Equitrans Midstream: There's More To Win Than To Lose, 50%+ Upside
Summary
- Equitrans Midstream stands out for still offering significant growth prospects on the horizon in an industry that has largely axed capital expenditure.
- When their trio of growth projects become operational in the coming two years, it stands to boost their adjusted EBITDA by upwards of 30%.
- This should also boost their free cash flow significantly and thus allow their dividends to at least be doubled.
- Based upon my Monte Carlo Simulations, investors only face a 16% downside even in a bearish scenario with zero growth but see over a 50% upside in a bullish scenario where their dividends double.
- Since this means that there is more to win than to lose with favorably skewed results, I continue believing that my bullish rating is appropriate.
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Introduction
Following the severe and now infamous downturn of 2020, the midstream industry is certainly no longer known for providing significant growth prospects with capital expenditure axed and projects deferred. Although this is where the Equitrans Midstream (NYSE:ETRN) stands out with significant growth prospects still on the horizon for their already high dividend yield of 5.80%, which provides desirable prospects for investors where there is more to win than to lose with a significantly higher upside than downside potential.
Background
Whilst companies see many moving parts influencing their operations, when it comes to sustaining and growing their dividends, arguably their cash flow performance is most important because they cannot consistently pay out cash unless they are generating a sufficient quantity. Thankfully despite the turmoil of 2020, their operating cash flow was not only resilient but actually still grew an impressive 16.84% year-on-year to $1.141b versus its result of $976.5m during 2019.
Image Source: Author.
This strong cash flow performance continued into the first half of 2021 with their operating cash flow edging slightly higher to $612.1m, which has been capable of funding all of their capital expenditure plus their dividend payments. Whilst this alone is already positive, when looking ahead there is a trio of significant growth prospects on the horizon that are fast approaching completion within the next two years, as the slide included below displays. The largest of the trio is their Mountain Valley Pipeline, which should become operational within one year during the summer of 2022 with the others following within the next year.
Image Source: Equitrans Midstream Second Quarter Of 2021 Results Presentation.
These three projects stand to boost their adjusted EBITDA by an impressive $320m, which should provide an approximate 30% increase over their 2021 guidance of $1.105b, as per slide twenty-one of their previously linked second quarter of 2021 results presentation. Thanks to the positive correlation between adjusted EBITDA and operating cash flow, it stands to reason that the latter will also see a similar-sized boost and thus given their operating cash flow of $1.14b during 2020, this should at least amount to $300m.
Since this additional operating cash flow should flow straight through to their free cash flow, they could at least afford to double their dividends that only cost $129.7m during the first half of 2021 or $259.4m once annualized. Following this point in time, their capital expenditure should wind down in tandem and thus further boost their free cash flow, although the extent presently remains uncertain. If interested in further details regarding this aspect or its positive impact upon their financial position, please refer to my previous article because nothing material regarding these smaller points has changed since being published.
Discounted Cash Flow Valuations
The midstream industry and its steady financial performance is most commonly desired by income investors. This makes their intrinsic value linked to their future income, which can be estimated by utilizing a discounted cash flow valuation that replaces their free cash flow with their dividend payments. If interested, all of the details regarding the inputs utilized for these valuations can be found in the relevant subsequent section.
Since selecting variables for discounted cash flow valuations can be rather difficult and open to small errors as well as manipulation, Monte Carlo Simulations have been provided to illustrate how the odds are stacked in each scenario. There is never a silver bullet for ascertaining whether the intrinsic value of an investment but generally speaking, the more positive the results are skewed, the better the probability of generating alpha. When conducting the analysis an estimated target price was found through finding the point whereby the results were equally split between positive and negative.
Bearish Scenario
A bearish scenario has firstly been provided to assess the downside risk for investors, which assumes that their significant growth prospects fail to transpire and thus their dividends remain unchanged at $0.60 per share perpetually into the future. Whilst a zero-growth scenario is commonly utilized to form my baseline scenarios when performing midstream valuations, this seemed unreasonable given their previously discussed significant growth prospects on the horizon.
Under this scenario only 26% of results produced an intrinsic value above their current share price of $10.35 with a target share price sitting 16.43% lower at $8.65. Whilst this may sound rather lackluster, it should be remembered that this represents a bearish scenario and thus the potential downside risk is actually rather low since an approximate mid-teen digit loss would certainly not be crippling in a diversified portfolio.
Image Source: Author.
Bullish Scenario
The second scenario takes a middle-of-the-road bullish path whereby their dividends remain unchanged for the first two years whilst they complete their growth projects before doubling to $1.20 per share and subsequently remaining unchanged perpetually into the future. Whilst they should scope to increase their dividends further as their growth project-related capital expenditure winds down, this was not counted to provide a margin of safety.
When turning to the bullish scenario, there was an extremely impressive 100% of results producing an intrinsic value above their current share price with a target share price of $16.40, which thereby represents a very desirable potential upside of 58.45%. Whilst this may sound over-optimistic, their share price originally traded for around $20 after listing during 2018 and thus historically, this intrinsic value is neither unrealistic nor without precedence. Since these results are very favorably skewed, when combined with the results of the bearish scenario, they indicate that the market is assigning little value to their significant growth prospects on the horizon. This presents investors with desirable prospects to generate significant alpha in the medium-term when their growth projects are completed and the benefits are realized, without also taking significant risks if these failed to materialize.
Image Source: Author.
Valuation Inputs
The Monte Carlo Simulations utilized 121 different discounted cash flow valuations, which were based upon a wide range of cost of equity assumptions with expected market returns from 5% to 10% and risk-free rates from 0% to 5%, both of which using 0.5% increments. Each of the discounted cash flow valuations utilized a cost of equity as determined by the Capital Asset Pricing Model that utilized a 60M Beta of 0.89 (SA).
Conclusion
Whilst the future remains inherently uncertain by nature, their growth projects on the horizon are fast approaching completion and stand to significantly boost their cash flow performance and thus easily make room for their dividends to double. Thankfully there is more to win than to lose at their current share price with a significantly higher upside than downside potential, thereby providing desirable prospects to generate alpha. Following this analysis, it should be of little surprise that my bullish rating is being maintained into the future.
Notes: Unless specified otherwise, all figures in this article were taken from Equitrans Midstream's SEC filings, all calculated figures were performed by the author.
This article was written by
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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Comments (19)
The issue is, we will have to wait for another couple of years if all will go smoothly from now on to see this multi billion dollar pipeline completed.
