UBS Investment Research published a report entitled “US Research” on December 30, 2011. The report isn’t publicly available, but we will summarize its main points. In the report, UBS analysts have listed the most and least preferred stocks for investment in 2012. Discussed below are the least preferred investments from within the energy sector.
Northeast Utilities (NU) has been given an equal-weight rating by UBS. Northeast Utilities’ merger with NSTAR is now pending with the MA regulators after the companies, the AG, and the Department of Energy Resources failed to reach a settlement agreement in late December. The longer the closing of the merger is delayed, the greater is the likelihood for legislative developments. Additionally, Northeast Utilities and NSTAR are jointly involved in the development of a high voltage DC transmission line, Northern Pass, from Canada into New Hampshire.
UBS has given a price target of $35 based on the SOTP valuation methodology with the assumption that the Northern Pass line will be implemented without further time delays or cost increases. Shares are currently trading at 13.5x UBS’s 2013 EPS estimates which is a 2% discount to the regulated group median. The shares are priced to yield 3.7% (vs. a group median of 4.4%).
Pioneer Southwest Energy Partners (PSE) has been given an equal-weight rating by UBS. Pioneer is viewed as being the weakest of the upstream MLPs due to its small size, limited distribution coverage, lack of distribution growth history and potential, and thin trading liquidity. Since its 2006 IPO, Pioneer has only lifted its distribution once (by 2%). UBS projects its distribution coverage ratio will decline from ~1.35x in 2011 to less than 1.10x in 2012 with the expiration of its $115 x $170/Bbl oil collars. On the other hand, its Spraberry drilling program has yielded solid results and will provide a source of oil production growth for the next several years.
UBS has given a $27 price target derived via a Distribution Discount Model which incorporates an approximate 2.25% distribution CAGR through 2016, coverage ratios climbing from 1.07x in 2012 to ~1.25x in 2016, and a 10.0% cost of equity. Despite lackluster distribution growth since its 2006 IPO, a small-scale production footprint, a marginal (relative) hedge profile, and limited daily trading liquidity, Pioneer continues to trade at a premium to its peers on an EV/EBITDA basis (8.9x 2012E EBITDA vs. 8.0x peer average).
PPL Corporation (PPL) has been given an equal-weight rating by UBS. UBS sees a nearer term risk as the management looks to announce 2012 guidance with 4Q results. The Street’s expectation of $2.46 is viewed by UBS as high as it does not fully appreciate a further equity issuance at the end of 2012, and in 2013 of $250m each. Limited improvement in the next 2015/16 PJM capacity auction is anticipated, with limited improvement in the pricing off this. Disproportionate earnings exposure in 2014 could offset this trend.
UBS has valued PPL using the SOTP EV/EBITDA, P/E and RAV methodology. An average of 12x P/E, 8.0x EV/EBITDA, and 115% of RAV is applied to its international businesses, 13.5x P/E to its PA Utility business, 12.5x P/E to its Kentucky business, and 8.0x EV/EBITDA to its Open Generation EBITDA. UBS has given a DCF-average price target of $29.
ConocoPhillips (COP) has been given an equal-weight rating by UBS. As E&P valuations are highly correlated to growth, ConocoPhillips’ low long term target growth rate (3-4% vs. a peer average of >9%) also has negative implications for its post-spin valuation. UBS suggests that ConocoPhillips is highly susceptible to commodity price declines and needs WTI and Brent prices above $100/Bbl and $111/Bbl, respectively, in order to generate positive organic free cash flow post-dividends and post-capex in 2012. ConocoPhillips’ upstream and downstream asset portfolios are believed to be less attractive than its soon to be new peers. Its multiples are near the bottom of the respective pure play peer ranges.
Using an upstream 2012 EV/DACF target multiple of 5.1x and a downstream EV/EBITDA multiple of 3.0x, UBS’s SOTP analysis indicates ConocoPhillips is worth ~$65/share at current strip prices. However its nearest standalone E&P peers trade at ~4x 2012 DACF, which would imply a downside potential towards ~$51 per share. Warren Buffett’s Berkshire had more than $1.8 billion invested in ConocoPhillips at the end of September.
NiSource Inc. (NI) has been given an equal-weight rating by UBS. NiSource stock has performed well in this low interest rate environment, climbing 27% year-to-date. Its current yield, however, is 4.1% and, with an estimated 2012 dividend payout ratio of 68%, an increase in NiSource's dividend is considered to be unlikely. NiSource is also expected to have a sizeable pension fund obligation at year-end 2011 which is believed to be underfunded. Additionally, NiSource's 2010 forward stock sale will be exercised in 2012. The company will issue approximately 24.3 million shares at $16.50 per share, a 27% discount from the current stock price.
Shares are currently trading at around $22.90, about 4% above UBS’s $22 DCF-and-SOTP-derived price target. At current levels, NiSource is trading at 15.5x the UBS 2012 EPS estimate, a 3% multiple premium to its peer group. All of the companies in its peer group are expected to have meaningful dividend increases in 2012. Israel Englander’s Millennium had $59 million in NiSource at the end of the third quarter.
Tesoro Corp (TSO) has been given an equal-weight rating by UBS. Tesoro is highlighted as the least preferred name for early 2012. Roughly 40% of Tesoro’s refining capacity is leveraged to a weak California economy and stringent emissions standards, which are expected to continue limiting gasoline demand growth. Additionally, while Tesoro has traditionally been regarded as the de-facto play on the West Coast refining environment, its Mid Continent refining operation has generated roughly 40% of this year’s refinery operating income through 3Q11.
Under UBS’s current refining margin forecasts, Tesoro trades are estimated at 2.1x 2012E EBITDA. A more conservative outlook would incorporate a 15% decline in margins from year-to date 2011 averages and a $5/Bbl WTI-Brent spread. Under this scenario, Tesoro would trade at 4.0x 2012 EV/EBITDA (above its mid-cycle average of 3.6x). UBS presently rate Tesoro Neutral with a price target of $27, or 2.4x 2012E EBITDA. David Tepper’s Appaloosa had $22 million invested in TSO at the end of September.