KNTK - Kinetik Holdings: Stock Should Be Rangebound Until Catalysts Take Effect

2023-03-22 04:55:44 ET

Summary

• Major projects are on track to be fully operational by November 2023, but the Gulf Coast Express expansion may not happen soon.
• Kinetik Holdings recently added a project to increase its natural gas gathering presence in New Mexico.
• The possible sale of KNTK's stake in GCX could be an immediate catalyst for the stock.

Thesis

Having looked over the 4Q22 results for Kinetik Holdings ( KNTK ), I feel it is best to maintain a hold rating. To put things in perspective, 2023 is anticipated to be a transition year due to the initiation of significant new contracts, the completion of significant new projects, and high CAPEX. In 2024, I anticipate all of these factors to combine to pave the way for a potentially more optimistic outlook, with commodity sensitivity decreasing, capital expenditures beginning to decline, and FCF beginning to strengthen. In my opinion, KNTK will not surprise anyone with its performance until the macro environment stabilizes. However, if KNTK is able to shift investors' focus to FY24 by providing more insights into FY24 outlook, I believe there could be positive catalysts for the stock price. The potential sale of their stake in GCX, CAPEX visibility, and further details around their new region expansion are the most important things I think investors want to know more about right now. Thus, I do not foresee any significant upside to the stock at the present time until we see a probable case for any of these catalyst to take effect.

4Q22 overview

There were no surprises in KNTK's financial performance in the last quarter of the year. The $133 million of adjusted EBITDA reported by midstream logistics was just below my estimates. The decrease in gas processing volumes (1,260 mmcf/d) was the primary factor in the underperformance. As for Pipeline, EBITDA was $79 million.

Projects on track

It looks like both the Permian Highway (PHP) and the Delaware Link will be fully operational by November of 2023. However, during the call, management expressed less optimism about a GCX expansion in the near future. As a result, investors will need to modify their forecasts in the near future to account for the fact that they must now exclude all relation assumptions. However, KNTK has recently included a new project in its collection which aims to enhance its natural gas collection operations in Lea County, New Mexico. The project is supported by MVC contracts that have been fully guaranteed by a large-cap producer counterparty. It is expected that the project will be finished by the first quarter of 2024. That's a big impetus, and it's what I was hoping would lead to expansion of capacity and new connections with other producers in the Northern Delaware area. Most importantly, this new project exemplifies KNTK's strategy to date to capture market share in the Permian by capitalizing on its open processing capacity and downstream connectivity.

Guidance

The $800 million to $860 million that management projected for 2023 adjusted EBITDA was 5% lower than the consensus estimate. Compared to my own projections, management appears to be assuming much lower commodity prices. This suggests that there is some form of caution on the part of management. KNTK maintains its forecast that gas processing capacity will reach 1.5 bcf/d by the end of 2023, up 20% vs last year. With all the new contracts being signed, I shouldn't be surprised. Even though escalators should mitigate some of the effects of inflation, I anticipate that growth will be partially offset by rising operating costs and inflationary cost pressures. Regarding commodities, KNTK has shifted its focus from Waha gas to ethane in the short term, which is expected to reduce its exposure. I expect the sensitivity to decrease once PHP becomes operational. In terms of hedging, the company intends to gradually expand its hedging program in a more systematic manner in the future.

Expect CAPEX to stay elevated

In 2023, KNTK anticipates spending between $490 and 540 million on CAPEX with Midstream segment responsible for $235 to 265 million of that total. As for the remainder, it will be used to fund the Transportation segment as Delaware Link and PHP will be received in 2023. In particular, I want point readers attention to the fact that neither the GCX nor the Shin Oak NGL expansions are included in this year's CAPEX guidance, nor is KNTK's initial 2024 capex guide of less than $150 million. In the distant future, however, I anticipate KNTK will invest in both the Shin Oak expansion and a new processing expansion.

Like I said before, there is a lot of uncertainty surrounding the CAPEX cadence beyond FY23. Therefore, the consensus (and myself) are very conservative in our estimates, limiting the upside for the stock in the near term, because it is difficult to model the outer years.

GCX sale

The possible sale of KNTK's 16% share in the GCX joint venture is an immediate catalyst. About a year ago, Targa Resources ( TRGP ) sold a quarter of its stake in GCX to an undisclosed financial buyer for $857 million (around 10-11x multiple). KNTK's stake could be worth more than $500 million if these factors hold true. In terms of KNTK's current market cap, this $500 million would be worth about 11%. However, I have no opinion on whether or not this agreement will be finalized.

Conclusion

In conclusion, I recommend to maintain a hold rating. While 2023 is expected to be a transition year, 2024 could be more optimistic with a decrease in commodity sensitivity, declining capital expenditures, and strengthened free cash flow. However, until the macro environment stabilizes, KNTK is unlikely to surprise anyone with its performance. My opinion is that for KNTK stock to move upwards in the near-term, investors need more insights into the FY24 outlook, including details about the potential sale of their stake in Gulf Coast Express, CAPEX visibility, and new region expansion. The possible sale of KNTK's 16% share in the GCX joint venture is an immediate catalyst, but I have no opinion on whether or not this agreement will be finalized. Overall, KNTK's performance is unlikely to see significant upside until there is a probable case for any catalysts to take effect.

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