Pipeline Integrity Improvements And Rising Oil Supply Will Drive Stronger Long Term Cash Flows

Catalysts

About South Bow

South Bow operates strategically positioned crude oil and natural gas pipeline infrastructure serving key North American supply basins and demand centers.

What are the underlying business or industry changes driving this perspective?

• Successful execution and on time, on budget delivery of the Blackrod connection, with commissioning underway and cash flows expected to ramp in the second half of 2026, should provide visible, contracted revenue growth and support higher normalized EBITDA.
• System wide integrity enhancements, including extensive in line inspections, digs and advanced inspection technology, are expected to support the phased lifting of Keystone pressure restrictions, enabling higher throughput and greater access to uncommitted volumes that can expand revenue and earnings in a stronger differential environment.
• Rising Canadian oil supply and improving cross border energy policy dialogue between Canada and the United States point to tightening egress over time, positioning South Bow’s pre invested corridors and existing footprint to capture incremental spot and walk up volumes that can meaningfully increase marketing revenues and boost margins.
• Transitioning off legacy transition service agreements and optimizing internal processes such as procurement and supply chain are expected to lower the structural cost base, improving competitiveness on tolls while allowing a portion of the savings to accrue directly to EBITDA and net margins.
• Disciplined capital allocation, including sustainable dividends, tax optimization that enhances free cash flow capacity in 2025 and 2026, and a targeted program of roughly $100 million of annual growth capital, creates room to sanction additional organic and potentially inorganic projects that can drive multi year EBITDA and distributable cash flow growth.

Assumptions

This narrative explores a more optimistic perspective on South Bow compared to the consensus, based on a Fair Value that aligns with the bullish cohort of analysts. How have these above catalysts been quantified?

• The bullish analysts are assuming South Bow's revenue will grow by 3.6% annually over the next 3 years.
• The bullish analysts assume that profit margins will increase from 16.8% today to 23.1% in 3 years time.
• The bullish analysts expect earnings to reach $505.8 million (and earnings per share of $2.37) by about December 2028, up from $332.0 million today. However, there is some disagreement amongst the analysts with the more bearish ones expecting earnings as low as $439.6 million.
• In order for the above numbers to justify the price target of the more bullish analyst cohort, the company would need to trade at a PE ratio of 16.2x on those 2028 earnings, down from 17.4x today. This future PE is greater than the current PE for the CA Oil and Gas industry at 15.3x.
• The bullish analysts expect the number of shares outstanding to grow by 0.1% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 6.77%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• Prolonged or more stringent Keystone pressure restrictions, or delays in PHMSA approving South Bow's remedial work plan, could limit access to uncommitted volumes for longer than anticipated. This could constrain throughput-driven revenue growth and reduce the upside to normalized EBITDA and earnings from marketing and spot volumes.
• Sustained tight crude price differentials and slower-than-expected normalization of Alberta inventories and egress constraints could materially reduce the profitability of marketing activities and spot volumes. This could cap expansion in marketing revenues and compress net margins and distributable cash flow beyond 2026.
• Regulatory or policy shifts in Canada or the United States that slow or complicate approvals for leveraging pre-invested corridors and new organic or inorganic projects could restrict the growth pipeline. This could lead to lower-than-targeted annual growth capital deployment and undermine the 2% to 3% normalized EBITDA CAGR and long-term earnings growth.
• Tax legislation changes in the United States or the exhaustion of accelerated tax pools after 2026 could reverse the current tax optimization benefits, raising the effective cash tax rate and reducing distributable cash flow and net earnings relative to current guidance.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bullish price target for South Bow is CA$44.52, which represents up to two standard deviations above the consensus price target of CA$38.09. This valuation is based on what can be assumed as the expectations of South Bow's future earnings growth, profit margins and other risk factors from analysts on the bullish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of CA$44.52, and the most bearish reporting a price target of just CA$23.3.
  
• In order for you to agree with the more bullish analyst cohort, you'd need to believe that by 2028, revenues will be $2.2 billion, earnings will come to $505.8 million, and it would be trading on a PE ratio of 16.2x, assuming you use a discount rate of 6.8%.
  
• Given the current share price of CA$38.42, the analyst price target of CA$44.52 is 13.7% higher.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.