Seeing rising global geopolitical tension pushing energy security to “the top of the Western world’s priority list through 2022,” National Bank Financial analyst Patrick Kenny thinks the valuations for Canadian energy infrastructure stocks “continue to benefit from a renewed longevity profile given the social need to balance reliability and affordability with the pace of transition.”
“Our coverage universe is well positioned to participate in the race to export low-cost, low-carbon energy with rising demand for gas processing / NGL fractionation (KEY, PPL, BIP), Westcoast LPG terminals (ALA), as well as LNG connectivity and liquefaction capacity (ENB, TRP, PPL),” he said.
In a 2023 outlook for the sector titled
If you ain’t first, you’re last…, Mr. Kenny reiterated the firm’s expectations for a slowdown in interest rate hikes, including from the Bank of Canada, seeing it as a “year of relief,” leading to “modest valuation tailwinds” across the sector.
“Despite interest rate relief on the horizon, dividend yield spreads remain at or below historical average spreads, suggesting potential downside risk,” he said. “We highlight the Utilities names within our coverage universe as being most exposed with current dividend yield spreads sitting 150 basis points tighter than the pre-pandemic five-year average spread of over 3 per cent, translating to valuation downside risk of approximately 20 per cent, assuming yield spread mean reversion. That said, we recognize Utility valuations have structurally gained positive investor sentiment from their participation in energy transition-related growth projects while also being considered a ‘defensive play’ during times of economic turmoil given the highly predictable, rate regulated return business nature. Overall, in light of recent political inference challenges surfacing related to inflationary pressures/affordability issues, we remain cautious surrounding further valuation pressure through 2023.”
While he expects oil prices to remain range bound for the year, Mr. Kenny sees commodity prices as “healthy” and “projects production growth across the WCSB, supporting increased utilization for oil & gas processing facilities with spare capacity (SES, KEY, ALA,
PPL).”
“Meanwhile, we forecast a relatively tight oil pipeline egress picture until TMX is in service (NBF estimate: mid-2024) with a call on rail of 200 mbpd through 2023, indicating an upward bias to differentials and Marketing margins (KEY, ALA, GEI,
PPL). Finally, a robust Alberta power price outlook continues with forward prices at $160/MWh for 2023 and $100/MWh for 2024, extending outsized cash flows and clean balance sheets for CPX and TA,” he added.
Mr. Kenny’s investing advice is: “We continue to screen our top picks using a multi-pronged approach for: 1) Double-digit free cash flow (AFFO) yield; 2) healthy balance sheet metrics; 3) attractive per share growth; and 4) strong catalyst potential (see individual catalyst calendars in the Appendix: Company Profiles). Our catalyst potential for 2023 largely relates to securing/executing on growth opportunities and capitalizing on energy security concerns, supporting renewed tailwinds as well as funds flow for the energy infrastructure sector. Overall, we recommend overweighting high-quality, double-digit FCF yields poised for continued valuation upside. Our top picks for 2023 include ALA, CPX, KEY and SES.”
He raised his rating for
TransAlta Corp. (
TA-T +1.89%increase) to “outperform” from “sector perform,” touting the impact of “surging” cash flow from its Alberta Hydro assets and several “positive 2023 catalysts.”
“We now forecast average annual EBITDA for the AB Hydro Assets for 2022-2024 of $440-million,” he said. “Recall, Brookfield has the option after Dec. 31, 2024 to convert its $750-million strategic Investment of 7-per-cent exchangeable securities into an equity stake in TA’s Alberta Hydro Assets with the value based on the trailing three-year average EBITDA contribution multiplied by 13 times. As such, we calculate Brookfield’s $750-million would convert into an equity stake of less than 15 per cent if exercised in 2025 (well below the initial 30-35-per-cent expectation), and compounding the positive DCF valuation impact from the outsized nearterm cash flow performance.”
“With rising corporate PPA demand for new renewables, combined with Canada’s recent 30-per-cent renewable ITC announcement, we anticipate the company successfully sanctioning 500 MW of contracted growth through 2023, while also completing rehabilitation of the entire fleet of turbines at Kent Hills. Meanwhile, with forward AB power prices sitting at $160/MWh through 2023, we expect TA to increase its initial 2023 financial guidance from $1.20-$1.32-billion towards our $1.5-billion forecast throughout the year, supporting another dividend increase of 10 per cent, which we expect to be announced towards year-end.”
He raised his target for TransAlta shares by $1 to $15. The average on the Street is $16.“TA trades at a 2024 estimated P/AFFO multiple of 4.5 times versus peers at 5.5 times, partly reflecting robust merchant contributions expected to normalize by 2025,” said Mr. Kenny. “That said, with strong merchant cash flows driving a much cleaner balance sheet of 2.0 times D/EBITDA, and 10-per-cent valuation upside related to its Clean Electricity Growth Plan, including 500 MW of contracted renewables to be sanctioned in 2023, we are upgrading our rating to OP from SP based on a 12- month total return profile of 19.7 per cent (group: 11.0 per cent).”
Mr. Kenny also made these target adjustments:
, “sector perform”) to $45 from $41. Average: $49.64.
- Canadian Utilities Ltd. (CU-T -0.80%decrease
, “sector perform”) to $37 from $34. Average: $37.81.
- Capital Power Corp. (CPX-T -0.53%decrease
, “outperform”) to $53 from $50. Average: $52.31.
- Emera Inc. (EMA-T -0.83%decrease
, “sector perform”) to $52 from $51. Average: $58.60.
- Enbridge Inc. (ENB-T +0.31%increase
, “sector perform”) to $56 from $54. Average: $58.25.
- Fortis Inc. (FTS-T -0.43%decrease
, “sector perform”) to $55 from $51. Average: $57.38.
- Gibson Energy Inc. (GEI-T +0.63%increase
, “sector perform”) to $25 from $24. Average: $25.43.
- Hydro One Ltd. (H-T -1.39%decrease
, “sector perform”) to $36 from $32. Average: $37.50.
- Pembina Pipeline Corp. (PPL-T -0.98%decrease
, “sector perform”) to $47 from $46. Average: $51.47.
- Secure Energy Services Inc. (SES-T +0.74%increase
, “outperform”) to $10 from $9. Average: $10.41.
- TC Energy Corp. (TRP-T +0.14%increase
, “sector perform”) to $56 from $48. Average: $63.68.