TWST: Let's start with an overview of your coverage universe.

Mr. Kirst: I cover the North American pipeline universe for BMO, which means I'm basically covering half of the traditional U.S. pipeline companies, the Williams (WMB) and El Pasos (EP) of the world, along with half of the Canadian infrastructure names, the two largest being TransCanada (TRP) and Enbridge (ENB), which are the two largest names in our space up until June, when Kinder Morgan (KMI) and El Paso come together. As well, a lot of the smaller, $2 billion, $3 billion, $4 billion market-cap infrastructure names that do a lot of the gathering, processing and natural gas liquids - the logistics in Canada - many of which were previously in a trust structure, which was analogous to an MLP until the Canadian government did away with the trust structure.

TWST: What's your overall outlook on your coverage space right now and why?

Mr. Kirst: Overall, as we entered 2012, in our year ahead outlook, we basically took what you might call a cautiously optimistic tone from a stock standpoint. And what I mean by that is that all of the things that allowed the group to work so well in 2011 would continue to do so in 2012. The ongoing expansion of shale supply is by no means stopping, the shift over to NGL-rich supply sources continues, so you wind up with everything from long-haul transportation needs for natural gas and liquids, but also the actual midstream infrastructure side. And now increasingly, as shale technologies are being applied to oil, we have oil transportation opportunities. So you combine that with the fact that we are still in a 2% Treasury curve, both in the U.S. and Canada, the demand for yield, especially for companies that have yield plus growth, makes for a compelling investment.

In contrast, when you look at a traditional utility, be it gas or electric, it tends to have a very low, secular type of growth rate associated with it. Because of the demand for infrastructure, a lot of our names have some fairly strong growth trajectories attached to that dividend, and so in this kind of market starved for yield, that's something that continues to really lead to positive funds flow into the group.

The reason why we have a cautious optimistic viewpoint, though, is that none of these trends are undiscovered or unknown. There is a reason why the average name in our 21 group universe was up about 35% last year. Our view is that the dynamics that propelled that last year will continue to propel this year, but make your expectations realistic. If we wind up getting 10% total returns for the group, inclusive of dividends, in a 2% yield market, that might actually be pretty good, right? Don't get used to what we saw last year. Certainly, there are opportunities within the group to make more than 10%, we think, but the general feeling that we've had with the group is that it's a place you want to be, but it's not an unknown place, and so we want to make sure we are keeping our expectations realistic.

TWST: You mentioned the ongoing expansion of the shale supply and NGL supply. Please talk about what the key trends are for the industry right now, such as particular locations that are especially productive.

Mr. Kirst: It's sort of a difficult question to answer, because when you think across North America, each region has its own supply/demand constraints. I think we are going to continue to see a need for new infrastructure in the Bakken. We are going to continue to see new infrastructure from the Permian, as well as between Mont Belvieu and Conway. A lot of this infrastructure has been proposed and is expected to come on line in the next two to three years, but these are still the areas that are getting a great deal of attention, as well as, of course, something that's been dominating our media headlines for the last year - getting Western Canadian crude oil down to the U.S., I mean TransCanada's Keystone XL and the political football that's become. But that's certainly not the only piece of infrastructure that is important to that dynamic. Whether it happens to be potential pipelines going to the West Coast, Enbridge's Northern Gateway, Kinder Morgan's Trans Mountain pipeline expansion - there are still more potential projects that could come.

In fact, I was talking with an account earlier who was suggesting that Energy Transfer (ETE) and the newly purchased Southern Union (SUG), which hasn't yet closed but is shortly expected to, could do something like basically shut down one of the pieces of its trunk line, convert it from natural gas to oil and basically make a Midwest oil pipeline down to the Gulf Coast. There are a lot of different things that are being thrown at the wall by the industry to see what's going to stick, but there is still a great deal of infrastructure that's going to continue to be required. This is probably a year stale now, but I know INGAA - that's the Interstate Natural Gas Association of America - commissioned a study that looked at gas pipelines, midstream and oil pipelines, the whole gamut, and it's coming to roughly $10 billion of annual industry spending for the next 25 years. Now, whether in a sub-$3 gas market we are really going to need all of that makes this something of a moving target. Certainly, we've seen dry gas activity begin to peel back, and that might impact some infrastructure. I can't reasonably sit here and tell you there is a need for a new natural gas pipeline anywhere in the country. I mean, basis is flat, which makes for probably the next three or four years, I think, a fairly dead driver for the industry, or at least a sleeping driver. I'm sure it will come back, especially with the need for future power generation. But right now, what's going to essentially be the bridge will be the oil infrastructure that's required, and most certainly the midstream and NGL infrastructure, which continues to be required, and you see everyone from the MLPs to the C-Corps participating in all of that. It is a highly competitive, robust market right now.

TWST: What are your top picks right now and why?

Mr. Kirst: There are three names that we still have as our top picks, recognizing that none of them are stocks that you are going to retire off of given the strong performance already achieved. One thing we've done this year is taken down our expectations for what really is the upside with some of these names.

That being said, Williams, for instance, the ability for them to show that they can deliver a 10% to 15% dividend growth rate over a multiyear period of time, I think it's going to prove to be a very good stock to own. We liked El Paso because it was a cheap way into Kinder Morgan. We thought Kinder Morgan was undervalued, so you wound up getting an arbitrage lift plus the upside of Kinder Morgan. Well, Kinder Morgan year to date is now up 16% and is at $37, so that one is beginning to be a little bit closer to fair value, perhaps. I would say there is still 10% to be made in the merger over a very quick three months, and so from that standpoint, time adjusted, it's still one that screens very well to us for what I think is very low risk. But you know, Williams and El Paso, when we are talking about upside, we are talking about 10% to 15% upside, we are not talking about the 40% to 50% upside we were talking about two years ago because the stocks were so disassociated from their sum-of-the-parts valuation.
Turning to Canada, risk/reward, we still very much like TransCanada, at least for those that have a one-year-plus time horizon. That's not to say that they have got the best benefit to the trends that are at hand. Quite frankly, I think you look at Enbridge, you look at ONEOK (OKE) - those are two names which have some phenomenal growth opportunities out there. We like TransCanada primarily from a risk/reward perspective. People basically are concerned that this very large and meaningful XL project is never going to get off the ground and it's never going to get approved. We very much believe that it is going to happen, so that's one of the reasons why we are still supporters of buying TransCanada stock, for basically an undervaluation element. But certainly, say for instance you were to give me a five-year kind of time horizon, with a name like Enbridge, a name like ONEOK, I think investors could continue to do exceedingly well.

TWST: What are your thoughts on the El Paso-Kinder Morgan merger? Is it a good deal? And does it change the industry landscape at all?

Mr. Kirst: It's certainly a deal that makes sense. It's why I have El Paso still rated "outperform." Does it change the industry? I'm not sure it changes the industry. It's not like the airline stocks, where there are so much economies of scale that when you have two companies come together, it forces the pairing up of dance partners elsewhere in the industry. There was a little bit of people immediately looking around and asking: Could Williams be next? Could Spectra (SE) be next? Is Enterprise (EPD) going to buy someone? It's not quite the same dynamics here, but I am one of the ones who do believe that footprint matters. The larger the footprint, the easier it is for you to find and leverage organic expansion opportunities, especially in different regions.

I don't cover Enterprise, but I think Enterprise has done a great job of, for instance, going into the Eagle Ford in South Texas, being able to provide a natural gas solution, a natural gas liquids solution and a crude oil solution to the producers. It has sort of one-stop shopping, and it has the asset size and the capabilities to pull all that off.

There has been undoubtedly, over the last 20 years of my career, a constant sizing up, excluding the period of time post-Enron, which had its own specific dynamics at work. But I do believe this is an industry that does lead to some economies of scale when it comes to footprint. I don't know if the El Paso-Kinder merger necessitates an answer by another party a la Enterprise or somebody else, but I do think that in the normal course of business over the next decade there will continue to be sizing up and consolidation.

TWST: You talked about what your top picks are. Are there any names you're especially bearish or cautious on?

Mr. Kirst: No. I mean, it's lucky and challenging. You always need to have stocks that you are somewhat bearish on to sort of counterweigh. But quite frankly, between the combination of a very low yield curve and a secular need for more infrastructure in our group across the board, there are a lot of opportunities that are clearly filtering down to pretty much everybody. So there's no one that, for instance, I look at and say, "Oh, here is a structural short, here is something that we wouldn't touch with a 10-foot pole." There isn't anything close to that.

I think the closest, which really has only to do with the timing of what you believe natural gas prices might do, might be someone like a National Fuel (NFG), which has great utility foundation but has a very large E&P operation and they are very long natural gas prices. If you believe that natural gas is going to remain sub-$3 for the next five years, this is probably not a stock that you want to be involved in. We certainly don't believe that. We think gas is going to get at least back up to $4. It may take a couple of years to do that, in which case, I think National Fuel has an extraordinarily bright future ahead of it. It's just a matter of timing. So there isn't anyone I would throw out to say we would either just avoid it, or here is a stock that is about to get cut in half sometime soon.

If there are two primary risks that we see, they are very macro driven for the whole of the group. One is most assuredly the concern whether or not next year - I certainly don't think it happens this year - in overhauling tax rules, MLP taxation is touched upon. One of the leading House Republicans, a Florida House Republican on the House Committee on Ways and Means, back in the first week of January made a comment in The Wall Street Journal on that, and I think caused a bit of a reverberation basically acknowledging that when we look at the tax code, everything is on the table, including the MLPs. Obviously, if something like that were to happen - and to be clear, I think the odds of that are very, very low, but they are not zero - that would have repercussions that would happen throughout the group. I think it's low-enough odds that I don't think it should keep people from these stocks. I personally own MLPs. But when we talk about big risks, that is something that we need to consider, and we just have to keep our eye on that ball over the next 12 months as it develops.

I think probably more practical and more realistic, as far as what a risk may be, is just very much the broad market, and what I would say is, ultimately, the return of the risk on trade. What was fundamentally clear over the last 12 months - and again, you can look at the stock performances - is that a dollar of yield was valued so much higher than a dollar of growth. We are in a 2% yield market. Unless you believe we are about to go into a global recession again, it is just a matter of time before yields eventually start creeping up. We just don't know what the time frame for that is. Is it 2013 or is it 2015?
During the last three months the amount of jobs created in the broad market was much higher than the three months preceding and the average for 2011, and it has largely been better than what conventional wisdom forecasts it to be. The point of that is that if we move forward 12 months in time and it just turns out that the market is actually recovering better than we all thought it was upon entering this year, that rotation from dividend yield to growth may start to happen, and clearly, that's going to be something that is going to be a headwind. Whether it's the MLP group or our group, the parent companies, it's definitely going to be something that's out there.

I do think that our names, the ones that have growth associated with their dividends, will fare better than perhaps the pure utilities, which tend to be stalwart, A-rated names but with fairly low growth on the dividend side. I think our names that show dividend growth will probably be better positioned, but make no mistake, it will still be a headwind, and the equities can still have downside exposure to them. Looking off into the future that is probably the single biggest concern that I have, just the timing of when does that happen, and that's partly why we entered 2012 saying we are cautiously optimistic, but keep your return expectations in check.

TWST: How should investors evaluate or compare the parent companies versus the MLPs? Are there certain pluses and minuses they should keep in mind?

Mr. Kirst: There are several things. The parent companies who are basically the general partners, obviously, they have advantages with respect to the incentive distribution rights, and usually what that means is that they simply have higher dividend growth expectations. It's a little bit of a different mindset that the people who are buying MLPs are typically buying yield, the ones who are buying the WMBs and KMIs of the world are buying growth. Not to mention the fact that there are a lot of institutions that can play the MLPs as a proxy through their parent companies, but they can't actually own directly the underlying MLP. Generally speaking, we've found - and it may just be a reflection of the current market dynamics - that right now the market seems to be being sorted out, not through its traditional EBITDA metrics, but quite frankly, by what's your dividend, what is the viewed risk of that dividend and what's the expected growth of that dividend. Those that have double-digit-plus growth expectations are trading in the 3% to 3.5% range; those that are high-single digits, they are 3.5% to 4.0%; and those that are low-single digits are 4% to 5%. You can pretty much see a transparent grouping that's happening here.

TWST: In terms of funding growth, it seems these companies have adequate access to the capital markets.

Mr. Kirst: Yes. Looking at some of the EBITDAs, again relative to historic metrics, it's a very strong market right now. Our stocks aren't cheap. That can be a benefit in the sense that you look at a name like Kinder Morgan-El Paso, they are likely going to have to sell some pipeline assets in the Rocky Mountains to satisfy FTC requirements. We are still waiting for that - and if they do, I suspect they'll be able to sell these assets in something like 60 or 90 days. It's just an extraordinarily strong market right now.

And that is one of the question marks too: As you marry cheap debt, plus low cost of equity, meaning high multiple stocks and access to capital being fairly strong, do you see more M&A in the space? That is clearly something that could happen. I tend to view it as less whole company - less Kinder buying El Paso, Energy Transfer buying Southern Union - and more project specific. I see it as here is a great opportunity for E&P companies across North America that are struggling with $2 and $3 gas prices to monetize some noncore assets, their midstream assets, at multiples that are still double digit.

I think by the same token, considering some of our Canadian names trade at 13 times EBITDA, but if you are the MLPs and you are trading at 11, 12 times EBITDA, you can basically - Williams Partners (WPZ) can use its paper to buy additional midstream assets, and quite frankly, it would be nicely accretive for both the MLP and the parent. So I think midstream divestitures from the upstream group to our sector is still very much a possibility, and I'm kind of surprised we haven't seen more of it yet. We saw a little bit of it last year, but we are already in March, and I thought we would have seen one or two already. People may be trying to figure out are gas prices going to get better first or are they going to stay down here in the dumps. Maybe it's just that the producers don't want to sell these assets until they are sure they have to, so to speak. But I still think that is a likely dynamic for this industry.

TWST: What would you advise investors to focus on most as we enter the next round of quarterly earnings and progress further into the year?

Mr. Kirst: From an industry standpoint, I think what has most people's attention, although it has fortunately fallen off a little bit, has been the concern of whether natural gas liquids prices would go the way of natural gas, meaning that we wind up getting an oversupply and getting a bubble of NGL such that liquids prices crash, and then that undercuts one of the big growth components of the industry. Fortunately, there have been many different dynamics going on. Certainly, NGL growth, and in particular ethane, has seen double-digit volume growth. I think volume growth was up 14% in 2011; it's very, very strong growth.

By the same token, we also had pet chem plants down for maintenance and some expansions. We had historically one of the warmest winters on record, and basically ethane was being displaced with propane, and so all of a sudden you had a free fall in ethane prices, leading basically to a panic, "the sky is falling." Fortunately, we have actually seen a bounce from the lows of mid-February, and I think that's given everyone a sense of relief to at least sort of catch their breath for a second. But near term, as you are talking about the next quarter and earnings, I'd say that's one of the things that people are trying to get a better sense of - OK, ethane prices have taken a bounce, is that what is affectionately referred to as a dead-cat bounce, or is it going to go right back down, or are we actually going to see some strengthening from here?

My own view is that ethane is going to remain choppy, but we are more constructive and bullish on ethane prices than I think the conventional wisdom is - at least over the near term. It's very much a timing issue. I think as we get strengthening back into the second quarter, into the summer, we will at that point see it roll and start sliding right back down, and probably slide for the next two years, because there is unarguably an increasing supply wave that has to be met. And it is being met with some of the incremental expansion of the petrochemical facilities, but the really big expansions - which will come - are several years away.

Every one of our companies, whether it's ONEOK or Williams or Enterprise Products, recognizes that from time to time you could have supply/demand disconnects and have ethane prices go south on you. But different companies have different views for 2013, 2014, 2015. Enterprise is fairly constructive that, for the most part, supply and demand will remain balanced. Williams, for instance, is a lot more concerned about 2013 and 2014. It is something that we'll have to watch, and I would say that's one of the things that, when you talk about the next quarter, people are definitely focused on as far as near-term dynamics. That impacts a lot of the midstream MLPs, as well as, of course, the parent companies.

TWST: Thank you. (MN)

Note: Opinions and recommendations are as of 03/09/12.

Carl Kirst

Senior Research Analyst & Managing Director

BMO Capital Markets Corp.

100 King St. W.

1 First Canadian Place
Toronto, ON M5X 1H3