March 10, 2022
Tidewater Midstream
Waiting to see what levers get pulled
Our view: Although the business has performed well and progress has been made on the near-term leverage target, the stock remains range bound. While we are hopeful announcements that enhance value, albeit down the road (e.g., a Pipestone expansion), could get the stock going, we wonder if it will take material capital allocation decisions, or at least very clear messaging on a capital allocation framework, to improve the valuation absent of just waiting for larger-scale projects to come into service and generate cash flow (e.g., renewable diesel within LCFS).
Key points:
We believe action may be needed, or at least very clear messaging, on capital allocation to get the stock going. With midstream investors favourably viewing companies that are generating free cash flow (after all capex and dividend payments), reducing leverage and buying back shares, we believe that Tidewater Midstream's stock is having trouble getting on investors' radar screen. To improve the share price, we believe the company may need to take material capital allocation decisions (e.g., asset monetizations to reduce debt/EBITDA into the 2.5-3.0x range and/or buy back shares). Alternatively, the shares may benefit if the company sets out a clear strategy with a hard cap on leverage (e.g., below 3.5x debt/EBITDA) and a commitment to reduce leverage into the 2.5-3.0x range after the renewable diesel project comes into service (with 3.0x debt/EBITDA then becoming the hard cap on leverage).
Management has a bullish outlook for 2022. On the conference call, management noted its expectation that Q1/22 EBITDA will be a 12th record quarterly result and that 2022 EBITDA would be roughly 10% higher than 2021. Following the commissioning of the renewable diesel project held within Tidewater Renewables (TSX: LCFS; covered by RBC Capital Markets analyst Matthew McKellar), the company expects EBITDA to increase by about 35%.
Pipestone expansion still under evaluation. With strong volumes at the existing Pipestone gas plant, Tidewater Midstream continues to evaluate a potential expansion of the facility. The company noted that it still needs to refine its cost estimate as well as determine how it will finance the project. Timing wise, management stated that it intends to move through the process in the next few months. While we would view a long-term take-or-pay contracted expansion of Pipestone as an attractive project, we believe the market may take a cautious approach if debt/EBITDA were to eclipse 3.5x, even on a temporary basis.
Increasing our EBITDA estimates largely due to higher forecast contribution from Tidewater Renewables. Primarily reflecting revisions to our forecast for Tidewater Renewables as a result of higher than previously estimated British Columbia Low Carbon Fuel Standard (LCFS) credit pricing as well as strong refined product pricing, we have increased our 2022 and 2023 forecast EBITDA to $221 million and $304 million, respectively (up from $220 million and $290 million, respectively)