Top Tier LNG Facility with Bi-Directional Approval, Export Rights and Strong Asset Dropdowns to Drive 25% Annual Distribution Growth
Dominion Midstream Partners LP (NYSE: DM) was founded in March 2014 as a growth-oriented Master Limited Partnership (MLP) to initially own and operate midstream liquefied natural gas (LNG) infrastructure assets in Maryland’s Chesapeake Bay, including 136 miles of interstate pipelines to import, store and transport natural gas to its LNG facility. Dominion Midstream Partners is managed by its General Partner, Dominion Midstream GP, and is sponsored by energy producer, Dominion Resources Inc. (NYSE: D), a leading energy and energy services provider with a $42 billion market-cap and a strong balance sheet to finance sizable growth opportunities as a preferred provider.
Units offer strong 25% annual distribution growth potential with EBITDA expected to grow from $197 million (for the 12-months ended June 30, 2014) to about $2 billion through rich dropdowns coupled with a strong, debt-free balance sheet and stable, long-term contracted cash flows with little direct commodity exposure. With strong LNG and natural gas demand, an LNG export license and a powerful sponsor in Dominion Resources, units are expected to garner premium valuation for at least the next five years as organic and dropdown growth drives best-in-class value.
With Cove Point, future dropdowns (Blue Racer and Atlantic Coast Pipeline) and key Dominion assets, the MLP can offer integrated midstream services – gathering, processing, transport and storage – to connect growing Marcellus/Utica natural gas production to end user and export markets.
October 2014 Initial Public Offering Raises $397 Million
Dominion Midstream Partners closed its initial public offering on October 20, 2014, with 20.125 million common units (representing a 31.5% limited partner interest in the company) offered at $21 per unit, including full exercise of the overallotment option on 2.625 million units. Units were priced at the high end of the offer range of $19 – $21. The public offering raised $397 million which management will use to fund parent company Dominion Resources’ $3.8 billion Cove Point liquefied natural gas terminal expansion in which the MLP will have 100% Preferred Equity interest. Public unitholders will have 31.5% limited partner interest in Dominion Midstream Partners with the remaining 68.5% interest belonging to parent company, Dominion Resources Inc.
The MLP’s General Partner will oversee day-to-day operations while limited partners, as investors in the partnership, will receive low-risk cash distributions. The MLP structure also benefits from no corporate taxes and a lower cost of capital for investments in growth projects. Cash Distributions to unitholders include return of invested capital and benefit from favorable tax laws.
Key Asset – Dominion Cove Point LNG
Dominion Midstream Partners owns a perpetual, non-convertible 100% preferred equity interest in the Dominion Cove Point LNG facility. This facility includes LNG storage tanks, regasification plants, an offshore pier and equipment to receive imported LNG from tankers and deliver regasified LNG through the Cove Point Pipeline to customers in the Mid-Atlantic region.
Cove Point can regasify upto 1,800 MDt per day, store 14.6 Bcfe in seven LNG storage tanks (with storage capacity fully contracted) and liquefy about 15 MDt/day.
This preferred equity interest entitles the MLP to the first $50 million of annual cash distributions. The Cove Point facility generates revenues through annual fees for storage, regasification and transport, and serves the Mid-Atlantic market through binding commitments with top-tier customers that include Royal Dutch Shell (RDS.A), BP (BP) and Norwegian oil and gas company Statoil (STO). Cove Point currently generates about $200 million in EBITDA.
Strong Distribution Growth Potential through Future Dropdowns
Over time, parent company Dominion Resources plans to ‘dropdown’ additional assets to the MLP, assets that will generate over $2 billion in EBITDA. Near term, Dominion Resources is expected to dropdown its interests in Blue Racer Midstream (a $1.5 billion joint venture with midstream company Caiman Energy) and the Atlantic Coast Pipeline (a joint venture with electric power holding company Duke Energy (DUK), natural gas distributor Piedmont Natural Gas Company (PNY) and energy services holding company AGL Resources (AGL)).
Blue Racer Midstream has long-term contracts with natural gas producers in Utica fields, with strong bookings for its 400 mmcf/d processing capacity. The Atlantic Coast Pipeline has 1.5 bcf/d capacity and contracts with 20-year terms for 90% of its capacity.
Cove Point Facility Expansion Will Boost Cash Flow, Distributions
The Cove Point facility recently gained approval from the Federal Energy Regulatory Commission to operate as a bi-directional facility on September 29, 2014. This approval allows the facility to either import LNG and vaporize it into natural gas or liquefy natural gas and export it as LNG. Cove Point is the closest LNG export terminal to the Marcellus Shale, the most productive natural gas deposit in the U.S. (see table below), and is expected to benefit significantly from this proximity once bi-directional operations commence. Cove Point also serves the Utica shale for additional contracted revenue.
Cove Point is one of only three facilities that have received approval to export LNG to countries that do not have free trade agreements with the United States. Dominion Midstream Partners has already signed 20-year export contracts with India’s largest state-owned gas company GAIL India Limited and Japanese trading company Sumitomo Corporation. Both companies will be able to export 2.3 million tonnes per year of LNG after the expansion is complete.
The expansion at Cove Point will require an investment of $3.8 billion and will support the community at Calvert County, Maryland, by providing 3,000 temporary jobs during construction and 14,600 permanent jobs during operation. The facility will also generate $9.8 billion in royalty payments to mineral owners in the area over the next 25 years, and pay about $1 billion in local, state and federal taxes over the next 23 years.
Strong Sponsor in Dominion Resources
Dominion Resources is a segment-leading energy and energy services provider with about $12 billion in annual revenue and a market capitalization of $42 billion with BBB+ credit rating (by Morningstar). Dominion has three primary business units – a regulated electric utility (Virginia Electric and Power Company), midstream natural gas services and unregulated energy production (Dominion Energy) which it has been gradually divesting to focus on core electricity and natural gas.
Dominion Resources has structured the MLP as its primary midstream growth vehicle and plans to capitalize on its favorable tax status and lower cost of capital to finance growth projects. Post IPO, the parent continues to be a sizable majority owner of the MLP and is well incentivized to drive MLP growth and distributions.
Strong Global Demand Will Drive Export Revenue
Dominion Midstream Partners operates in the oil and gas pipeline sector which has benefited from consistent growth due to global LNG demand, more so with Russia’s natural gas customers scrambling to find alternative sources after Russia’s continuing strong arm tactics over Ukraine.
Moreover, energy analysts routinely predict rising energy demand to meet the needs of a growing and more affluent world population. From 2015 to 2030, LNG demand is expected to increase by 14% in the Americas, 93% in Asia, 296% in Europe and 850% in the Middle East and Africa.
As natural gas production ramps up in the U.S., demand for facilities such as Cove Point will remain strong. Cove Point will also benefit significantly from liquefying and exporting natural gas, while regasifying energy to meet domestic demand.
Units Up 30.7% since IPO; 2% Minimum Annual Distribution Yield
Dominion Midstream Partners units began trading on October 15, 2014. As of 11/14/14, units closed at $34.50, an increase of 30.7% since the IPO, giving the company a market capitalization of $2.28 billion. Units have handily outperformed the S&P 500 Index since they debuted amid strong demand and significant bullishness for the MLP’s future distribution growth prospects.
Units trade at 21.6x trailing 12-month earnings and 19x trailing cash flow, roughly in-line with other midstream MLP valuations.
Dominion Midstream Partners plans to pay minimum quarterly cash distributions of $0.175 per unit ($0.70 annualized) for a minimum annual distribution yield of 2.0%. After common units receive minimum quarterly distributions, distributions will be paid to 5.6 million subordinated units held by Dominion, requiring $44.8 million in annual cash available to meet minimum distribution requirements, which is more than covered by the $50 million in preferred first rights that the company holds on Cove Point cash flow, even after about $3 million in G&A expenses.
Analysts Bullish on Growth Prospects
Several Wall Street firms initiated coverage on Dominion Midstream Partners after the quiet period for its initial public offering ended on November 10, 2014. Goldman Sachs (GS) initiated coverage with a Neutral rating and a $32 price target on 20% distribution growth compounded annually, offset by a high valuation. Citigroup (C) initiated coverage with a Buy rating and a $37 price target on EBITDA growth from $203 million in 2015 to $794 million in 2018 due to the addition of liquefaction capacity at Cove Point. Barclays PLC (BCS) initiated coverage with an Overweight rating and $39 price target on growth from large dropdown inventory worth over $2 billion of EBITDA, solid cash flow and low commodity exposure. UBS AG (UBS) initiated coverage with a Buy rating and $38 price target on growth of 24% compounded annually from dropdown inventory worth between $2.1 billion to $2.2 billion of EBITDA.
JP Morgan recently initiated coverage with an overweight rating and a price target of $43 by December 2015, with 25% price appreciation upside over the next year.
Committed, Experienced Leadership Team
Dominion Midstream GP, the General Partner of Dominion Midstream Partners, is led by Chairman and Chief Executive Officer Thomas Farrell II. Farrell has held several senior positions with Dominion since joining the company in 1995 and is intimately familiar with Cove Point operations.
Mark McGettrick serves as Executive VP and Chief Financial Officer of Dominion Midstream GP. Mcgettrick joined the company in 1980 and oversees all things financial for the company including accounting, investor relations, risk management and financial analysis.
Paul Koonce serves as Executive VP of Dominion Midstream GP and is responsible for the Virginia Power and Energy business units of the company. Koonce has over 30 years of energy industry experience and currently oversees approximately 3.7 million customer accounts.
Distributable Cash Flow of $50 Million, Zero Debt
For the 12 months ended June 30, 2014, Dominion Midstream Partners had revenue of $351.8 million, EBITDA of $197.2 million and net income of $102.6 million. The company has a profit margin of 29% and operating margin of 47%. As of June 20, 2014, the company had $340.7 million in total cash, no long-term debt and operating cash flow of $136.9 million.
Dominion Midstream Partners LP offers safe distribution income and exposure to the strongest growing segments (Marcellus/Utica) of the U.S. natural gas industry without significant commodity risk. In addition, distributable cash is expected to rise at a 25% annual rate from three large dropdowns, and this upside reflects the company’s relatively rich valuation relative to its sole current asset, Cove Point. As one of only three approved companies that can export LNG to countries not in a free trade agreement with the U.S., Dominion Midstream faces reduced competition with locked-in contracts for its Cove Point facility. While a lot of the upside is built into units at the $34.50 price, current valuation still does not reflect significant upside from asset dropdowns, strong EBITDA growth and 25% distribution growth in the years to come.