KNTK - Kinetik Holdings: GCX Sale A Key Trigger In 2023

2023-06-14 04:51:12 ET

Summary

• Kinetik is a pure-play midstream firm in the Permian Basin.
• Its balance sheet is in mediocre shape, and when combined with a capex backlog, some are concerned.
• Selling its non-operated stake in Gulf Coast Express raises money at a great price to rotate into higher return projects.

Kinetik Holdings (KNTK), as a pure play in the Permian, faces pressure from various fronts, including concerns regarding the involvement of APA Group, Blackstone, and iSquared, as well as the growing spending outlook. Despite being a smaller player in a highly desirable market, Kinetik is undertaking significant expansions and connectivity projects, which require substantial capital. The company's history of leverage issues, including off-balance-sheet concerns, adds complexity to its financial situation. However, the potential returns on investment in the Permian justify the expansion efforts. In my view, while the market's support for growth capital is expected to return eventually, a sale of Gulf Coast Express will come to fruition in the coming quarters, offsetting all of the growth capital set to be spent this year.

Capital Spend Outlook

Kinetik has gotten pressure from two fronts realistically on the bearish side. Obviously, the overhang of APA Group, Blackstone, and iSquared has some investors on edge - even with the strong governance profile and Up-C structure. The other factor is, of course, the growth spending outlook.

As a pure play in the Permian, Kinetik is still a smaller player in a market that everyone wants to play in. In addition to the usual well connect and compression costs that it has to undertake to support its customers, it also is building out key expansions (into New Mexico and the Delaware side of the Permian) and adding intra-basin connectivity (Delaware Link). On the large long-haul pipeline front, Kinetik is also on the hook for its share of the Permian Highway compression expansion and likely upcoming buildout of Shin Oak by Enterprise late in 2024. This all takes a lot of capital, especially for a firm that was a merger between two companies that had well-known leverage problems, some of which still remain off-balance sheet (EPIC Crude).

Honestly, I think the market has to come back around to supporting growth capital eventually. 5.5 - 6.5x implied EBITDA returns justify expansion all day, every day. The return on investment is just too strong, but many fear a cascade of overbuilt pipes causing re-contracting issues if production tanks are in shale. We've already seen what happens to rates when pipelines were built ahead of growth that never came in Texas: long-haul Permian crude pipelines are still years away from earning a fair return on walk-up shippers.

Gulf Coast Express Sale

Kinetik has publicly stated that they are looking to sell its non-operated stake in Gulf Coast Express. Recall that Targa Resources (TRGP) sold its own minority interest in this pipeline in early 2022 for a near 11.0x 2023 EBITDA multiple. Obviously, the market has changed some in the time since. Interest rates are up, and thus institutional money is likely looking for slightly better returns on investment in passive investments like these. That is likely the buyer here - not another publicly-traded (or even private) midstream entity.

In my conversations with Kinetik, a workup on the pipeline has been circulated to more than four dozen buyers; many of them have indicated interest. While the bidding pool will get whittled down, I do think Kinetik gets a buyer here. Permian to Gulf Coast natural gas pipelines have attracted significant interest due to the nature of the contracts and the perceived longevity of this route due to the LNG demand-pull.

I see Kinetik raising about $550mm in proceeds or around 10.5x 2023 EBITDA on the stake. While this is only mildly down from the 2022 multiple, I think the overall long-term sentiment on global LNG demand is better now than it was in late 2021 when Targa Resources was shopping its stake. This cash infusion would cover the entire 2023 expansion budget in both the Midstream Logistics and Pipeline Transportation segments, meaning Kinetik would essentially rotate capital from a built pipeline at 10.5x EBITDA into projects that will earn 6.0x EBITDA once completed.

While the long-term tail of income from Gulf Coast Express is likely larger, the net present value is higher on these growth projects in my opinion. The Gulf Coast Express stake also yields little benefit to Kinetik from a marketing/customer perspective, and shedding the stake does allow them to avoid a capital call for more compression when a Gulf Coast Express expansion does likely receive enough committed shipper interest.

Takeaways

Growth capital is an impediment for many at Kinetik. Borrowing costs are not dirt cheap anymore and management unfortunately missed an easy refinancing window. While they got rid of the toxic preferreds from Altus Midstream, it came at a cost. Ideally, the entirety of the $2.0B unsecured term loan would have instead been rolled onto senior unsecured notes but that market was shut to them by the time balance sheet work was truly underway at the combined organization.

In my view, the sale of Gulf Coast Express is a great trigger. This will be extremely EBITDA accretive (lowering debt to EBITDA) and while some might frown on overall asset quality, I still think credit rating agencies would step away from the capital rotation feeling like it was a net positive. While concerns about what the long-term goals of major owners exactly is will remain an overhang, I view Kinetik's market moves as extremely positive. The asset base is wonderful and getting better day by day. For those that are bullish on the Permian, the value proposition today is just extremely hard to ignore.

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