears to have placed a greater focus on the rising costs for the KAPS project versus the strong Gathering & Processing volume trends, the better-than[1]expected quarter, increased Marketing guidance, and positive statements on leverage (i.e., reaching its target range by the end of 2022). We recommend the stock for patient investors willing to wait for KAPS to come into service at the end of Q1/23.
Key points:
KAPS costs move higher; arithmetically, it is not material. Following a cost increase unveiled in March 2022 when it held its investor day, Keyera disclosed another cost increase to $900 million (net) for the KAPS project (up from $800–880 million) while continuing to message its anticipation of an in-service date at the end of Q1/23. The company attributed the cost increase to weather-related productivity issues as well as inflationary pressure. We note that from the midpoint of the prior range, the higher costs are only about $0.25/share to value for a company with a strong balance sheet with debt/EBITDA below 3x.
Statements seem to indicate that buying the other half of KAPS is not likely. Following on Keyera’s prior commentary, the company noted that “we look forward...to continuing our strong track record of collaborating with our partners,” which on the surface indicates that Keyera is not likely to acquire the other half of the project. Further, the company highlighted that it expects to exit 2022 within its 2.5–3.0x debt/EBITDA target range, which indicates to us that it is not planning to acquire the other half of KAPS absent a sizeable common equity issue or a very low value for KAPS.
Solid volume trends could drive further upside from filling spare capacity and possibly underpinning capital expansion. Keyera’s Q2/22 results featured 6% year-over-year volume growth in its Gathering & Processing segment, while we also highlight an 11% year-over-year increase in volumes in the South region where the company has the greatest amount of unutilized capacity. Further, the company is exploring the potential to expand its capacity, including a potential capital project at its Pipestone plant.
Marketing: Making hay while the sun shines; increasing our 2022 estimates to reflect a stronger Marketing outlook. Keyera announced another increase in its guidance for Marketing, which it now expects to generate $380–410 million of realized margin in 2022 (prior guidance was for $300–340 million). Our new 2022 EBITDA estimate is $1.039 billion (up from $975 million), and for DCF/share, we now forecast $3.03 (up from $2.85), with the greatest driver of the increases being the stronger forecast for Marketing.
Valuation
Our $37.00/share price target is based on applying an 11.5x EV/EBITDA valuation 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 11.5x EBITDA), Liquids Infrastructure (at 12.5x EBITDA), and Marketing (at 8.5x EBITDA). The risk-adjusted expected total return to our price target supports our Outperform rating for the shares.
Upside scenario Our upside scenario of $45.00 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 $25.00 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., no volume recovery as well as no upside from the optimization program). Further, this scenario does not include any value for KAPS.
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 Keyera’s targeted 2.5–3.0x debt/EBITDA range (credit facility calculation). Despite the major turnaround at AEF scheduled for 2022, we expect that the payout ratio will continue to be at or below 70% in both 2022 and 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.