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Morningstar | Tallgrass Reports Good 3Q; Pony Express and REX Continue to Shine

Tallgrass reported good third-quarter earnings, and we plan to maintain our $28 fair value estimate and narrow moat rating. The firm's major pipelines, REX and Pony Express, continue to operate nearly full, with REX averaging volumes in excess of 4.1 bcf/d during the quarter and Pony Express actually being prorated (shippers will only be able to transport a certain percentage of their barrels) with estimated volumes topping 360,000 bpd during October, and nominations (shipper requests for pipeline capacity) over 400,000 bpd for November. For pipelines that we once thought faced far more challenging outlooks, this type of performance is quite strong. The firm is clearly benefiting from strong production growth out of the DJ and Bakken Basins for Pony, while new takeaway capacity being added out of the Marcellus has hasn't impeded REX's ability to generate healthy volumes.

Overall, adjusted segment EBITDA declined to $223 million from $242 million last year. While the overall result is decent, and a modest improvement sequentially, the oil and gas pipeline results are going in opposite directions for the time being, with REX's weakness more than offsetting Pony's strength.

Pony Express is benefiting from higher production in the basins it serves. New projects such as the joint venture with Silver Creek made up of two pipelines and storage facilities. The first pipeline is the under-construction Iron Horse pipeline, a potential 200,000 bpd pipeline due online in the first quarter of 2019 to transport crude to Pony Express' system in Guernsey, Wyoming, from the Powder River Basin. The second pipeline is the existing Powder River Gateway, a 90,000 bpd pipeline (expandable to 125,000 bpd) offer similar transportation options. Both pipelines will eventually offer connections to Tallgrass' new offshore terminal effort for export, the Plaquemines Liquids Terminal, that is planned to be in service in mid-2020. Tallgrass indicates that it has multiple expansion projects around the Powder River Basin and its Silver Lake venture that it is working to bring to fruition, potentially providing more shippers with access to export options.

We believe REX has actually lost some east-to-west flows (transporting Marcellus gas elsewhere) to some of the new pipelines starting up, mainly Rover. However, the pipeline appears to have made up for it with higher flows on gas moving west-to-east, meaning more Rockies gas. Net net though, with contract resets, REX's financial results have worsened, with segment EBITDA falling to $121 million from $160 million last year. However, we do think REX results are near a trough and should stabilize as the effects of new contracts roll through.

Still, we remain impressed with Tallgrass management team's ability to source creative projects. Tallgrass' offshore terminal effort is centered around St. James, Louisiana, and the new Plaquemines Liquids Terminal (PLT) scheduled to come online in mid-2020. It is planning a 700-mile pipeline called Seahorse capable of transporting up to 800,000 bpd from Cushing to St. James, which has more than 30 million barrels of storage, and this pipeline will also connect to the new PLT terminal. Seahorse will be online in the third quarter of 2021. The PLT terminal will initially have 5 million barrels of storage but can be upgraded to 20 million barrels over time. It can also load 1 million barrels per day. One advantage is that Tallgrass plans to handle imports and exports at the offshore terminal, putting it in direct competition with LOOP. Another advantage is that the Seahorse pipeline will be "batch," which means if overseas buyers want to receive crude from the Bakken, the Powder River Basin, or the DJ, Tallgrass can provide it.