Equitrans: MVP Woes Continue

Back in August, I wrote that the completion of the long-delayed Mountain Valley Pipeline (MVP) presented a significant opportunity for Equitrans (NYSE:ETRN), but there were still potential delay and cost overrun risks associated with the project. Earlier this week, the company pushed out the time line for the project and well as increased its projected costs. With a lot of news coming from ETRN ahead of its earnings report at the end of this month, let’s take a close look at the stock.

Company Profile

As a quick reminder, ETRN is a midstream company involved in the gathering and transport of natural gas. The company’s gathering segment accounts for over two-thirds of its operating revenue, and consists of three primary gathering systems operating in Appalachia. Its transmission segment, meanwhile, includes interstate natural gas pipelines and associated storage assets and accounts for approximately 30% of its operating revenue. The company also has a water segment, representing about 4% of its operating revenue, that consists of freshwater delivery pipelines and above ground storage.

MVP Updates

In my original article, I noted that the long-delayed and expensive Mountain Valley Pipeline coming online was the biggest opportunity for the firm. The project began construction in 2018, but has been hit by a number of protests and legal action that has kept it from being completed.

ETRN got some good news at the start of the month, when it reached an agreement with the Pipeline and Hazardous Materials Safety Administration on conducting safety inspections. In August, just prior to my original write-up, the PHMSA ordered the company to undergo a number of safety inspections on MVP. At the time, investors feared this could lead to costly fixes and potentially large fines.

Much of the agreement centers on engineering firm KTA-Tator inspecting, remediating, and testing the pipeline’s existing and future coatings. At the time, ETRN said the agreement was not expected to have a material impact on the total project cost or schedule.

Earlier this week, however, ETRN pushed back the timeline on MVP, as well as the costs. The company now expects the pipeline to be completed in Q1 of 2024 compared to its earlier projection for the project to be finished by year-end. It anticipates the pipeline to come online on or before April 1^st. Given that ETRN’s largest customer and former parent EQT (EQT) was projecting MVP to come online in mid-2024, it's not surprising the completion time was moved back from its end of 2023 guidance.

ETRN also announced that the cost of the project will now run $7.2 billion (including $120 million of contingency), up from its last projected estimate of $6.6 billion. As a reminder, MVP is part of a joint venture with several utility and power companies, including NextEra Energy (NEE), Consolidated Edison (ED), AltaGas (OTCPK:ATGFF, ALA:CA), and RGC Resources (RGCO).

ETRN has already spent $3.0 billion funding it part of the project, and that will go up to $3.7 billion following this latest budget overrun. It also said its equity interest in the project will increase from approximately 47.7% to about 48.8%. It noted it will spend $220 million in excess of its ownership interest on the pipeline.

Commenting on the cost overruns in a regulatory filing, the company said:

“Certain unforeseen factors have substantially affected the pace of construction and account for more than half of the increase in estimated project costs. The ramp up of MVP’s contractor workforce has been slower and more challenging than expected, due to multiple crews electing not to work on the project based on the history of court-related construction stops, and the inability to recruit crews with required and sufficient experience. Additionally, productivity and cost have been adversely affected in areas of challenging terrain and geology, in part because of the MVP Joint Venture’s commitment to, and application of, heightened environmental protocols. The MVP Joint Venture will continue to prioritize the safety of its workforce, communities, and assets, and the project’s compliance with applicable environmental standards and regulations. The remaining increase in total project cost is attributable to a number of other factors, including certain financial settlements with contractors, labor and fuel inflation, and enhanced safety and security measures. While the remaining construction is subject to certain factors, including, among others, the physical construction conditions, crew availability, and productivity during the winter season, the MVP Joint Venture has made meaningful forward construction progress and construction will continue into the winter months, with the goal of responsibly completing the remaining construction activity and realizing the benefits of the MVP project for a diverse mix of stakeholders as promptly as practicable.”

ETRN last projected that MVP would contribute about $220 million in EBITDA when complete. With the increased ownership stake, that can likely be pushed up to $225 million. However, that is a pretty terrible 6% a year return on its $3.7 billion investment, and after interest expenses, it’s pretty much 0%, with ETRN’s average cost of debt around 6%.

Notably, MVP was originally projected to cost about $3.7 billion to build, so the cost is nearly double. Last month, the company filed with FERC (the Federal Energy Regulatory Commission) to significantly raise the maximum tariffs on MVP, including increasing reservations fees by 80% from 97 cents/Dth to $1.76/DTH and interruptible fees from 53 cents/Dth to $1.78/Dth.

While this may get investors excited, it is important to distinguish between how interstate crude and natural gas contracts differ. Crude tariffs are often regulated by FERC, which will adjust rates based off things like inflation. However, natural gas contracts are generally negotiated contracts that tend to have small capped inflation escalators.

MVP’s 2 BCf/d capacity is fully contracted out under 20-year negotiated contracts, so even if approved, these tariff changes aren’t going to have much impact on MVP’s earnings power. The company could benefit by being able to get some higher fees from interruptible shippers when there is some excess capacity on its system. Generally pipelines can sometimes run over capacity, and early on, shippers might take a while ramping up their usage leaving some excess capacity. However, that is likely just some small upside, and current natural gas prices don’t really support these new maximum tariffs at the moment either.

So overall, while some investors may have saw the filing and gotten excited, it really doesn’t have much impact on MVP’s prospects.

Conclusion

The cost overruns for MVP are a negative, as the company will have to finance an additional $300 million in project costs with what could be high-cost debt that eats into the project’s return. Free cash flow this year was projected to run slightly negative before this update on MVP costs, as is. It will also reduce 2024 EBITDA by around $55 million as well. So overall a slight negative.

MVP is the big needle-mover for ETRN, as the company has seen EBITDA be pretty stagnant over the 2021-23 period at just over $1 billion, as its producer customers have not really been growing volumes. Thus the $225 million boost from MVP and $75 million from Hammerhead, plus some other incremental projects can go a long way to changing its growth profile.

Even assuming MVP and Hammerhead are fully operational at the start of the year (which they won’t be) and everything was going well, the company could theoretically generate $1.5 billion in run-rate EBITDA against $7 billion in debt (including cash outflows in 2H), and the stock would have about 4.7x leverage trading at 7.2x full rate EBITDA for MVP and Hammerhead.

There is a path to deleverage and get to an 9x multiple down the road, which is where a lot of midstream companies currently trade at, such as Buy-rated Antero Midstream (AM) and Buy-rated Williams Companies (WMB). But there are also a lot of good midstream companies trading around 8x EBITDA, such as Energy Transfer (ET), which is a stock I like and heavily own, and Buy-rated Western Midstream (WES) that are good values as well without some of the leverage issues as ETRN.

As such, while I think the recent sell-off makes the stock look more attractive, I still consider it a “Hold.” Risks also remain that MVP is further delayed or that there are more cost overruns, as the company doesn’t have the best track record predicting these two things. I think a fair valuation is currently around the current price until the company gets MVP online and shows that it can delever its balance sheet.