Description

Investment Summary

Tidewater Midstream and Infrastructure Ltd (“TWM”) is a diversified midstream and infrastructure company traded on the TSX. 

For a small-cap Canadian energy company, it is quite a complex story, with three distinct assets, recent management turnover, and perceived funding issues related to capex projects. We will address each of these in turn and explain why there is an opportunity here. 

The shareholder base does seem ready for change – the founder and CEO recently resigned (likely with significant pressure from shareholders). The company has two large active shareholders, Birch Hill (Canadian private equity firm who owns 22%) and Kicking Horse Capital Inc. (run by several long-standing Canadian investment professionals who own 4%) who participated in a 2022 private placement, along with nomination agreements whereby Kicking Horse inserted one of their partners, Thomas P. Dea to the Board of Directors as Chairman.

As part of the Q4 2022 earnings, management stated that they are undertaking a strategic review of their entire asset base, and further elaborated on the Q1 2023 conference call that they are “deep” into the process and expect to announce results in the months to come. Our valuation analysis suggests that the company is severely undervalued, with the entire business trading as if it were a low-multiple refinery, and we believe that management is cognizant of this and will take the required steps to unlock value here. 

Business Segments

Asset #1: Downstream 

TWM owns the Prince George Refinery (“PGR”), which refines light crude into low sulfur diesel (45% of output), gasoline (40% of output) and liquefied petroleum gas and heavy fuel oil (15% of output). The asset has refining capacity of 12.0 Mbbl/d, storage of 1.0 Mbbl/d, and takes feedstock of 85% BC light oil and 15% Boundary Lake. 

TWM paid a headline multiple of 2.9x EV/2020E Adj. EBITDA of $75mm for this asset (purchased from Husky). While the consensus views refining assets as being highly volatile, it is important to recognize that refining is a very regional business and we think the PGR is quite unique and attractive for several reasons:

1. The PGR is one of only two refineries in the province of BC, which is structurally short refining capacity to the tune of approx. 150 Mbbl/d which is imported by tankers and trucks.  This shortfall is so acute that the province has actually held a public inquiry as to why refined gasoline and diesel prices are so high.

2. The Prince George market is very attractive from a demand perspective for diesel, due to several large-scale infrastructure projects underway (Enbridge Line 3 Replacement; Keystone XL Pipeline; TMX Expansion; Coastal GasLink). All of these projects are multi-year, multi-billion dollar projects and will provide continued strong demand for diesel for the foreseeable future.

3. PGR is a direct addition to TWM’s value chain, as TWM’s Pipestone Gas Plant provides ideal feedstock for PGR (15 mbbl/d of 45 degree API crude/condensate).

The above factors have resulted in refining margins in the province to be substantially higher than the rest of Canada, as demonstrated in the chart below:

Overall, we think TWM paid a very low-price for an asset in a structurally attractive region, and if this asset were to be sold again, it would fetch a significantly higher price than what TWM paid for it. 

Asset #2: Midstream

TWM owns several assets in this segment:

1. Pipestone – very well located gas gathering and processing plants in the prolific and liquids-rich Montney area: 

   1. Pipestone Phase 1: 110 MMcf/d sour, deep-cut Montney gas processing plant with 20,000 bbls/d of NGL processing capability (as of Q2 2023 the facility is fully contracted with an average contract life of 4.5 years on a take-or-pay basis). Pipestone gives customers access to both the Alliance and the NovaGas pipeline systems, as well as natural storage reservoirs used to mitigate the impact of AECO seasonality.
      
      

   2. Pipestone Phase 2: a development project to add near double capacity, adding 100 MMcf/d of sour natural gas processing. The current capex envelope is estimated at CAD$300mm, but has not passed FID yet.
      
      

2. Brazeau River Complex: a 225 MMf/d deep-cut gas processing facility located in the West Pembina region, with 10,000 bbls/d of liquid fractionation capability, along with 225km of gas gathering pipelines.

3. Ram River Gas Plant: a rail-connected 600 MMcf/d processing facility located in the Strachan region in west central Alberta.

Asset #3: Tidewater Renewables

TWM owns 68.85% of Tidewater Renewables Ltd (“LCFS”), a separate publicly traded company focused on the production of low carbon intensity fuels. The assets are co-located at TWM facilities, and consist of existing energy transition assets (hydrogen production, storage of renewable fuels) as well as capital projects to produce renewable diesel, hydrogen, and renewable natural gas.

HDRD 

The HDRD is LCFS’ flagship asset and received FID with construction commencement in Q3 2021. It utilizes renewable feedstocks (tallow, canola, soybean, UCO, DCO) to produce renewable diesel at the PGR site. Nameplate capacity is 3.0 Mbbl/d of renewable diesel, and 23.7 MT/d of hydrogen. This reflects supportive fundamentals with the local provincial government planning for 1.3 billion liters of renewable fuel production by 2030. 

With a revised capital cost of $342mm , it is anticipated that HDRD will generate annualized EBITDA of between $90-115mm, implying quite attractive economics. The project is essentially complete, with start-up anticipated next month (July 2023).

With Q4 2022 financial results announced in March of this year, the company disclosed that the HDRD project had a capex overrun, creating the perception of a $50mm funding gap. Opportunistic funds likely sold/shorted the stock in anticipation of a potential dilutive financing, resulting in a share price decline of over -20%. 

Why Is TWM So Cheap and How Is Value Unlocked?

We believe the stock trades where it does, is because of a number of investor misconceptions about the company, which we will address in turn:

1. Perceived “Funding Gap”: With the company’s Q4 2022 results announced in March 2023, LCFS disclosed that due to challenging labour markets, supply chain issues, metal shortages, and general cost inflation, the 3,000 bbl/d HDRD capital cost budget had increased to $342mm (from the original $225mm). This had created the perception of a funding gap, which drove TWM’s stock down significantly from $1.10/share to below $0.90/share.  Approximately a month later, TWM announced that they had the full support of their banks, who upsized the credit facilities by $50mm, which combined with $43mm of additional low carbon credits sold to the government, resulted in the funding gap being completely addressed.  As of now, the project is complete, the ‘funding gap’ is no longer an issue, and we anticipate start-up in the next month.
   
   

2. Investor fears over budget overruns on Pipestone 2:  There is also perhaps some investor concern about the Pipestone Phase 2 expansion project, but upon speaking with analysts our understanding is that this project is much simpler than the HDRD facility (essentially a replica of the existing Pipestone Phase 1 facility, which was completed on-time and on-budget). The gating item is the financing plan, which likely requires a partner.
   
   

3. No guidance provided: given that PGR had a large turnaround this year and the HDRD facility was not yet complete, management did not provide EBITDA guidance. We expect that with both of these issues resolved, management should be in a position to provide guidance with Q2 2023 results, which the market and sell-side analysts will be able to lean into what should be pretty attractive guidance figures to update their target prices.
   
   

4. Management team discount: TWM was previously run by President, CEO, and Chairman Joel MacLeod, our understanding was that he was not well liked by investors, who viewed him as being too ambitious, tackling too many projects at once, making too many acquisitions, and not having enough regard for balance sheet strength and stability (see above for funding gap on the HDRD project). In late November 2022, TWM announced that Joel MacLeod was stepping down from all his positions, with Robert Colcleugh appointed as interim CEO of both TWM and LCFS. Colcleugh was previously Chairman of Beyond Energy Services, and CEO/Director of Iron Bridge Resources, with a background in M&A prior to that. In addition, both Birch Hill Equity Partners and Kicking Horse Capital have nominees on the Board for adult supervision, including Kicking Horse’s nominee being Chairman.
   
   

5. Sum-of-the-parts discount: getting to the heart of the matter, we believe that TWM is too complex a story for a small-cap Canadian name, particularly with the combination of the Prince George Refinery (low multiple biz) being combined with what should be  high-multiple midstream infrastructure assets. This is further complicated by it being the majority owner of a separate publicly traded entity.

As such, we think that the only true reason why TWM trades at a significant discount is reason #4 above. Management appears to be acutely aware of this, and announced a strategic review the prior quarter.  In the most recent quarter, management stated that they are “pretty deep” in that process and expect an announcement of results in the coming months.

We note with interest that on June 29, 2023, the WSJ reported that Starboard had built a sizeable stake in Algonquin Power (AQN) and held talks with management about their belief that the core business was valued, and that investors were not giving the company credit for the value of its renewable energy operation – a story we feel is very similar to TWM.

Valuation

Looking at the cap table below, we can see that TWM trades at a headline 5.0x 2022 deconsolidated Adj. EBITDA (i.e. not including Tidewater Renewables’ EBITDA generation). As such, it is appropriate to remove the value of the LCFS shares held by TWM.

After removing the value of the LCFS shares, TWM is trading at just 3.9x 2022 deconsolidated Adjusted EBITDA. In other words, TWM’s midstream infrastructure assets are being valued as if the entire business was a low-multiple refinery.

Applying reasonable valuation multiples of 4-4.5x for PGR (analysts are using 4.3x to value Parkland’s refinery – the only other refinery in BC) and 8-9x for TWM’s midstream assets, we arrive at a target share price of $1.95-$2.31, implying a return of between 127% to 168% from current levels.

Catalyst

1. Successful start-up of the HDRD facility in the next four weeks.
   
   

2.  In the next couple of months, we expect TWM to announce the outcome of its previously announced strategic review, which could encompass one or both of: sale of Prince George Refinery and either a secondary or spin-out of Tidewater Renewables
   
   

3. Management providing the market with EBITDA guidance concurrent with Q2 2023 results.