Midstream Top Picks from BMO Capital - Oct 10

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dan_s
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Midstream Top Picks from BMO Capital - Oct 10

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From Danilo Juvane, CFA • Oil & Gas Sector at BMO Capital
Bottom Line:

The 3Q19 earnings season kicks-off with KMI reporting on October 16th. We expect the sector to show initial signs of moderating future growth capex and higher FCF against a backdrop of lower US production growth and commodity price expectations; spurring increasing investor focus on capital allocation. Our top picks remain LNG, PAA/PAGP and WMB.

Key Points

Our pecking order remains intact. We're keeping intact our top three picks of LNG, PAA/PAGP and WMB, where we continue to see significant value in each name, noting ~35%+ upside potential relative to our price targets. LNG remains our top pick as we view the name trading markedly below the value of existing contracts, with incremental upside to be had via the potential commercialization of Stage 3 at the Corpus Christi Liquefaction complex.

Valuation roll-forward to 2021. We've rolled forward our valuations to 2021, with our price targets in turn reflecting a 15-month time horizon. We've increased price targets for LNG, MMP, OKE, PAA/PAGP, TRGP and WMB, with valuations with the remaining coverage universe kept intact.

Where we see potential for positive/negative earnings surprises. Our OKE and MMP EBITDA forecasts reside ~4% lower than consensus. We think the Street will come down on the latter after accounting for lower Permian crude differentials, with the former impacted by ethane rejection (lower pipes and frac volumes) and narrowed Conway-to-Belvieu NGL optimization spreads.

Key 3Q19 themes. Given expectations for a lowered US production outlook, we see moderation in midstream growth capex in 2020/2021, which should not only transition the sector to lower growth but also translate into significant free cash flow (FCF) generation. To this end, we see capital allocation becoming an increasing focus especially for companies with significant de-leveraging ahead, with investor preference for further buybacks over dividends. Additional topics of investor interest during the quarter include: 1) Infrastructure bottlenecks, a recurring theme, no doubt, but one that we see as pertinent particularly for NGL storage given still-robust production and increasing Gulf Coast frac capacity through 2021; 2) the Permian, where competition remains particularly fierce within the crude oil value chain; and 3) preliminary 2020 guidance, which we expect from ET, PAA/PAGP, ENBL and LNG/CQP.
Dan Steffens
Energy Prospectus Group
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