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Pembina Pipeline Corporation Message Board

  • lizahuang54321 lizahuang54321 Dec 6, 2012 3:45 PM Flag

    another view

    Rating: 1-Sector Outperform
    Risk Ranking: Medium
    Valuation: 6.6% 2013E Free Cash Yield and 15.2x 2014E EV/EBITDA
    ey Risks to Target: Regulatory approvals; Interest rates; Refinancing; Oil prices & throughput

    PPL announced a $965m 2013 capital budget last week and will hold its annual investor day on Tuesday.

    We view the capital budget announcement as positive because it signals an enhanced organic growth program. Details on project design and returns provided at the investor day will likely reinforce this view.

    Our thesis on PPL and much of the pipeline/midstream sector is that accretive organic growth will outweigh commodity headwinds resulting in cash flow and dividend growth. PPL's 2013 budget is consistent with this theme as the capital plans exceed our estimate by about 20%.

    More important, the types of investments available to PPL appear to be significantly accretive because they build off of the company's existing assets. After the Provident deal, we reasoned that expansion would accelerate due to the strengthened business position and the integration of oil/NGL infrastructure. PPL is on track to prove out this hypothesis.

    Estimates revisions are modest as we now assume $200 of external equity and some investments (i.e. phase 2 expansions on conventional pipelines) won't contribute full-year returns until 2015. Nevertheless, these investments strengthen and lengthen the duration of PPL's cash flow growth profile. Our opinion that PPL will ultimately trade at a premium valuation is intact and we recommend accumulating at this level.

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    • Growth Building

      When sea-changes wash over an industry investors in companies with best positioning and best execution are often rewarded with outsized returns. The about-face in Canada's conventional oil and NGL production picture constitutes as much of a sea-change as we have seen in the energy infrastructure business perhaps only with the exception of the oil sands. Only a few years ago both were in significant decline and now NGL and conventional oil are rising rapidly. Pembina with its acquisition of the Provident assets is in our view best positioned now to capture benefits and it appears management is executing to plan.

      Any company announcing a 75% increase in its year-over-year organic capital program is worthy of attention. Last week's announcement marks the largest capital program in the company's history, including years when it was constructing oil sands pipelines. As the vast majority of capital is directed toward the once-declining conventional oil and NGL assets, a sea-change is clearly underway. Though "only" $355m of the budget is directed at the conventional pipelines, we view the ~$345m of downstream terminal and storage investments as integrated and linked to the increased volume flow and pipeline expansions.

      The confidence we have that PPL's capital program will deliver attractive returns stems from two facts. First, much of the investment is in expansion/extension of existing assets where PPL has an oligopoly business position. Second, to the extent the assets are new (NGL extraction facilities), they are contracted on a fee basis and will ultimately tie into the PPL pipelines. Our research suggests that the combination of fixed fees for new capital plus increased capacity utilization on existing assets downstream generally delivers a low double-digit return on investment. These returns generate significant cash flow per share accretion given the low cost of capital PPL and its peers enjoy in today's low bond yield environment.

      Despite the ~$200m increase in our 2013 capital budget forecast, and the accretion we ultimately anticipate from these investments, we are only modestly boosting our 2014 EBITDA estimate (from $850m to $858m). Much of the capital that was absent from our forecast involves second-phase expansion of the pipelines that will only start generating cash flow in 2015. Nevertheless, the expansions extend and improve multi-year growth visibility.

      Nor are we materially altering our free cash flow per share estimate for 2014. The lack of any change here arises from a new financing assumption. Previously we had assumed PPL would raise equity through the DRIP only. Now we are building in a $200m external common equity issuance in mid-2013. Under this assumption, our forecasts have total company debt-to-EBITDA dropping from about 4.8x in 2012 to just under 4.0x by the end of 2014. This improvement in cash flow coverage should be sufficient to maintain the company's low cost of debt capital.

      The main risk to our forecasts remains PPL's commodity exposure. Until 2015, PPL will carry material frac spread exposure, at which time we believe it will be largely diluted down by fee-based infrastructure assets. However, in 2014, we estimate that every $0.10/gal change in frac spread could impact our EBITDA forecast by $12m. Our base case frac assumption is $0.90/gal and lately frac spreads have weakened back off from about $0.70/gal to $0.60/gal with a decline in propane (frac spreads bottomed at about $0.50 this summer).

      We remain optimistic that, almost regardless of frac spreads, PPL should manage to boost cash flow per share and, ultimately, its dividend. The 2013 capital budget still excludes major items that could come to fruition in 2013/14. These include a new fractionator at Redwater, additional NGL extraction assets and significant oil and NGL terminal expansions. Further organic growth, then, should continue to outweigh any commodity headwinds (frankly there is probably more upside than downside to propane prices given today's oil price in any case).

      PPL is not a "cheap" stock but we still believe it can outperform within the energy infrastructure group. The forward free cash yield is roughly in line with the group at about 8% in 2014. Normally the stock has traded at a premium due to its strong business position, visible growth, and management track record. Therefore, we believe it will again trade at a premium once new projects come on line and commodity concerns fade. We are maintaining our $31 target price and 1-Sector Outperform rating and recommend accumulating shares at this level.

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