World markets are in chaos over the COVID-19 outbreak. That's hammering energy demand as global economies shut down to slow the spread. Making matters worse, energy supplies are surging because of the collapse of OPEC's market support agreement with Russia. These dual shockwaves have caused crude prices to crater, which has weighed on most energy stocks.
One of the harder hit energy companies is Targa Resources (TRGP -0.40%), which has lost more than 80% of its value this year. Here's a look at whether the midstream company is an unbelievable buy or a value trap.
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The case for buying Targa Resources
Targa Resources took aggressive actions following the historic plunge in crude oil prices this month. The company reduced its capital spending range from $1.2 billion-$1.3 billion to between $800 million and $900 million, a 32% cut at the midpoint. On top of that, Targa slashed its high-yielding dividend by 89%, which will save it $755 million. The company plans to use those savings to reduce its debt.
These moves will immediately bolster Targa's financial metrics, which were just starting to get back on solid ground before the oil market tanked. By allocating the cash it would have paid out in dividends toward debt reduction, Targa will be able to more quickly de-lever its balance sheet. That will put it in an even stronger position to weather the current storm in the oil market. It's currently on solid footing since it has $2.7 billion of liquidity and no debt maturing until 2023.
The case against buying Targa Resources
While Targa cut its budget and dividend, the company hasn't yet made any adjustments to its 2020 financial outlook. Its current guidance forecasts that the company will generate between $1.625 billion and $1.75 billion of adjusted EBITDA this year, up 18% year over year at the midpoint. If the company delivers on that guidance, it will trade at less than eight times EBITDA, which is historically cheap for a midstream company.
However, Targa has much more direct exposure to commodity prices than most midstream companies since fee-based contracts only supply about 80% of its earnings compared to more than 85% for most peers. On top of that, there's increasing concern that those fees might not be as secure as initially anticipated. That's because the plunge in the oil market could cause a wave of bankruptcies across the sector. If that happens, those companies might be able to renegotiate their midstream contracts at lower rates. Targa did note that 75% of the revenue from its top 25 customers either comes from investment grade counterparties or it has credit protections in place. But, it also said that it's "continuing to monitor and manage its credit exposure closely."
Another concern with Targa is the current state of its balance sheet. While it has lots of liquidity and no near-term maturities, it currently has junk-rated credit. That will make it more challenging and costlier for the company to borrow money in the future, even when conditions normalize. That could hold it back from taking advantage of opportunities that could emerge in a recovery since it won't have as much financial flexibility as its peers to make acquisitions or invest in new expansion projects.
Verdict: Too much uncertainty and risk to buy right now
Targa Resources made the right moves to shore up its financial foundation by slashing capital spending and its dividend. However, it will take time before those actions shore up its still weak balance sheet. Add that to the uncertainty in the market about how future bankruptcies might impact midstream cash flows, and Targa Resources isn't enticing enough to buy right now. However, it is worth watching since it could have lots of upside once market conditions stabilize.
