TRP - Keyera: Dividend Hike Finally Comes Through For This 6% Yielding Stock (Rating Downgrade)

2023-08-24 17:24:15 ET

Summary

• Keyera's Q2 2023 earnings were excellent, with adjusted funds from operations exceeding consensus estimates.
• The company raised its guidance for the year, citing higher oil prices and strong performance in the marketing segment.
• We examine if the company would still get a buy rating after the outperformance vs. peers over the last 12 months.

In our last coverage of Keyera ( KEY:CA ) ( OTCPK:KEYUF ) we gave it one of our rare "buy" ratings. Underpinning that decision was a case of strong (but not exceptional) value, high yield, low debt and contractual cash flows. It did not hurt that we were bullish on the general direction of commodity prices either. The stock has delivered since our first and second articles on this one and the stock has almost managed to keep up with the unstoppable S&P 500 ( SPY ).

We examine the Q2 2023 results and look at whether this merits another vote of confidence.

Q2 2023

Keyera's second-quarter earnings were excellent and adjusted funds from operations (AFFO) came in at 90 cents per share, comfortably above consensus estimates. This was driven by the marketing segment which was the biggest contributor and Keyera raised the midpoint of its guidance to $395 million. For reference, this guidance was as low as $350 million just last quarter. Besides the marketing segment, key drivers for the guidance were higher oil prices, hedges in place, and the KAPS pipeline system margins exceeding earlier expectations.

The awful wildfires did impact the cash flow and this was estimated to be about $13 million for the quarter. The overall guidance boost after a quarter of such a strong negative impact was music to investor ears. Keyera bumped this dividend up to C$2.00 per share on an annual basis.

Outlook

Investors have had to be patient with Keyera in the past few years. The company stopped dividend increases after 2019 due to the impact of the COVID-19 pandemic and also to complete the KAPS project while keeping debt-to-EBITDA in check. With the dividend increase this quarter that wait is finally over. Management actually commented that the near term would be balanced between reducing the leverage further and then adding more hikes down the line.

Eileen Marikar

Yes, that is a great question. I think it is important to take it back to our overall priorities. Our first priority will always be to maintain our balance sheet strength, and we're certainly there today.

For this year, we are prioritizing paying down short-term debt from the higher marketing contribution. But beyond the balance sheet, our objective really is to grow distributable cash flow on a per share basis so that we can continue to grow the dividend.

And this can really be achieved in two ways: one, buying back shares; or reinvesting in the business. As we look out to next year it will be a competition for capital between these two options.

Our preference would be to do smaller size, but impactful growth projects that meet our investment criteria. And really, by small, I mean smaller relative to the large-scale projects that we've undertaken over the past few years.

Source: Keyera Q2 2023 Transcript

The exceptional execution by management which made sure that KAPS was completed without endangering the balance sheet has certainly made more hikes possible in 2024 and beyond. Median estimates for 2024 show that Keyera will have at least $250 million left over after capex and paying its dividend. The raw AFFO estimates for the same year are around $3.45, again, showing a lot of room to increase the dividend. Finally, the debt to EBITDA estimates are close to 3.2X for 2024. Assuming no silly antics by management, this would fall under 3.0X at the end of 2025.

Valuation & Verdict

On an absolute level Keyera is still on the cheap side. We are looking at less than 10X AFFO with a very low debt to EBITDA ratio. That is very appealing on whichever side of the border you examine midstream companies. There is one small caveat on the debt to EBITDA ratio though. Analysts tend to exclude the subordinated hybrid notes in the debt to EBITDA calculation or give them 50% equity credit as the rating agencies do.

So on a realistic level, debt to EBITDA is a bit higher than what we hear about.

One other factor here is that Keyera has gone from being cheap to being a little expensive versus the Canadian midstream peers. How did that happen? Well Keyera went up and everyone else went the other way since we last wrote about Keyera.

Despite this recent dividend hike, the price performance has meant that Keyera now sports the lowest dividend yield in the sector and even Pembina Pipeline's ( PBA ) conservative payout gets you more than that.

So on a relative basis, it is harder to argue that Keyera is as undervalued, especially when you pitch it against Enbridge Inc. ( ENB ). TC Energy Corporation ( TRP ) of course has its own issues, but even that is now looking quite appetizing all things considered. So if you held it from the last buy call, you have a different decision than if you are deciding which one to buy today. On the latter, we are quite clear that Keyera would not be your number one or even number two choice today. On the former, well, that is harder. But we cannot give it a buy rating with the plethora of midstream choices available today. We are downgrading this to a hold, while commending management on negotiating the last three years with a high level of competence.

Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.

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