No-Moat AmeriGas Reports Full-Year Results
by Andrew Bischof, CFA, CPA | Morningstar Research Services LLC | 11-13-18

We are reaffirming our $41 fair value estimate and no-moat and negative moat trend ratings for AmeriGas Partners after the partnership reported fiscal 2018 adjusted EBITDA of $605.5 million compared with $551.3 million in the same year-ago period. These results were in line with our estimates. Management initiated fiscal 2019 adjusted EBITDA guidance of $610 million-$650 million based on normal weather but excluding any planned acquisitions.

We recently reduced our fair value estimate by $5 per unit. We lowered our per-gallon gross profit expectations as we think it will be harder to maintain and increase margins in an industry with numerous headwinds. For these same reasons, we lowered our stage II expectations for return on invested capital and EBI growth. We think this is supported by a 19% increase in the average propane price during the year, increasing the incentive for customers to switch to cheaper natural gas where available.

Overall, temperatures in the year were 13% colder than normal, but retail volumes were up only 4%. Retail margins were approximately flat year over year. The company's smaller cylinder exchange and national account volumes continue to be a growth area for the company, increasing 4% and 11%, respectively, year to date. During the year, management acquired 3 million gallons, below our expectations, suggesting to us that the number of attractive acquisition candidates may be declining. We continue to incorporate minimal distribution growth in our outlook.

Management Meeting: Duke Energy's Atlantic Coast Pipeline Investor Focus a Key to Earnings Growth
by Andrew Bischof, CFA, CPA | Morningstar Research Services LLC | 11-12-18

We are reaffirming our $87 per share fair value estimate, narrow moat, and stable moat trend for Duke Energy after meeting with management at the Edison Electric Institute Financial Conference in San Francisco.

Management's recent announcement noting the increasing costs and delay at Atlantic Coast Pipeline remains a concern, as the investment is key to our five-year 5% earnings growth forecast. Costs for the Atlantic Coast Pipeline, or ACP, increased from $6.5 billion to $7.0 billion. Duke and majority partner Dominion will now pursue a phased-in service with the pipeline in full operation by mid-2020. We don't expect the delay to have a material impact on our fair value estimate as we had already assumed a ramp-up in capacity for the line, rather than full capacity in late 2019.

Duke noted it has gone back to its ACP partners for revenue increases for previous cost increases and has contract provisions in place ensuring utility-like returns. This provides us comfort that returns will remain within our expectations, supporting our growth forecast. Most major permits have been received, and construction is taking place in numerous regions. We also see significant long-term growth opportunities from a completed ACP, so near-term struggles such as working through numerous permits and legal challenges we think will payoff for investors long term.

Recently, Duke Energy Carolinas and Duke Energy Progress requested revenue increases of $168 million and $59 million, respectively, with allowed returns on equity of 10.5% and a 53% equity component. We expect a ruling in line with Duke Energy's recent rate case rulings in North Carolina, which allowed for a 9.9% allowed return on equity, slightly above the peer average. The recent rate case outcomes support our view that the Carolinas will continue to be an average regulatory jurisdiction providing support for the company's capital plan.

Oil Prices Reach Our Midcycle Forecast; Energy Valuations Looking More Attractive
by Dave Meats, CFA | Morningstar Research Services LLC | 11-13-18

WTI crude plunged 8% on Nov. 12, extending a rout that has wiped off 28% of the benchmark's value in about six weeks. Front-month futures ended the day at $55/bbl, aligning with our midcycle forecast for the first time since October 2017. The slump has weighed heavily on upstream equities, pushing the stocks of narrow-moat rated industry cost leaders like Diamondback Energy, Pioneer Natural Resources, and Continental Resources into 4-star territory. Among integrated firms, narrow-moat rated Royal Dutch Shell and Total are now considered undervalued as well.

The latest oil price declines came after OPEC (citing secondary sources) reported overall production growth of 127 mbbls/d in October. Saudi Arabia and the UAE further underscored their ability and willingness to ramp when necessary, collectively adding almost 270 mbbls/d in the period (after adding 147 mbbls/d in the prior month). That was more than enough to assuage market jitters related to Iran and Venezuela, which reported relatively modest losses of 156 mbbls/d and 40 mbbls/d, respectively. The full impact of U.S. sanctions is still unclear, as these did not take effect until November. But Iran has already lost 500 mbbls/d since the U.S. withdrawal from the nuclear pact was announced, and in the same period total production from OPEC has increased by 600 mbbls/d. Consequently, the supply shortage fears that drove up crude prices earlier this year now look overblown. In fact, key OPEC producers are now contemplating the need for further production cuts next year to avoid a glut forming instead.

We caution that further volatility is likely. OPEC's remaining spare capacity is unknown, and it's possible that steep declines are still on the way for Iran and Venezuela (not to mention Angola, Libya, and Nigeria). Likewise, on the demand side we note that the rebalancing of China's economy is widely expected to dent crude imports in the next few years, even though consumption and investment actually have comparable elasticities of demand. On the other hand, we question whether the market has fully incorporated the impact on demand of higher product prices, the strength of the U.S. dollar, or the downside risk associated with U.S.-China tariffs. The bottom line is that undersupply and oversupply are both plausible outcomes next year and making a directional bet on short-term crude prices is extraordinarily risky.

Instead, we focus on the midcycle price and activity level that keeps U.S. output growing in lockstep with the “call on the U.S.” For shale producers, collectively the global swing producer, the marginal cost is around $55/bbl. Though prices have now reached this level, the U.S. rig count still exceeds the “Goldilocks” level that balances the market in the next five years (by at least 150 rigs). Accordingly, we still see an upcycle playing out. Prices must fall further in the short run, or at least remain at the current level, to avoid excessive shale growth like what we saw in 2014. That limits our stock picks to the handful of undervalued producers listed above that can still thrive in a $55 environment.

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