Targa Assets: Giant Progress Potential With Excessive Capex Spending

Thesis

Targa Assets (NYSE:TRGP) is a midstream firm that focuses its operations on a vertically built-in worth chain for pure fuel and pure fuel liquids out of the Permian Basin. The wellhead to the water technique provides a one-stop store from the Permian Basin to worldwide export markets.

During the last two years, TRGP has deployed a formidable quantity of capital to broaden its pure fuel processing and NGL fractionation capabilities out of the Permian Basin. The corporate has a full set of processing vegetation, fractionators and long-haul pipelines getting into service between now and 2026 to drive future development for the corporate.

For individuals who comply with the midstream sector, this enterprise mannequin is akin to that employed by Enterprise Merchandise (EPD), one of many premier names within the midstream area. Nonetheless, resulting from its smaller dimension, I count on the expansion fee of Targa Assets to far exceed that of EPD.

TRGP is right for buyers that covet share appreciation greater than earnings. The corporate has a average yield of two.3% and deploys its extra free money movement to buyers within the type of share buybacks.

I undertaking over 35% share worth appreciation via 2026 with a worth goal of $180/share.

Firm Profile

TRGP derives over 80% of its pure fuel and NGL volumes out of the Permian Basin, with the steadiness coming from the Barnette and Anadarko basins. The corporate operates via the full-value chain of pure fuel gathering, processing to extract NGLs out of the product stream, and fractionation for separation into butane, ethane, propane, and many others. The method culminates on the firm’s liquid propane fuel (LPG) export terminals for exportation to Asia.

Progress Trajectory

TRGP has been busy for the reason that finish of the Pandemic, finishing a number of M&A transactions in addition to organically constructing out its built-in system with eight Permian processing vegetation and two fractionators. This construct out has grown CAPEX spending from $500 million in 2021 to an estimated $2.7 billion via the completion of 2024. The corporate expects 2024 to be the height yr in CAPEX spending, after which IT initiatives pulling inner development investments again to $1.7 billion yearly.

The corporate believes this moderated degree of CAPEX spending is adequate to complete its present slate of initiatives out via 2026. TRGP expects to convey on-line six new pure fuel processing vegetation, three fractionators, a protracted haul NGL pipeline, in addition to increasing the capability of the corporate’s LPG export terminal, Galena Park over the following two and half years.

EBITDA Progress By The Numbers

Whereas I used to be doing my analysis on TRGP, the similarities between the TRGP and EPD methods actually caught out to me. In truth, the slate of initiatives beneath building can also be very comparable between the 2 firms. Just like TRGP, EPD has a number of processing vegetation, fractionators and an NGL pipeline beneath building. Nonetheless, one crucial issue separates what these initiatives imply to buyers over the long run. EBITDA.

EPD is on monitor to generate roughly $9.6 billion in adjusted EBITDA throughout 2024. Conversely, TRGP’s up to date steering for the yr initiatives EBITDA to hit $4.0 billion. On this case, EPD’s sheer dimension hinders its development fee, as the identical undertaking slate does not transfer the necessity as aggressively as IT does for TRGP.

In a earlier evaluation, I projected that EPD would be capable to keep between 5% and 6% development charges via 2028. Nonetheless, based mostly on its smaller dimension, TRGP can simply double this development fee.

Through the Q2 convention name, Matt Meloy (Targa’s CEO), gave EBITDA steering for the present initiatives beneath building.

Manav Gupta – UBS Analyst

How has that steering modified as a number of the new initiatives are coming in? And the way ought to we take into consideration these incremental development initiatives delivering EBITDA of over 2025 and 2026?

Matt Meloy – TRGP Chief Govt Officer

Positive, sure. Sure, we indicated sort of our funding a number of going ahead about 5.5 instances, name IT, 5 to 6 instances EBITDA. And I believe you have seen our monitor document during the last a number of years. EBITDA a number of has even been maybe slightly bit stronger than that. We’re investing in the identical sort of initiatives which have delivered return — robust returns for us during the last a number of years. IT‘s investing in our gathering and processing enterprise after which increasing our downstream NGL infrastructure to accommodate these volumes.

So we’re actually sticking to our core enterprise. We count on the returns to be excellent. That 5.5 is sort of what we indicated could be a fairly good base case, what we expect we will do. I hope we will beat that. But when we do 5.5, IT might be a very good return profile for us.

With over $6 billion value of development CAPEX to be invested between now and 2026, TRGP can obtain a formidable development fee. On the midpoint, these investments can develop EBITDA to $5.1 billion. This suggests over 25% development by year-end 2026 and a 13% CAGR. Moreover, this assumes no extra earnings development from fee will increase for the corporate’s current property or commodity sensitivity, offering some margin to those estimates.

EBITDA A number of	5.0x	5.5x	6.0x
EBITDA Progress	$1.2B	$1.1B	$1.0B
CAGR	14%	13%	12%

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Investing For Protection

Whereas lengthy haul pure fuel take-away just isn’t a core enterprise for Targa, the corporate has invested within the subsequent large-scale pure fuel pipeline within the Permian. TRGP introduced IT might be a 17.5% minority proprietor within the Blackcomb pipeline. Whereas the corporate’s $200 million funding within the undertaking is not going to be a needle mover, IT helps maintain manufacturing development within the Permian.

Permian exercise is centered across the worth of oil. Earnings attributed to pure fuel are negligible within the huge image for producers. Nonetheless, if fuel take away just isn’t managed correctly, IT can constrain oil manufacturing. Due to this fact, by serving to to make sure the undertaking will get accomplished, IT helps to make sure exercise within the Permian continues with out interruption. This helps derisk the corporate’s operations, whereas additionally reaching a return on its funding.

Valuation Evaluation

At present, TRGP trades at a barely larger EV to EBITDA a number of than EPD for a really comparable set of property and enterprise mannequin. Regardless of the premium paid on right this moment’s EBITDA, I consider buyers will discover this minor premium to be very profitable in the long term. Assuming each firm’s expertise no a number of growth, an funding in TRGP would considerably outperform EPD from a share worth efficiency standpoint.

The compounding impact of the upper EBITDA development fee can result in vital worth returns, as demonstrated by the simplified diagram under. Primarily based on the present slate of initiatives, 25% annual EBITDA development seems to be simply inside attain by year-end 2026 (12 months 2 in picture under). In distinction, EPD would solely expertise roughly 13% EBITDA development over the identical time interval. Due to this fact, buyers ought to count on considerably improved worth efficiency out of TRGP.

The ahead EV to EBITDA a number of for TRGP yields 10.4x based mostly on present year-end projections. Assuming TRGP’s EBITDA grows to $5.1 billion as projected above, the implied share worth would $178/share. This suggests over 35% appreciation in share worth. Any share repurchases executed throughout that point would offer extra upside.

Stability Sheet Dialogue

The expansion fee exhibited by TRGP is a robust funding thesis. Nonetheless, there isn’t any such factor as a free lunch. To realize this development fee, TRGP has been spending at a fee larger than operational money flows, leading to debt accumulation. Conversely, EPD transitioned to a self-funded CAPEX mannequin a number of years in the past and thus its debt ranges are way more steady.

I count on the present development in debt ranges for TRGP to stabilize as future CAPEX spending is at the moment budgeted to be inside money flows. As proven under, with 6 initiatives finishing in 2024, 2025 seems very promising from a money steadiness perspective. Subsequent yr opens the potential of reaching a impartial money steadiness after CAPEX, dividends, and buybacks.

	2024	2025 Est.
EBITDA	$4,000 Million	$4,520 Million
Curiosity Expense	($700 Million)	($765 Million)
Tax Expense	($380 Million)	($430 Million)
Progress/Upkeep CAPEX	($2,925 Million)	($2,000 Million)
Dividend Expense	($665 Million)	($665 Million)
Share Repurchase Expense	($515 Million)	($660 Million) *
Web Money Burn	($1,185 Million)	($0)

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*Money accessible for share buybacks could be diminished by any potential dividend enhance.

Observe: Information sourced from Q-2 10-Q report.

Past 2025, the remaining undertaking completions present incremental free money movement to be supportive of debt retirement and shareholder returns within the type of dividend will increase and share buybacks.

Dangers

The expansion trajectory I’ve outlined right here implies the profitable completion of over $6 billion value of capital development initiatives which are in numerous phases of completion. There are any variety of regulatory or bodily challenges that might delay and/or drive up the capital prices of those initiatives. This would scale back the general return prospects for the corporate.

Moreover, whereas the Daytona NGL pipeline might be getting into service within the coming weeks, EPD’s Bahia NGL pipeline is projected to enter service within the 1st half of 2025. East Daley Analytics initiatives this might affect margins on NGL pipelines due to decreased overall utilization within the area. The Daytona pipeline might show to be troublesome to fulfill administration’s expectation for an EBITDA a number of of 5.5x till extra capability is consumed.

Investor Key Takeaways

1. Targa Assets is a high-growth midstream play that property present an built-in system to ship NGLs from the wellhead to export terminals.
2. The corporate may be very akin to Enterprise Merchandise in some ways. With a equally sized undertaking backlog, the smaller dimension of TRGP will enable the corporate to appreciate a bigger development fee.
3. 2025 and 2026 CAPEX steering is anticipated to cut back by roughly $1 billion from 2024 ranges. This can enable the corporate to spend inside free money movement and halt the corporate’s debt accumulation development.
4. The upper development fee mixed with average ranges of share repurchases will drive vital share worth appreciation in comparison with that of EPD. Due to this fact, an investor on the lookout for capital appreciation versus yield could be perfect.
5. I fee TRGP as a purchase with an preliminary worth goal of $180/share.

Editor’s Observe: This text was submitted as a part of In search of Alpha’s Finest Progress Concept funding competitors, which runs via August 9. With money prizes, this competitors — open to all analysts — is one you do not wish to miss. If you’re serious about turning into an analyst and participating within the competitors, click on right here to seek out out extra and submit your article right this moment!