We met with CEO Alan Armstrong and CFO John Chandler on our trip to Oklahoma last week (see Josh Silverstein’s note here for the E&P takeaways), and it was clear that there is a lot of confidence in the growth plan. Williams continues to be one of our favored gas-focused US midstream companies. It ticks the boxes for the names we like - solid growth, low risk, reasonable leverage/coverage, and no IDRs – all at an attractive value.
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KMI’s pause on meaningful construction of TMX makes a lot of sense. The NEB should rule on KML’s request for a federal permitting backstop within a month and the federal court challenge of the project is ripe for decision by Q2. These are key risk hurdles and it would be imprudent for KML to spend significant money before attaining clarity. That said, another 3 month delay since the timeline provided just a month ago was discouraging and leaves us without much confidence. As discussed in our KML note, we have revised our TMX base case to a 2022 in-service (1 year delay vs. KML guidance).
Management language has become increasingly clear that KML will not move ahead with TMX until key legal / regulatory hurdles are resolved over the next several months. KML reiterated a “primarily permitting” approach to TMX spending and pushed back the in-service date another 3 months to December 2020 (assuming no mitigation). We think this strategy makes a lot of sense from a value standpoint and recognize it is not easy for the company even if it is the right thing to do. That said, we continue to recommend that investors wait on the sidelines. While KML may rally some if near-term risks are mitigated, there is still a long road to go and we think the risk-reward skew favors waiting. We’ve updated our base case for TMX to a 2022 in-service date (1 year delay vs. KMI guidance). Our valuation now gives a 55% weighting to this base case, a 20% weighting to a bull-case (COD 2021), and a 25% weighting to an abandonment scenario. Our TP remains unchanged at $18/share. See Ex. 5 / p. 3 for
KMI will report Q4 results AMC on Wednesday (01/17/2018). We forecast 4Q17 DCF of $1,130M and EBITDA of $1,875M, which is slightly above $1,862M consensus. This implies 2.5% YoY EBITDA growth driven by new investments – see detailed drivers on p. 3. Our Q4 DCF estimate is down slightly YoY as higher EBITDA is more than offset by higher capex and DCF attributable to KML public holders.
In mid-December, we made a big sector shift downgrading Utilities to Underweight and upgrading Midstream to Overweight. For Utilities, the call was specifically tied to tax reform, which we viewed as a negative game changer for the sector. Utilities 1) are a relative earnings loser; 2) lose cash flow and need more equity; and 3) are a bond proxy exposed to higher interest rates fueled by tax reform. Our Midstream upgrade was based on reasonable valuation after a horrible 2017 and better fundamentals in 2018 with commodity tailwind, less equity needs, and improving DCF/unit growth. So far, these calls have worked very well, very fast. YTD, the AMZ is already up 9.2% outperforming the market (up 4.2%) while Utilities have dropped -4.5%. Most of the questions we are getting on both sectors is whether there is more room left to go. The answer is yes for both in our view.
Wolfe Research's Senior Utilities Analyst, Steve Fleishman, joined by Senior Midstream Analysts Keith Stanley & Alex Kania hosted a webcast to discuss their outlook for 2018.
Today (1/4/18), the PA DEP issued an order suspending ETP’s construction permits for the $2.5B Mariner East NGL pipeline (ME 2). DEP cited an “egregious and willful” violation of rules. Specifically, DEP cited 8 locations where HDD drilling was used as a construction technique without a permit, unreported inadvertent releases (IRs), and well water issues. From here, ETP has 30 days to submit detailed documentation of past incidents and future work plans across a number of issues, and address alleged well water impacts. DEP then must approve ETP’s filings prior to the resumption of construction.
Earlier this morning (1/2/18), Mike Kiernan, Wolfe’s Director of Research, sent around the Wolverine update for the firm’s top fundamental picks for the next 6-12 months (see his email below). Always a believer in marrying the fundamentals with the technicals, I thought it would be helpful to provide the charts for each. While a few have some work to do, there are plenty of constructive setups on both the long and short side.
We do not see a lot of direct benefits for the midstream space from corporate tax reform: MLPs already do not pay taxes and not many C-corps are cash taxpayers. This stands in contrast to other sectors that are positioned to see a meaningful improvement in both earnings and cash flow. That said, we still see a lot of positives for the sector in 2018 – resumption of DCF/unit growth, better commodity fundamentals, and a more attractive relative valuation to the market.
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