Looking Through The
Boardwalk Recontracting
Boardwalk Pipeline Partners (BWP) trades at a rock bottom
valuation due to uncertainties surrounding contracts that are set to expire in
the coming years (ie. recontracting). The goal of this write up is to put forth
a conservative estimate of where EBITDA will be following the recontracting and
establish a value for the shares.
Boardwalk operates natural gas pipelines and storage
facilities. The vast majority of Boardwalk’s revenue is from long term
contracts and as a result there is typically high visibility on revenue and
EBITDA. When a pipeline is built customers typically sign 10 to 20 year
contracts guaranteeing revenue for the pipeline regardless of usage.
History Of The Recontracting
Well over a decade ago Boardwalk started planning a pipeline
system that would flow gas from the shale fields in the middle and southern
part of the country to Southern Texas and Louisiana. After the pipeline system
was built more economic shale gas was discovered in other parts of the country,
primarily the Utica and Marcellus Shale. This led to less drilling in the areas
which Boardwalk’s pipeline system served. Despite the decreased drilling,
Boardwalk’s customers were locked in for 10 years and had to continue paying. These
contracts will all be up for renewal over the next 3 years and revenue will
decline.
In 2014 Boardwalk management recognized the fact that this
recontracting was looming. To plan for the recontracting they slashed the
dividend and used the vast majority of the cash flow for growth projects to
offset the looming revenue losses. Boardwalk has been successful in increasing
EBITDA over that period. The table below from Boardwalk’s latest investor
presentation shows the growth in EBITDA that resulted from the growth projects
Boardwalk is fortunate that its pipeline system feeds into Southern
Texas and Louisiana, the area of the country that is seeing the largest demand
growth for natural gas. A large number of LNG export facilities are being built
in this area and exports to Mexico leave from this area. In addition, a large
number of electrical and petrochemical facilities are being built in this part
of the country.
Boardwalk’s largest pipeline system coming up for
recontracting is Gulf Crossing. Currently, 70% of the capacity is being
utilized even as the vast majority of the pipeline’s capacity is under contract.
Cheniere is building a large amount of LNG export capacity and needs natural
gas to flow its facilities. In order to facilitate this they are planning a
pipeline called Midship that will go from the SCOOP and STACK to Bennington. At
Bennington, Midship can connect into Boardwalk’s Gulf Crossing and a competing
pipeline. As a result it is likely that Gulf Crossing will be able to
recontract close to 100% of its capacity, albeit at a lower price.
Putting A Number On
The Recontracting Loss
Most analysts estimate that Boardwalk will lose around $200
million from recontracting from 2017 to 2021. For the purpose of getting a very
conservative estimate of the earnings power of Boardwalk I am going to assume
they lose $250 million in EBITDA to recontracting between 2017 and 2021. It
assumes a poor outcome for all regions coming up for recontracting but also
assumes Midship gets built (which seems very likely). My estimate of
recontracting losses is far in excess of any analyst I have seen, including
Goldman Sachs which has a sell rating on the stock.
Growth Projects
Boardwalk currently has $1.3 billion of growth projects in
the pipeline. This should lead to roughly $160 million in EBITDA based on
industry returns and past Boardwalk growth projects. Boardwalk has already paid
for the majority of this through free cash flow and should earn enough free
cash flow over the next year to pay for the rest. These projects will be put
into service by 2020 with the majority of the revenue starting during 2019.
Valuation
In 2017 Boardwalk earned $845.5 million in EBITDA adding
back a recontracting loss of $7 million. Over the coming years I estimate they
will gain $160 million from growth projects and lose as much as $250 million to
recontracting. That leaves them with EBITDA of at least $755 million.
Steady, natural gas pipeline MLPs trade at roughly 12 times
EBITDA. Post recontracting Boardwalk will be a high quality natural gas
pipeline company, with the vast majority of revenue coming from predictable,
long term contracts. Boardwalk’s recent growth projects have an average
contract life of 17 years. After recontracting their problematic pipelines will
represent a small amount of revenue and be at market rates. A dirty little
secret of pipeline companies is that most of them have some recontracting
issues but they are not as transparent as Boardwalk has been.
At 12 times $755 million in EBITDA Boardwalk would trade at
$21.50. Since Boardwalk still needs another year of cash flow to pay for the growth
projects the price target should also be for a year out. Discounting that back
to today for a 10% return (including the dividend) works out to roughly $20 of value
today.
So how is it possible that I have lower estimates than every
analyst and a higher price target? Quite frankly my only major insight is that
once the recontracting is resolved there will be no more uncertainty and the
stock should be valued like its peers. Even in an adverse outcome that is worse
than any analyst is expecting the stock should be higher. Over the next year we
should find out the recontracting results for the majority of Boardwalk’s
pipelines and the uncertainty should be lifted.
Distributable Cash Flow
At $755 million in EBITDA Boardwalk would have $475 million in
distributable cash flow. If Boardwalk wanted to maintain 1.2 times dividend
coverage they could pay a 14.3% dividend at today’s price. I believe they would
first want to delever before paying out such a large percent of cash flow. Over
time the dividend should go much higher although the timing is uncertain.
Boardwalk Management
Boardwalk management gets a bad rap because of the stock
price and the dividend. When they planned the pipelines that are being
recontracted over a decade there was no way to know that more productive shale
fields would be discovered. As Forrest Gump says “Sh*t happens”. This is not
the fault of management.
Boardwalk management was transparent and proactive when they
realized the problem. They cut the dividend and planned ahead for the coming
recontracting. Most MLP managements in a similar situation would just keep paying
out a big dividend and drive off the cliff. With Boardwalk management I am comfortable
because they are transparent about the problems. With other MLPs one doesn’t
know what recontracting issues lie in the future.
Storage Upside
Boardwalk’s storage business has two types of customers,
strategic and financial. A strategic customer might be an electrical plant that
wants to have some natural gas in storage. A financial customer takes advantage
of the natural gas futures curve. In recent years storage revenue has declined
mainly because the natural gas curve has been unfavorable.
Management is bullish on strategic customers because of the
location of their pipelines. Boardwalk has storage in areas where large amounts of facilities are being built that use natural gas such as LNG export facilities,
petrochemical plants etc. These facilities may want to utilize some of Boardwalk’s
storage. On the financial side they don’t think the natural gas futures curve
could get any worse. This valuation doesn’t include any potential storage
upside.
My clients and I are long shares of Boardwalk Pipeline Partners (BWP) at the time of this writing. Positions may change at any time
