Keyera Corp (TSX: KEY) is a Canada-based integrated energy infrastructure company with extensive interconnected assets and depth of expertise in delivering energy infrastructure solutions. Its predominantly fee-for-service based business consists of natural gas gathering and processing; natural gas liquids processing, transportation, storage and marketing; iso-octane production and sales; and an industry-leading condensate system in the Edmonton/Fort Saskatchewan area of Alberta.

Investment Rationale

• Strong Second Quarter Performance: Keyera delivered strong results in the second quarter despite the ongoing COVID-19 pandemic and low commodity prices that continue to affect the global economy and energy industry. The Gathering and Processing segment reported operating margin of CAD 69 million (CAD 70 million in 2Q19) and the Liquids Infrastructure segment generated CAD 100 million in operating margin (CAD 93 million in 2Q19). The protected margins on the Marketing segment due to the resilience of the Liquids Infrastructure business and Keyera’s disciplined and effective risk management program. In addition, Keyera’s strong customer relationships ensured there were only modest volume shut-ins in the Gathering & Processing business. For the second quarter of 2020, net earnings were CAD 18 million (Q2 2019 – CAD 225 million), and Adjusted EBITDA was CAD 182 million (Q2 2020 – CAD 249 million). During the second quarter, all three business segments performed well.

• An Income Play: At the last traded price, the stock of Keyera was offering a lucrative dividend yield of 8.62%, which is encouraging from an income investor standpoint. Also, the company’s dividend yield is approximately 2.4 times higher than the TSX Composite Index dividend yield of 3.6% and 15.4 times of the Canada 10-year Government Bond Yield of 0.56%. Further, the company has track-record of consistent dividend payment, and the company has increased its monthly dividend 16 times since going public in 2003. The company’s dividend distribution recorded a CAGR of 8% since 2003. Moreover, amid challenging business condition led by COVID-19 pandemic, Keyera has maintained its monthly dividend while preserving its strong financial position, investment-grade credit ratings, and low dividend payout ratio.

Source: Company Presentation

• Solid Financial Position: The company has maintained a strong financial position which includes two investment-grade credit ratings by credit agencies, a CAD 1.5 billion undrawn credit facility, a healthy balance sheet, and minimal long-term debt obligations in the next five years. The group’s financial strength is likely to allow it to comfortably pass through the challenging business condition. However, the group’s long-term debt position is relatively higher than the industry median, with Long-term debt to total capital ratio stood at 46.4%, whereas the industry median stood at 36.9%. However, the company’s ability to generate hefty cash flow is quite enough to service its debt obligations as the interest coverage ratio stood at 5.92x and Net Debt to Adjusted EBITDA ratio stood at 2.5x.

Source: Company Presentation

• Creditworthy Customer Base: Approximately 78% of Keyera’s customer bases comprise of creditworthy counterparties, including investment-grade/secured and split rated customers. A strong customer base is likely to help the group in generating consistent cash flow.

Source: Company Presentation

• Risk Associated to Investment: The group is exposed to a variety of risks, including foreign currency exchange risk associated with the purchase and sale of NGLs and iso-octane. Also, the company is slightly exposed to the crude oil price risk in its marketing business. Further, Keyera is subject to a range of laws and regulations imposed by various levels of government and regulatory bodies in the jurisdictions in which it operates. In particular, income tax laws, environmental laws and regulatory requirements can have a significant financial and operational impact on Keyera’s business.

Business Segment

Business segment & Geographical Segment (% to total revenue).  Source: Annual Report 2019 

Quality Cash Flow from Creditworthy Customers

Source: Company Presentation 

2QFY20- Financial Performance- Key Takeaways

• During the second quarter of 2020, Keyera made significant progress in enhancing its long-term competitive positioning by reducing its overall cost structure. Keyera implemented a number of measures to reduce both operating and general and administrative (“G&A”) expenses, while continuing to advance the optimization of gas plants in the Gathering and Processing segment. Keyera expects these efforts to contribute a total annual improvement in earnings before tax of between CAD 45 million and CAD 65 million, with the majority to begin in 2021.
• For the three months ended June 30, 2020, the group reported net earnings of CAD 18 million, CAD 207 million lower than the same period in 2019 due to lower operating margin.

Source: Company Filing

• For the three months ended June 30, 2020, operating margin was CAD 160 million, CAD 122 million lower than the same period in 2019 primarily due to: i) the inclusion of an unrealized non-cash loss of CAD 63 million associated with risk management contracts from the Marketing segment in 2020 compared to an unrealized non-cash gain of CAD 3 million in 2019; and ii) CAD 57 million in lower realized margin primarily attributable to the Marketing segment.
• Total realized margin (excluding the effect of unrealized gains and losses from commodity-related risk management contracts) was CAD 223 million, CAD 57 million lower than the same period in 2019 primarily due to CAD 61 million in lower realized margin from the Marketing segment.

Source: Company Filing

• Cash flow metrics were solid in the second quarter of 2020 despite the decrease in realized margin primarily attributable to the Marketing segment and an increase in G&A expenses associated with severance costs. Cash flow from operating activities stood at CAD 160 million in the second quarter of 2020, CAD 32 million lower than the same period last year. Distributable cash flow was CAD 158 million for the three months ended June 30, 2020, CAD 14 million higher than the same period in 2019 due to lower current income tax and lower maintenance capital expenditure.

Source: Company Filing

• The Gathering and Processing segment reported operating margin of CAD 69 million, similar to the same period last year (Q2 2019 – CAD 70 million), reflecting Keyera’s strong customer relationships that helped ensure only modest volumes were shut in during the quarter.
• The Liquids Infrastructure segment generated CAD 100 million in operating margin (Q2 2019 – CAD 93 million), demonstrating the resilience of Keyera’s storage, transportation and fractionation assets.
• The Marketing segment earned realized margin of CAD 54 million (Q2 2019 – CAD 115 million) as Keyera’s effective risk management program protected margins and inventory values from the sharp decline in commodity prices that began in March. The group expects the realized margin from the Marketing segment to range between CAD 300 million and CAD 340 million, which exceeds the previous guidance of CAD 270 million to CAD 310 million.

Stock Performance

Despite a fundamentally strong business and investment grade client bases, the stock is significantly beaten down on the stock exchange, because of uncertainties hovering over oil and gas industry in the wake of a reduction in demand due to COVID-19 pandemic. On a YoY basis, its shares have plummeted approximately 34%, and corrected 35% on a YTD basis. The stock is down approximately 5% in a month over period. However, the stock has generated a positive price return of 2.25% over the past three months and outperformed its peer set by 13% at the same time.

1-Year Price Chart (as on September 10, 2020). Source: Refinitiv (Thomson Reuters)

At the last traded price, its shares were trading approximately 39% below its 52W High price level and 122% above its 52W low price level. This reflects that its shares have recorded a sharp recovery from its year’s bottom and edging higher on the stocks exchange. 

Top Ten Shareholders

Top-10 shareholders in the company held around 35.06% stake in the company. CI Investments Inc and RBC Global Asset Management Inc. among the largest shareholder in the company and carrying an outstanding position of 8.88%, and 6.71% respectively. The institutional ownership in Keyera Corp stood at 50.48%, and ownership of the strategic entities stood at 1%.

Source: Refinitiv, Thomson Reuters

Valuation Methodology (Illustrative): EV/EBITDA Based Valuation Metrics

Note: All forecasted figures have been taken from Refinitiv (Thomson Reuters)

Stock Recommendation: Despite COVID-19 led business challenges that emerged in the first half of 2020, the group’s performance was decent with all business segment performing well. The group’s financial position remained strong, with CAD 1.5 billion undrawn credit facility, a healthy balance sheet, and minimal long-term debt obligations in the next five years. Further, investment-grade client base and fee-based revenue model provide safety to the group’s business and allow it to generate predictable and stable cash flow.

It is worth mentioning that the group maintained its dividend distribution at a time when the sector is going through a steep pain, which is encouraging from an income investor’s point of view. The group has a solid history of dividend payment and increased its dividend per share at a CAGR of 8% since 2003. At the last traded price, the stock was offering a dividend yield of 8.62%, which is lucrative considering the current interest rate environment.

The full effect and duration of the COVID-19 pandemic continue to be unknown, Keyera continues to implement measures to ensure long-term success. The company believes that the commodity prices have stabilized and are now at levels that are incenting both natural gas and oil sands producers to return their production volumes to pre-COVID levels. As a result, the company expect volumes, moving through its facilities to continue to recover for the remainder of 2020 and 2021.

Therefore, given the strong business model, solid financial health and consistent income play chrematistics of the company, we have given a “Buy” recommendation at the closing price of CAD 22.27 (as on September 10, 2020, after the market close), with lower double digit upside potential based on the NTM Peer’s Average EV/EBITDA multiple of 10x, on the FY20E EBIDTA. We have considered Inter Pipeline Ltd (TSX: IPL), Pembina Pipeline Corp (TSX: PPL), and Gibson Energy Inc (TSX: GEI) etc., as a peer group for the comparison purpose.

*Recommendation is valid at September 11, 2020 price as well.

*Please be aware that dividend is variable and not guaranteed.

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Disclaimer

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