With media headlines surrounding President Trump’s meeting with energy CEOs last week and tomorrow’s meeting between OPEC and its allies to discuss supply cuts, midstream investors could have easily missed notable developments from our northern neighbors in recent weeks. With Canadian C-Corps now representing the largest portion of the North American energy infrastructure universe by market cap (read more) thanks to defensive performance this year, Canadian macro and micro headlines bear watching. Today’s piece updates Canadian midstream performance and explains why Canadian midstream has outperformed its US peers.
The chart below compares the relative equally-weighted performance of Canadian energy infrastructure to the Alerian US Midstream Energy Index (AMUS), which includes both US MLPs and C-corporations. This analysis uses the six Canadian C-corps in the Alerian Midstream Energy Select Index (AMEI) to represent Canadian midstream: Enbridge (ENB), Gibson Energy (GEI), Inter Pipeline (IPL), Keyera Corp (KEY), Pembina Pipeline (PPL CN/PBA), and TC Energy (TRP). Although both groups have been pressured by the challenging commodity price environment, Canadian names have outperformed their US peers by 14.0% through April 7. The two largest names, ENB and TRP, have been the most defensive year-to-date, declining by only 23.7% and 7.2%, respectively. For comparison, AMUS has fallen by 52.6% year-to-date. Of the six names, only IPL and KEY have underperformed the AMUS Index, albeit modestly, having declined 58.8% and 56.5%, respectively. Recent outperformance is not an anomaly; Canadian midstream increased by 29.6% on a price-return basis in 2019 compared to an 8.0% price return for the AMUS (read more).
The outperformance by Canadian midstream has come despite unique macro challenges in Canada. Namely, Canadian production has been curtailed since the beginning of 2019, and pipeline capacity constraints limited production growth even before oil prices collapsed (read more). Despite continued oil production curtailments from the Government of Alberta, Western Canadian Select (WCS) crude prices reached an all-time low of $4.26 per barrel (bbl) on March 30, representing an 89% year-to-date decline. Canadian midstream’s defensive performance in spite of these macro headwinds reflects the strength of their underlying businesses, which in the case of ENB and TRP include many assets in the US. As discussed more below, Canadian companies have a solid track record for weathering past downturns, and multiple companies have been able to reiterate past guidance despite oil’s collapse – testaments to the fee-based nature of these businesses and their limited commodity price exposure. For example, TRP highlighted 93% regulated or contracted EBITDA with only 1% commodity price exposure at its November Investor Day. While more difficult to quantify, Canadian companies also likely benefit from domestic investors’ comfort and familiarity with energy, which may help stem panic selling. For context, 20% of the world’s oil and gas companies are listed on the Toronto Stock Exchange or TSX Venture Exchange. These factors are evidenced by lower correlations to oil prices. Canadian energy infrastructure companies have a five-year correlation of 0.54 to WTI crude prices on average compared to a 0.79 correlation between AMUS and WTI. The average five-year correlation between Canadian midstream companies and WCS crude prices is even lower at 0.44.
As noted, constructive updates from Canadian companies have also contributed to their more defensive performance. In a recent presentation, ENB reaffirmed 2020 EBITDA guidance, while highlighting its 95% investment grade customer base and 98% fee-based EBITDA exposure. ENB also pointed to the EBITDA growth demonstrated during the financial crisis and 2014-2016 downturn. In mid-March, PPL reiterated 2020 EBITDA guidance, noting that guidance may come in at the low side of the provided range, and reduced expected 2020 capex by 43% at the midpoint. In terms of project updates, TRP announced last week that it will begin the construction of Keystone XL, an 830 thousand barrel per day oil pipeline connecting Alberta to Steele City, Nebraska. Additionally, in support of the project, the Government of Alberta plans to invest $1.1 billion in Keystone XL and will provide TRP with a $4.2 billion project-level credit facility in 2021.
Another significant distinction can be made between Canadian and US midstream companies when it comes to dividends. All the Canadian AMEI constituents continued to grow their dividends during the 2014-2016 downturn, while MLP distribution cuts were prevalent then and subsequently. Earlier this week, PPL announced that it would maintain its April dividend sequentially. Prior to the collapse of oil prices, TRP was guiding to annual dividend growth of 8% to 10% through 2021 and 6% at the midpoint thereafter, and ENB raised its dividend by 9.8% sequentially in 4Q19. The dividend picture isn’t completely rosy, however. IPL reduced its monthly payout by 72% and will use the cash savings to self-fund the remaining equity portion of its Heartland Petrochemical Complex. IPL was the only Canadian name with a yield above 20% in March, peaking at nearly 32%.
Given positive company updates, particularly from larger names, and the defensive characteristics of Canadian midstream equities, these companies are well positioned to continue to outperform in a tough energy environment.