Analyst Note| Stephen Ellis |
DCP Midstream’s second-quarter results were strong, as the partnership is benefiting from a very healthy natural gas liquids environment and strong pricing. After updating our model to reflect a higher volume outlook, we’ve raised our fair value estimate to $24 per unit. We’ve also reduced our uncertainty rating to high to reflect DCP’s improved financial position to better handle its near-term maturities, given its healthy level of excess free cash flow generation. Given the strong natural gas liquids environment, DCP is now guiding toward the high end of its prior outlook, putting 2021 EBITDA around $1.28 billion, matching our updated forecast. While DCP volumes still remain below last year’s levels, the recovery from the poor performance in the first quarter due to DCP’s mishandling Winter Storm Uri was material at 16% for the logistics and marketing pipes and 6% for the gathering and processing operations.
We remain concerned about the balance sheet but acknowledge that DCP has more options to fix its issues in a much-improved market environment. Leverage at 4.2 times debt/EBITDA is still too high; we’d prefer to see it in the low 3s. Total debt has increased year to date to $5.75 billion from $5.6 billion, despite over $200 million in excess free cash flow after distributions. The easiest lever to pull remains reducing the still too-high distributions again and devoting the extra cash to debt reduction. However, with the improved market environment, we believe DCP management has missed its opportunity to do so. Now that the market environment has strengthened materially, we think any further distribution cut will be met with substantial unitholder pushback. An equity offering remains an option, though Phillips 66 and Enbridge would need to be involved unless they are willing to accept a reduction in their ownership stakes.