Keyera Stock: Record Results In FY2023 But Don’t Get Too Excited (KEYUF)

Author’s Note: Since Keyera Corp. is reporting in Canadian Dollars, all numbers refer to Canadian Dollars (unless stated otherwise).

Introduction

I have written twice about Keyera Corp. (OTCPK:KEYUF)(TSX:KEY:CA). The first article was published on November 22, 2022, and the second on May 22, 2023. I expressed a neutral rating on Keyera both times.

In my last update, I wrote that the volatility of the marketing segment makes the other two segments (“Gathering & Processing” and “Liquids Infrastructure”) the main cash flow drivers for the company. With the, according to Keyera, game-changing KAPS pipeline fully going into service in the second half of 2023, I said that I wanted to wait and see how KAPS will affect the DCF (“Distributable Cash Flow”) of these two segments.

In this article, I will go over the recently released FY2023 results and the FY2024 guidance. I will also address how KAPS impacted Keyera’s cash flows and make a new attempt to value Keyera.

I will skip a company introduction and refer you to my first article for an overview of Keyera’s business. The segments are still the same and the way that Keyera earns money hasn’t changed since then.

But let’s start with a short recap of my previous coverage.

Recap of Previous Coverage

In the first article, I made the following statements:

• Keyera generates returns on capital of around 10%
• The target DCF Payout ratio sits at 60%
• In conclusion, Keyera reinvests 40% of DCF back into the business

With Keyera reinvesting 40% of DCF back into the business, generating returns on capital of around 10%, Keyera should be able to grow around 3-4% per year. In addition to that, you will get a dividend yield that will be around 60% of DCF which is the mid-point of the targeted payout ratio.

Since Keyera generates mediocre returns on capital, the stock trades on yield and not on growth. Very simplified, if you expect returns above the 10% level that the broader stock market delivered over a very long timeframe, Keyera should be a buy above 7% and a sell below 5.5% yield because the long-term return outlook would be around 11% or 9% respectively. On average, Keyera should trade at around 6% yield.

I also highlighted that Keyera’s terrible returns of the past were the result of a massive multiple-contraction. Between 2013 and 2022, Keyera’s Price-to-Book (P/B) multiple nearly halved. While I normally don’t use P/B as a valuation metric, it can make sense for capital-heavy infrastructure businesses like Keyera.

I concluded my first article with a DCF valuation showing that Keyera seemed to be fairly valued assuming 4% growth for a decade and 2% growth into perpetuity in line with inflation targets, ultimately resulting in a “hold” rating.

In the second article, I gave an update on what happened since I started covering Keyera and expressed concerns about the uncertainty for the marketing segment (this will be a topic in this article again) and the effects that rising refinancing costs could have on Keyera’s cash flows. While the other two segments showed some decent growth, I also wanted to wait and see how the KAPS pipeline fully going into service would impact cash flows (this will also be discussed today).

FY2023 Results

Now that we are in the same boat again, let’s start with a review of Keyera’s performance in FY2023.

First of all, let me remind you what metrics I use to assess Keyera’s financial performance:

• Adjusted EBIT
• Distributable Cash Flow (DCF)
• Return on Tangible Capital

Adjusted EBIT is just the reported Adjusted EBITDA minus depreciation and amortization expenses. Return on Tangible Capital is defined as Adjusted EBIT divided by Tangible Invested Capital. Tangible Invested Capital is defined as Long-term Liabilities + Shareholders’ Equity – Goodwill and non-current intangibles.

In 2023, Adjusted EBIT increased by close to 15% YoY while DCF increased by a bit above 30% YoY. Both metrics came in at an all-time high. Return on Tangible Capital came in at 11.3%. The last time we have seen returns on capital in this range was back in 2014/2015. So overall, Keyera delivered excellent results in 2023.

Here is a screenshot of what I call the “DCF Bridge” which is reported in Keyera’s financial reports:

Here we can see that DCF increased from C$654 million to C$855 million. The main drivers were an increase in what Keyera calls “Realized margin” and a decline in cash taxes.

With this, I have to talk a bit about the “Realized margin”. Realized margin is defined as:

Revenue – operating expenses (OPEX) +/- unrealized gain/loss on risk management contracts = Realized margin

Note that Realized margin doesn’t take into account:

• G&A expenses
• Finance costs
• Depreciation and amortization expenses

So in conclusion, the realized margin is a very rough estimate for the operating results. It is still usable though. Since we know that the increase in realized margin was the main DCF driver, let’s take a look at the realized margin for each segment over the past three years (in C$ thousands):

Click to enlarge

As we can see, the realized margin increased for every segment with the main drivers being Liquids Infrastructure and Marketing. The Liquids Infrastructure segment benefitted from the KAPS pipeline fully going into service while the Marketing segment delivered unexpectedly strong results. In the Q1 2023 report, Keyera only guided for a C$330-370 million realized margin for the Marketing segment. The final number of C$479 million exceeded this by a wide margin.

Here is what I wrote in the “What to look out for” segment of my last article:

Another uncertainty is the realized margin for the marketing segment. If we look at the YChart I highlighted earlier, we can see that current NGL prices are at the 5-year average. Assuming that FY2023 should be a weak year because Keyera bought at higher prices at the end of 2021 and throughout 2022, the contribution from the marketing segment should be below average in FY2023 (as Keyera indicated with the marketing segment’s guidance range).

Source: Author’s article from May 22, 2023

The strong results for the Marketing segment surprised me. However, we will see that the downturn in the Marketing segment has just been pushed out a couple of quarters.

2024 Guidance

Understanding Keyera’s guidance is not that easy. Here is a screenshot from the current investor presentation showing the 2024 guidance:

This is not helpful if you don’t understand the cash flow drivers for Keyera so let me explain. Going over the drivers for DCF over the last five years, I concluded that the main cash flow drivers are:

• Realized margin
• Maintenance CAPEX
• Cash Taxes
• Finance/G&A/Other costs are of lesser relevance

So we have to take the guided numbers and apply them to the FY2023 results to come up with a projection for 2024 DCF. Here is a short table showing how the guided numbers should affect DCF for 2024 (in C$ thousands):

Click to enlarge

So according to the guidance, DCF should decrease by around $179 million.

This doesn’t take into account the increases in realized margin for the other two segments though. Here is a chart showing the development of the realized margin for Gathering & Processing and Liquids Infrastructure over the last eight quarters (in C$ thousands):

Here we can see that Gathering & Processing finished the year strong in Q4 23. The highlight has been the performance of the Liquids Infrastructure segment though. This segment has been growing every year since 2014 (the latest data I have) and has shown great YoY and QoQ performance every quarter of 2023. And remember, the KAPS pipeline has just gone into service in the middle of 2023.

I assume that these two segments may improve realized margin by around C$70 million. So in total, I think 2024 DCF could come in at around C$745 million, down around 13% YoY.

Valuation

Author’s note: If you are based in the U.S., I added the US$ equivalents for your convenience.

With 229,153,000 shares outstanding and the estimated C$745 (US$552) million DCF, DCF per share should come in at around C$3.25 (US$2.40) for 2024. As this assumes a realized margin from the Marketing segment of only C$330 (US$244) million (the low range of realized margins for this segment that we have seen since 2018), I think this is a rather conservative estimate.

With Keyera currently trading at C$33.23 (US$24.60) per share, Keyera seems to be trading somewhere around 10x forward DCF.

I will value Keyera with two different approaches and I will start with the “simple approach” I talked about earlier. Regarding the dividend, Keyera aims for a payout ratio of 50-70% DCF. So the mid-point of that range would result in a dividend of C$3.25 x 60% = C$1.95 (US$1.44) per share. With the current dividend sitting at C$2 (US$1.48) per share, I don’t think that we will see a dividend increase this year, and even if we do, it should be very small. Keyera kept the dividend unchanged at C$1.92 (US$1.42) per year from 2020 to 2023 and only increased it to C$2 in the second half of 2023. So I will just assume an unchanged dividend of C$2 per share for 2024. I said earlier that Keyera should be able to grow at around 4% per year going forward because the company aims to reinvest 40% of profits back into the business, and generates returns on capital of around 10%. So if we aim for 10% returns going forward, Keyera would need to trade at a dividend yield of 6%. With C$2 per share, Keyera would need to trade (and be fairly valued) at C$33.33 (US$24.68) per share which is exactly where it is trading at now.

Now let’s do the second approach, a Discounted Cash Flow calculation. For this, I will repeat what I wrote in my first article:

For the DCF valuation, there is one thing I need to mention beforehand. The DCF number is not comparable to the traditional Free cash flow (FCF) for other businesses. While FCF is the excess cash flow after maintenance and growth capex, DCF only takes into account maintenance capex. So to be precise, we would need to deduct the growth capex from the DCF to get the starting point for a DCF valuation. I will keep it really simple and just use the target payout ratio of 60% since I already assumed that the other 40% will be reinvested as retained earnings.

Source: Author’s article from November 2022

I will just use C$2 per share (the current dividend) as the FCF per share equivalent, 4% growth for a decade, 2% growth into perpetuity, and a discount rate of 10%. Here is the result:

So using a DCF calculation, according to my estimates, Keyera should be fairly valued somewhere around C$30 (US$22.21) per share which is a bit higher than my above-mentioned fair value using the simple method.

Keyera may be guiding the realized margin for the Marketing segment too conservatively. This might be the reason that Keyera is trading at the higher end of my estimated fair value range.

Some More Thoughts on Valuation

As you might have noticed, I will have to give a neutral rating for Keyera again. Since this is my third article on Keyera, this might be a bit disappointing so I want to lose some more words regarding valuation.

As I highlighted earlier, Keyera generates mediocre returns on capital of around 10%. This is above the cost of capital but the gap between returns on capital and cost of capital is not large enough to create great value for shareholders while holding the stock. That is the reason why Keyera trades on yield and not on growth. The intrinsic value of Keyera increases over time but at a very slow pace. You need a decent yield to generate good total returns.

Here is a chart showing Keyera’s dividend yield over the past decade:

As you can see, Keyera has traded in the range between 5-6% yield since 2018 and below that level before that. Keyera trading at sub 5% yield back then is, in my opinion, the main reason for Keyera’s poor total returns over that timeframe:

With a company like Keyera, buy-timing is crucial if you intend to hold it for the long term. There was a timeframe right after the pandemic (when the dust had already begun to settle) where Keyera traded at yields above 8% for quite some time. I bought my small position at the end of 2022 for C$22.36 (US$16.55) per share.

I think that Keyera is an interesting company so I will keep covering it and look out for another selloff and an opportunity to buy it at prices that enable market-beating returns. Now is not that time though.

If you are looking for a high-yielding Canadian energy infrastructure stock, you might want to take a look at Enbridge Inc. instead. I wrote a well-received article on Enbridge (ENB)(ENB:CA) on October 30, 2023, and I think it offers far better value than Keyera at the moment.

Conclusion

Keyera delivered excellent results for FY2023 but the FY2024 guidance leaves me to assume that it is still not a good time to buy. Very simplified, I think that Keyera is a buy at a yield of 7%+ (around C$28-29 (US$21.10) per share) and a sell at a yield in the range of 5.5% (around C$36 (US$26.65) per share) or below.

I will keep covering the company, looking out for another selloff that enables entry points with market-beating return potential. Now is not the time though.

I also reiterate my stance regarding potential actions with my own shares: I would probably sell my whole position at around C$35 (US$25.91) and might change my stance to a buy rating at around C$25 (US$18.51).

With that, I reiterate my “hold” rating on Keyera.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.