Targa Resources: Large Growth Potential With High Capex Spending

Thesis

Targa Resources (NYSE:TRGP) is a midstream company that focuses its operations on a vertically integrated value chain for natural gas and natural gas liquids out of the Permian Basin. The wellhead to the water strategy gives a one-stop shop from the Permian Basin to international export markets.

Over the last two years, TRGP has deployed an impressive amount of capital to expand its natural gas processing and NGL fractionation capabilities out of the Permian Basin. The company has a full set of processing plants, fractionators and long-haul pipelines entering service between now and 2026 to drive future growth for the company.

For those who follow the midstream sector, this business model is akin to that employed by Enterprise Products (EPD), one of the premier names in the midstream space. However, due to its smaller size, I expect the growth rate of Targa Resources to far exceed that of EPD.

TRGP is ideal for investors that covet share appreciation more than income. The company has a moderate yield of 2.3% and deploys its excess free cash flow to investors in the form of share buybacks.

I project over 35% share price appreciation through 2026 with a price target of $180/share.

Company Profile

TRGP derives over 80% of its natural gas and NGL volumes out of the Permian Basin, with the balance coming from the Barnette and Anadarko basins. The company operates through the full-value chain of natural gas gathering, processing to extract NGLs out of the product stream, and fractionation for separation into butane, ethane, propane, etc. The process culminates at the company’s liquid propane gas (LPG) export terminals for exportation to Asia.

Growth Trajectory

TRGP has been busy since the end of the Pandemic, completing several M&A transactions as well as organically building out its integrated system with eight Permian processing plants and two fractionators. This build out has grown CAPEX spending from $500 million in 2021 to an estimated $2.7 billion through the completion of 2024. The company expects 2024 to be the peak year in CAPEX spending, after which it projects pulling internal growth investments back to $1.7 billion annually.

The company believes this moderated level of CAPEX spending is sufficient to finish its current slate of projects out through 2026. TRGP expects to bring online six new natural gas processing plants, three fractionators, a long haul NGL pipeline, as well as expanding the capacity of the company’s LPG export terminal, Galena Park over the next two and half years.

EBITDA Growth By The Numbers

While I was doing my research on TRGP, the similarities between the TRGP and EPD systems really stuck out to me. In fact, the slate of projects under construction is also very comparable between the two companies. Similar to TRGP, EPD has multiple processing plants, fractionators and an NGL pipeline under construction. However, one very important factor separates what these projects mean to investors over the long term. EBITDA.

EPD is on track to generate approximately $9.6 billion in adjusted EBITDA during 2024. Conversely, TRGP’s updated guidance for the year projects EBITDA to hit $4.0 billion. In this case, EPD’s sheer size hinders its growth rate, as the same project slate doesn’t move the need as aggressively as it does for TRGP.

In a previous analysis, I projected that EPD would be able to maintain between 5% and 6% growth rates through 2028. However, based on its smaller size, TRGP can easily double this growth rate.

During the Q2 conference call, Matt Meloy (Targa’s CEO), gave EBITDA guidance for the current projects under construction.

Manav Gupta – UBS Analyst

How has that guidance changed as some of the new projects are coming in? And how should we think about these incremental growth projects delivering EBITDA of over 2025 and 2026?

Matt Meloy – TRGP Chief Executive Officer

Sure, yes. Yes, we indicated kind of our investment multiple going forward about 5.5 times, call it, five to six times EBITDA. And I think you’ve seen our track record over the last several years. EBITDA multiple has even been perhaps a little bit stronger than that. We’re investing in the same kind of projects that have delivered return — strong returns for us over the last several years. It’s investing in our gathering and processing business and then expanding our downstream NGL infrastructure to accommodate those volumes.

So we’re really sticking to our core business. We expect the returns to be very good. That 5.5 is kind of what we indicated would be a pretty good base case, what we think we can do. I hope we can beat that. But if we do 5.5, it will be a really good return profile for us.

With over $6 billion worth of growth CAPEX to be invested between now and 2026, TRGP can achieve an impressive growth rate. At the midpoint, these investments can grow EBITDA to $5.1 billion. This implies over 25% growth by year-end 2026 and a 13% CAGR. Additionally, this assumes no additional earnings growth from rate increases for the company’s existing assets or commodity sensitivity, providing some margin to these estimates.

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Investing For Defense

While long haul natural gas take-away is not a core business for Targa, the company has invested in the next large-scale natural gas pipeline in the Permian. TRGP announced it will be a 17.5% minority owner in the Blackcomb pipeline. While the company’s $200 million investment in the project will not be a needle mover, it helps sustain production growth in the Permian.

Permian activity is centered around the price of oil. Earnings attributed to natural gas are negligible in the big picture for producers. However, if gas take away is not managed properly, it can constrain oil production. Therefore, by helping to ensure the project gets completed, it is helping to ensure activity in the Permian continues without interruption. This helps derisk the company’s operations, while also achieving a return on its investment.

Valuation Analysis

Currently, TRGP trades at a slightly higher EV to EBITDA multiple than EPD for a very comparable set of assets and business model. Despite the premium paid on today’s EBITDA, I believe investors will find this minor premium to be very lucrative in the long run. Assuming both company’s experience no multiple expansion, an investment in TRGP would significantly outperform EPD from a share price performance standpoint.

The compounding effect of the higher EBITDA growth rate can lead to significant price returns, as demonstrated by the simplified diagram below. Based on the current slate of projects, 25% annual EBITDA growth appears to be easily within reach by year-end 2026 (Year 2 in image below). In contrast, EPD would only experience approximately 13% EBITDA growth over the same time period. Therefore, investors should expect significantly improved price performance out of TRGP.

The forward EV to EBITDA multiple for TRGP yields 10.4x based on current year-end projections. Assuming TRGP’s EBITDA grows to $5.1 billion as projected above, the implied share price would $178/share. This implies over 35% appreciation in share price. Any share repurchases executed during that time would provide additional upside.

Balance Sheet Discussion

The growth rate exhibited by TRGP is a powerful investment thesis. However, there is no such thing as a free lunch. To achieve this growth rate, TRGP has been spending at a rate higher than operational cash flows, resulting in debt accumulation. Conversely, EPD transitioned to a self-funded CAPEX model several years ago and thus its debt levels are much more stable.

I expect the current trend in debt levels for TRGP to stabilize as future CAPEX spending is currently budgeted to be within cash flows. As shown below, with 6 projects completing in 2024, 2025 looks very promising from a cash balance perspective. Next year opens the possibility of achieving a neutral cash balance after CAPEX, dividends, and buybacks.

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*Cash available for share buybacks would be reduced by any potential dividend increase.

Note: Data sourced from Q-2 10-Q report.

Beyond 2025, the remaining project completions provide incremental free cash flow to be supportive of debt retirement and shareholder returns in the form of dividend increases and share buybacks.

Risks

The growth trajectory I have outlined here implies the successful completion of over $6 billion worth of capital growth projects that are in various phases of completion. There are any number of regulatory or physical challenges that could delay and/or drive up the capital costs of these projects. This would reduce the overall return prospects for the company.

Additionally, while the Daytona NGL pipeline will be entering service in the coming weeks, EPD’s Bahia NGL pipeline is projected to enter service in the 1st half of 2025. East Daley Analytics projects this could impact margins on NGL pipelines due to decreased overall utilization in the region. The Daytona pipeline may prove to be difficult to meet management’s expectation for an EBITDA multiple of 5.5x until excess capacity is consumed.

Investor Key Takeaways

1. Targa Resources is a high-growth midstream play that assets provide an integrated system to deliver NGLs from the wellhead to export terminals.
2. The company is very comparable to Enterprise Products in many ways. With a similarly sized project backlog, the smaller size of TRGP will allow the company to realize a larger growth rate.
3. 2025 and 2026 CAPEX guidance is expected to reduce by approximately $1 billion from 2024 levels. This will allow the company to spend within free cash flow and halt the company’s debt accumulation trend.
4. The higher growth rate combined with moderate levels of share repurchases will drive significant share price appreciation compared to that of EPD. Therefore, an investor looking for capital appreciation versus yield would be ideal.
5. I rate TRGP as a buy with an initial price target of $180/share.

Editor’s Note: This article was submitted as part of Seeking Alpha’s Best Growth Idea investment competition, which runs through August 9. With cash prizes, this competition — open to all analysts — is one you don’t want to miss. If you are interested in becoming an analyst and taking part in the competition, click here to find out more and submit your article today!