Credit Suisse Upgrades Enbridge Energy Partners, Downgrades Targa Resources

• Shares of Enbridge Energy Partners, L.P. EEP and Targa Resources Corp TRGP are down YTD 48 percent and 75 percent, respectively.
• Credit Suisse’s John Edwards upgraded the rating on Enbridge Energy Partners to Outperform, while downgrading the rating on Targa Resources to Underperform.
• Volatile commodity prices and declining production volumes are making a recovery in the MLP segment difficult, Edwards noted.

Analyst John Edwards mentioned that MLPs remain under pressure, with sector valuations at multi-year lows or around 10 percent and yield spreads at multi-year highs of over 750 basis points. Continued volatility in commodity prices and declining production volumes are making a recovery difficult, the analyst added.

“We point out that MLPs traded at lower than current yields from 2000-2007 which was pre-shale revolution and pre-global financial crisis,” the Credit Suisse report mentioned.

High storage levels are impacting prices, which in turn affect volumes and cash flows. Although inventories are expected to decline eventually, the timing remains uncertain, Edwards stated. He added that a further decline in oil prices would continue to exert pressure on volume recovery in the US, further delaying the realization of returns on cheap valuations.

Capital spend by MLPs was at its peak in 2014. The report added, “Per our est., ~$35-$40Bn will end up being spent on midstream build out by MLPs in 2016 as less economic projects are deferred due to higher cost of capital, uncertain turn-around of volume decline.” Capital spending in 2016 is expected to decline 10-15 percent y/y.

Edwards expects a slowdown in distribution growth in 2016, with the sector median expected to be 4-6 percent, versus around 6 percent in 2015. MLPs with stretched balance sheets, high yields and tight distribution coverage are likely to search for alternative financing and consider internally generated cash as an equity source.

Yield spreads to the US 10 year are expected to rise with higher risk premiums and slower distribution growth. Edwards expects the contraction in valuations to make “the hunters the hunted” and companies outside of midstream players to enter the M&A space in 2016.

Enbridge Energy Partners

Edwards upgraded the rating on Enbridge Energy from Neutral to Outperform, while reducing the price target from $39 to $34. The analyst noted that the units appear to have sold off more relative to its risk profile.

“While we acknowledge the capital market needs the next couple of years, EEP has a supportive parent, we assumed ~11% yield on units issued in 2016 and ~9.5% yield in
2017 and we raised the discount rate to 9.5% (50bp above a typical I/G credit owing to
capital markets risk),” the report mentioned, adding that there remains considerable upside in Enbride Energy’s shares.

Targa Resources

Edwards downgraded the rating on Targa Resources from Outperform to Underperform, while reducing the price target from $79 to $36.

The company has announced the collapse of its MLP structure, which was to improve balance sheet. Given the continued deterioration in the commodity price outlook, the company’s leverage is expected to move above 6x in 2006, while distribution coverage will fall below 1.0x without a reduction, Edwards mentioned.

“Even with an 80% reduction in 2016 and no growth until 2020 is the first sign of leverage dropping solidly below 4x,” the report added.