ETRN - Hess Midstream: Attractive Dividend Growth Backed By Stable Earnings

Summary

• Hess Midstream has delivered robust results for Q42022 and the full year of 2022. The company has provided strong guidance for 2023.
• The stock offers an attractive dividend yield that is backed by stable cash flows.
• The company’s leverage metrics are better than its peers.

Investment rationale

Hess Midstream (HESM) has delivered robust results for Q4 2022 and the full year 2022 with an increased dividend. Higher demand in 2022 led to better revenues and profits for the company. The company's capital allocation framework aids its impressive expansion plans leading to higher gas capture which is one of its important growth drivers. HESM stock is trading around 17% lower than its 52-week high price of $35.71. The company's strong fundamentals and the stock's lower valuation add to its attractiveness and make it a suitable investment candidate for long-term investment.

Resilient operational performance

Hess Midstream Corporation showed a resilient performance in Q4 despite its production numbers being hurt due to severe winter conditions.

Net Income attributable to Hess Midstream rose around 28% on a YoY basis in Q4 2022. The company was able to maintain healthy net income as well as operating margins through all the quarters of 2022. The average net income margin is 6.57% whereas the operating margin is 62.06%. The EPS slightly dipped from $0.51 to $0.49 as a result of an increase in Class A shares on its secondary equity offering announced in March 2022. The distribution coverage ratio of 1.5x was in line with the ratio planned for 2022.

In the past three years, the company's revenue rose by an average of 15% whereas the average net income growth is 36%. The net income margins as well as operating margins are on an upward trend, showing healthy operational performance on an annual basis.

Higher dividend payments

The EPS number for Hess Midstream has increased over the past three years from $1.31 to $2.01. In Q4 2022, the company declared a quarterly dividend of $0.5696 per Class A share. The dividend grew 1.2% and is in line with the company's target of 5% growth per Class A share. On an annual basis, in the past five years, the dividend, as well as EPS, has been continuously rising.

Healthy capex framework

The total capital expenditure rose from $54.4 million in Q4 2021 to $62.4 million in Q4 2022, around a 15% rise. The majority of the capex was on the expansion of gas compression capacity. The company expanded its gas compression capacity by more than 25% in 2022. The company's 2023 capital program expects total expenditure to be $225 million with a focus on expansion capital. In 2023, the company expects to generate adjusted free cash flows of $625 million and distribution coverage between 1.4x to 1.5x. Hess Midstream's disciplined capital allocation should help it in generating attractive distributable and free cash flows.

Focus on higher financial flexibility

In Q42022, Hess Midstream's net cash provided by operating activities was $222.6 million whereas its adjusted free cash flow was $144 million. The company aims to attain financial flexibility of more than $1 billion by 2025 through the expected growth in adjusted EBITDA, generating higher cash, and meeting the expected leverage capacity of 2.5x by 2025.

The cash flows for Hess Midstream are based on 100% fee-based contracts and have no direct commodity price exposure which makes them comparatively more stable. Besides, the MVCs (Minimum Value Commitments) provide downside protection. Overall, the cash generation outlook for Hess Midstream looks strong.

On the liabilities side, Hess Midstream's debt was approximately $2.9 billion, with a Debt to EBITDA ratio of around 3x. The company had a balance of $18 million on its revolving credit facility at the end of 2022. The company aims an adjusted EBITDA growth of 10%, in excess of the targeted 5% distribution, through 2024 and 2025. It aims at a gross adjusted EBITDA margin of around 75% in 2023. The EBITDA growth will be aided by more than 85% revenue protection from the Minimum Value Commitments that the company has for 2023 to 2025.

The current debt to EBITDA ratio is comparatively lower than its peer companies giving a favorable edge to Hess Midstream over its peers. The peer companies in the below graph include Antero Midstream ( AM ), Enbridge ( ENB ), Enterprise Products ( EPD ), Equitrans Midstream ( ETRN ), Kinder Morgan ( KMI ), Magellan Midstream Partners ( MMP ), ONEOK Inc. ( OKE ), Pembina ( PBA ), Targa Resources Corp. ( TRGP ), Western Midstream ( WES ), and Williams Companies Inc. ( WMB ).

Optimistic 2023 guidance

The 2022 numbers reported by Hess Midstream were quite close to the 2022 guidance announced earlier. The slight downward deviation from the guidance numbers was due to the impact of severe winter in Q4. The company has shown a resilient performance through 2022 and has declared buoyant guidance and targets for 2023 as seen in the below image.

The production graph for Bakken has been strong historically due to effective long-term commercial contracts which help to stabilize cash flows. The company plans to bring 110 new wells online in 2023. The company's significant presence in the Bakken region as well as its impressive inventory of high drilling locations boosts its production outlook for Bakken.

Attractive valuation of HESM stock

HESM stock appears to be attractively valued based on forward EV to EBITDA and price to free cash flow ratio when compared to the stocks of its peer companies namely New Fortress Energy ( NFE ), EnLink Midstream ( ENLC ), DCP Midstream ( DCP ), and Antero Midstream Corp.

The dividend yield offered by HESM stock is also reasonably higher when compared to stocks of peer companies.

Conclusion

Except for a slightly weak performance in Q4 2022 due to the winter storm, Hess Midstream's operational performance has been stout in 2022. The company already has a significant footprint in the Bakken and further expansions for gas captures will aid the company's future growth. The capex plans and stable capital framework underpin the expected EBITDA numbers which will eventually lead to better financial flexibility. The company's planned MVCs and positive financial guidance for 2023 give a healthy outlook regarding the company's future performance. HESM's stock appears to be a compelling investment opportunity owing to the company's resilient operational performance, healthy financial base, and attractive stock valuation.

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