DCP Midstream: better-than-expected performance, not a purchase

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Introduction

After their 2020 distributions were halved in 2020 due to the severe Covid-19 inspired recession, at the end of 2021 it appeared that higher 2022 distributions were coming for DCP Midstream (New York Stock Exchange: DCP), although it remains curiously risky due to their very high leverage and low liquidity, because my previous post Underline. A follow-up analysis is provided in this article examining their subsequently released results for the fourth quarter of 2021 as well as their updated outlook for 2022, which despite disappointing better-than-expected performance leaves their units still not worth the price. hard to buy at their current price. prices that caused their payout yield to drop to a moderate 4.40%.

Executive summary and ratings

Since many readers are likely short on time, the table below provides a very brief summary and scores for the main criteria assessed. This Google document provides a list of all my equivalent grades as well as more information regarding my grading system. The following section provides a detailed analysis for readers wishing to delve deeper into their situation.

Intermediate DCP rankings

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*Instead of simply assessing distribution coverage through distributable cash flow, I prefer to use free cash flow as it provides the strictest criteria and also best captures the true impact on their financial position.

Detailed analysis

Intermediate DCP cash flows

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After a weak start to 2021 due to the winter storm in Texas, fortunately the strength later in the year saw strong overall cash flow performance, despite what their operating cash flow at the surface would indicate otherwise with their result of $646 million, down a significant 41.22% year-over-year from their previous result of $1.099 billion in 2020. Although removing the temporary impacts from working capital movements, which in 2021 represented a relatively very large build of $369 million versus a drawdown of $128 million in 2020, their underlying operating cash flow was $1.015 billion dollars in the first period versus $971 million in the second, which is a decent 4.53% year-over-year increase. Looking ahead to 2022, their forecast points to an even better year with higher growth, likely due to their sensitivity to commodity prices which benefit from these currently very high oil and gas prices, as indicated by the tables below.

Intermediate orientations of the DCP for 2022

DCP Midstream March 2022 Mizuho Energy Summit Presentation

It can be seen that management expects to achieve adjusted EBITDA of $1.425 billion in mid-2022, which is a solid 10.38% year-over-year increase from their result of $1.291 billion. dollars in 2021, consistent with their fourth quarter 2021 results announcement. Since their underlying operating cash flow is expected to see a positive correlation, it is also expected to increase by around 10% year-over-year for 2022, leaving their estimated operating cash flow at around $1.12 billion. After their relatively low capital expenditures in 2020 of $267 million and subsequent even lower levels in 2021 of just $113 million, it seems quite surprising to see forecasts for another solid increase in profits. Although their ability to take advantage of these very high oil and gas prices is likely the reason for their better than expected performance in 2021 after their soft start and the continuation of higher forecasts for 2022, this could act as a weapon. a double-edged sword in the years to come if prices get lower again.

Whichever direction oil and gas prices influence their results in the coming years, fortunately, their 2022 capital expenditure forecast allows for abundant free cash flow with a sustaining portion of $120 million. mid-term, commonly referred to as maintenance and additional growth. $125 million mid-term portion. After both are subtracted from their estimated operating cash flow, that’s about $875 million, which comes to an estimated free cash flow of about $800 million after subtracting their $59 million per year. preferred distributions and various other relatively minor miscellaneous cash outlays, as shown below the chart. included above. Following this positive outlook for ample free cash flow, it appears higher payouts are imminent, based on management comments included below.

“We ended the year with a target of ending 2021 with 4x leverage, and I am extremely pleased to report that we ended the year with 3.8x leverage. This trajectory is on an accelerated basis to achieve a 3.5x target and allows us to advance our strategy of returning additional capital to our unitholders this year.”

“In order to deliver immediate value, we believe that a significant increase in distribution is an important first step and we should be able to execute this increase as early as the middle of this year. Following this increase, a significant flow of excess available cash will give us the flexibility to consider additional capital allocation options, such as distribution increases, opportunistic buyouts, or capital-efficient, low-multiple executed investments…”

-DCP Midstream Q4 2021 Conference Call.

Exactly what qualifies as ‘significant’ remains to be seen, but in my eyes it should be an increase of at least 10%, which would see their quarterly distributions increased to $0.43 per share, thus now costing 358 $.4 million per year based on their last outstanding. unit count of 208,378,739. Given that this easily falls well below their estimated free cash flow of around $800 million, their coverage would still be very strong at over 200%, but unless their very high leverage is resolved, their ability to safely finance growth in the years to come would nonetheless be capped.

Structure of the intermediate capital of DCP

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Although their cash flow performance throughout 2021 was weighed down by the build up of their working capital, their minimal capital expenditures still resulted in a slight decrease in their net debt to end the year at $5.432 billion versus its slightly higher level of $5.572 billion at the end of 2020. Although without their working capital build of $369 million this would have been significantly lower, which bodes well for 2022 as this build relatively very large should at least partially reverse, thus reinforcing their already positive outlook for their free cash flow but at the same time, the extent to which their net debt will decline will depend on the exact height to which they push their yields for the unitholders.

DCP Midstream Leverage Ratios

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Despite their slightly lower net debt and decent underlying operating cash flow in 2021, their net debt to EBITDA ratio of 4.96 actually saw a tiny 0.06 increase from the end. of 2020, although fortunately this is not significant and is simply a result of the usual fluctuations in earnings through years. Meanwhile, the leverage ratio as used by management has decreased to 3.80 from its previous result of 3.90 at the end of 2020, which they expect to reach their target of 3.50 in 2022, consistent with their previously linked Q4 2021 earnings announcement. The reason for the significant difference from my net debt to EBITDA stems primarily from their leverage ratio excluding some of their debt related to their junior subordinated bonds, as discussed in detail in my previous article for any interested new readers.

Regardless of how an investor wants to see these sometimes complicated accrual-based leverage ratios, their net debt to operating cash flow would still be 5.35 even if they removed their working capital build. previously discussed, thus being easily above the threshold of the very high territory of 5.01. This means that despite their very strong payout coverage, they still cannot necessarily safely return all of their free cash flow, thus capping the prospects for payout growth in the medium term after delivering their “significant increase”. imminent in 2022. While their forecast for earnings growth in 2022 should reduce their leverage as it looks likely to be inflated by currently very high oil and gas prices, it remains to be seen whether this advantage is sufficient in the medium and long term.

DCP Midstream Liquidity Ratios

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Although their leverage is higher than would have been preferable, their liquidity has improved and is therefore now adequate. Even though their current ratio of 0.87 at the end of 2021 is effectively unchanged from their previous result of 0.88 when performing the previous analysis after Q3, they have refinanced and therefore reduced significantly their wave of upcoming debt maturities, as the table included below displays.

DCP Midstream debt maturities

DCP Midstream 2021 10-K

They previously faced relatively large maturities of $700 million in 2022, although this has now been halved and given their recently renewed and amended $1.4 billion credit facility, whose maturity is extended from 2024 to 2027, this indicates that the debt markets are open. and favorable to more refinancing. In addition, since they ended 2021 with a relatively very large amount of $1.383 billion available under this now renewed credit facility, they have the flexibility to manage their 2022 and 2023 debt maturities by drawing on this facilitated if necessary.

Conclusion

Thanks to their now adequate liquidity as well as their better-than-expected financial performance and resulting prospects for continued growth in 2022, fortunately, their distributions now appear safe and therefore more risky, despite their very high leverage. So far the tone of my analysis seems more bullish than bearish and realistically their better than expected performance deserves kudos, however I still believe that maintaining my sell rating is appropriate, due to their unit price. When estimating their intrinsic value last year in my other article, even in a bullish scenario in which their distributions increase by 10% per year for seven consecutive years, it still only produced a result of around $28 and thus well below their current unit price of around $35. . Despite their better than expected performance, in my opinion, nothing has changed enough to justify a significantly higher intrinsic value.

Notes: Unless otherwise stated, all figures in this article are taken from DCP Midstream’s SEC Filingsall calculated figures were performed by the author.

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