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Morningstar | Targa Reports Solid Quarter; Resolves 2019 Funding Gap with Sale of Badlands Stake

Targa reported a solid fourth quarter, and we do not anticipate material changes to our $52 fair value estimate or no-moat rating after incorporating the recent sale of its Badlands assets to Blackstone. We do remain concerned about the outlook given the recent volatility in frac spreads and uncertainty around gathering and processing volumes and spreads. However, the sale and the $1.6 billion in cash removes our concerns around funding 2019 growth capital spending plans of $2.3 billion and its dividend payouts. We estimate the funding gap prior to the sale was about $2 billion, assuming Targa hits its guidance, meaning the proceeds will be devoted entirely toward capital spending, not debt reduction. As a result, leverage remains uncomfortably high at 4.9 times EBITDA. Distributable cash flow of $214 million failed to cover its common plus preferred dividend for the quarter, but overall distributable cash flow of $942 million managed to cover both for the full year.

Revised 2019 EBITDA guidance of $1.3 billion to $1.4 billion adjusted for the Badlands sale is down from the prior guidance of $1.5 billion to $1.7 billion. We estimate lower natural gas liquids prices account for about $40 million of the difference with the remainder likely the associated Badlands EBITDA with the sale of the 45% stake, which is estimated at $225 million. As a result, the $3.6 billion valuation implied with the Badlands sale is about a 7.2 times multiple on a estimate of $500 million in EBITDA. We believe this is a fair price for the asset, as Targa paid $950 million for the assets in 2012 and invested at least $250 million in growth capital since then while volumes have doubled. At the same time, Targa was a motivated seller given the extent of its need for capital to fund its 2019 growth plans.

Targa's results generally benefited from higher volumes. Permian volumes for its gathering and processing operations were up 24% year over year, and overall volumes increased 17%. Similarly, higher fractionation and LPG export volumes helped its downstream segment. Offsets include lower marketing gains, lower commodity prices, and higher operating expenses associated with new Permian gathering and processing plants. Overall gathering and processing volumes are expected to increase another 10% this year, and 20% in the Permian. The startup of the Grand Prix in the third quarter will also be critical in terms of making sure Targa hits its full-year targets, and so far, it seems to be on track. Finally, the firm wrote off the remaining $210 million in goodwill related to its Atlas mergers in 2015, which is a risk that we've highlighted previously and a reminder of the substantial original overpayment for the Atlas assets.