Crestwood Equity Partners (CEQP) is the type of stock that income investors drool over. It currently yields a mouthwatering 8.4% and can cover that payout with cash flow by a comfortable 1.3 times. Furthermore, it has several expansion projects underway, which could enable the company to start growing its distribution again by the middle of this year.
That said, one reason why Crestwood offers such an enticing yield is that it currently trades at a bargain-basement valuation. That could make it a gold mine for value investors, especially when factoring in what's coming down the pipeline.
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Inexplicably cheap
Crestwood Equity Partners expected to generate between $210 million and $230 million in distributable cash flow (DCF) last year, or about $2.88 to $3.36 per unit. With Crestwood's units currently trading at around $28.50 apiece, it implies they sell for a price-to-DCF ratio of just 8.2 times -- using the midpoint of its guidance range. That's well below the mid-teens level that most other pipeline stocks trade at these days.
On the one hand, Crestwood should probably sell for a lower valuation than others in its sector. With just a $4 billion enterprise value, it's dwarfed by other pipeline companies, with many larger ones spending that much on growth projects each year. Given their larger size, they're more diversified, making them less risky. In addition to that, Crestwood's leverage ratio was 4.1 times debt to EBITDA at the end of the third quarter, which is above its 4.0 times target and higher than the leverage ratios of some of its financially stronger rivals.
That said, Crestwood shouldn't trade as far below its peers as it does because its financial metrics rival those of some of the strongest companies in the sector. For example, Magellan Midstream Partners (MMP) has one of the highest credit ratings in the midstream space because it has a leverage ratio of less than 3.5 times and covered its distribution by 1.25 times. Crestwood, however, isn't that far behind. Its coverage ratio for 2017 should end between 1.2 to 1.4 times, and leverage will end the year at 3.8 times, thanks to a recent asset sale. With metrics so close to one of the sector's best, it's hard to explain why Crestwood trades at about eight times DCF when Magellan fetches more than 16 times DCF.
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Hidden value on the horizon
The market seems to have valued Crestwood as if it were still in decline, which is a mistake given what's ahead. That's because the company's earnings and cash flow should increase this year since it recently completed several expansion projects. Crestwood estimates that these projects will provide it with about $35 million in incremental EBITDA this year, which is about 9% higher than the company's estimate for last year. In addition to that, the company has several other expansions underway, which should increase earnings more than $120 million by 2021, or about 30% above last year's level.
That said, this estimate only includes projects currently underway. In the Delaware Basin alone, for example, Crestwood has identified expansion opportunities that could potentially supply it with more than $100 million in incremental EBITDA by 2021. These include crude oil gathering lines, oil storage terminals, and produced water gathering and disposal projects. This growth seems increasingly likely to materialize considering that Royal Dutch Shell (RDS.A) (RDS.B), the main customer on its Nautilus System, called this region "the most important asset" within its unconventional portfolio. Because of that, Shell plans to invest $1 billion per year through 2020 to increase its output from the area, which should drive incremental growth for Crestwood. That's just one of four regions that could supply additional growth above the company's current forecast in the coming years.
A compelling value play
Value investors have several ways to win with Crestwood. For starters, the company's valuation should move up toward the peer group average over time as the market realizes that it's no longer the struggling pipeline company it was during the oil market downturn. In addition to that, the company should create more value for investors in the coming years as its growth projects come online and increase cash flow. Finally, with a more than 8% yield, investors get paid incredibly well while they wait for the market to wake up to the fact that Crestwood is just too cheap. Those three drivers make Crestwood a potential gold mine for value investors, which is why I couldn't resist adding it to my own portfolio.
