SMLP - Summit Midstream Partners Is Playing With Fire

Summary

• Summit Midstream Partners, LP has made an opportunistic acquisition at an expensive cost. There's no guarantee it pays off.
• The company has a strong history of paying down debt, which makes us optimistic about the management team's strength and ability to execute.
• The company needs to focus on aggressively paying down debt and improving its overall balance sheet to drive future returns.
• We remain cautiously optimistic about Summit Midstream Partners' ability to drive future shareholder returns.

Summit Midstream Partners, LP ( SMLP ) is a $170 million company that has remained incredibly volatile. The company's market capitalization is dwarfed by its debt load, leading to this volatility. As we'll see throughout this article, the company is taking some risks, however, it has the ability to generate substantial long-term rewards.

Summit Midstream Partners Bolt-On Purchases

Summit Midstream Partners recently made a risky call with some bolt-on purchases .

The company recently made the acquisitions of Sterling DJ and Outrigger DJ for $305 million total. That's almost double the company's market capitalization for perspective. The two assets have 10-11 year weighted average terms, with low-cost assets and near-term connectivity, and the expected cash flow should be significant.

The company also has $85 million in senior secured second lien notes due 2026, along with $115 million in cash raised from prior divestments. The company expects YE 2023 leverage at ~4.25x, normally a respectable number, although the company does need to pay down debt substantially. The company expects projected EBITDA of $75 million in 2023E.

The company expects $75 million in EBITDA for 2023 with primarily fixed-fee contracts across a number of leading customers. The company's capital expenditures are $12.5 million, which are incredibly minimal and include roughly $7.5 million in growth capital which will help support future growth and earnings.

The company is expecting the assets to rapidly ramp up well connections. 2023E well connections are expected to hit 75, or roughly 50% growth from 2021. It's worth noting that the company is susceptible to market crashes shown from the weakness several years ago. The company also expects volumes to continue ramping up, hitting new highs.

That volume growth should help cash flow to continue growing. The acquisition is risky, but it has the potential for substantial returns.

Summit Midstream Partners Overview

Summit Midstream Partners continues to have a strong and distributed asset portfolio.

The company has diversified and distributed assets with a number of major key customers. The company's average contract life ranges from 6 years to more than a decade with volume throughput remaining strong. The company's EBITDA continues to remain incredibly strong and capex remains minimal, which we expect to continue.

The story with Summit Midstream Partners is underutilization of its assets and the company's ability to solve that. The company's utilization is currently 41%, and across some of the company's highest spare capacity segments, such as the Northeast, the company has minimal incremental cost to bring additional wells online.

The company relies on continued market growth here, which requires demand and prices to remain higher for longer. Here natural gas is a more promising field than crude oil. Demand can be expected to remain stronger for longer, it's especially supported by growing LNG demand. Still this is something investors will need to pay close attention to see long-term returns.

Summit Midstream Partners Forecast

The company's forecast is focused on continued de-levering of its balance sheet .

The company has $1.034 billion in debt net of cash. It's worth noting that this will expand past $1.3 billion from the company's acquisitions, which have yet to close. This is partially with cash but also partially with new debt that the company is issuing. It's worth noting that the majority of cash for this acquisition is coming from the company's revolving credit facility.

The company's interest payments are an issue. The company's pro forma annual interest obligations will be more than $100 million annualized. That's half the company's market capitalization and a substantial part of its $300 million EBITDA. It affects the company's ability to provide free cash flow ("FCF") substantially, which affects future returns.

The company expects $125+ million in 2023 free cash flow that's slightly gas oriented. The company's $75 million in new EBITDA will have around 1/3 of that EBITDA go towards interest for the acquisition. But the potential is there. The company's FCF on its market capitalization is 65%, but the FCF on its enterprise value is single digits.

The company's target is a 3.5x leverage ratio in 2024, which implies $200+ million in debt paydown plus potential EBITDA expansion. The company expects it can move $100 million of debt to Double E as well, and potentially hand that out as a dividend to itself. Overall, the company's projects are solid but fraught with risk.

Our View

The company is in a risky position.

Its future is based on the ability to pay down debt. At the same time, Summit Midstream Partners, LP already has a substantial asset portfolio, which means that increasing utilization is cheap, but the company can't really afford to lose utilization. The company has $125 million in annualized FCF that we expect to continue remaining strong or growing.

Summit Midstream Partners, LP needs to aggressively repurchase debt, save interest, and take the saved interest to repay debt. It needs to do that rapidly to position itself as well as possible by 2025-2026. That's when the company needs to roll over its debt regardless of both the market and the prevailing interest rates and how they define growth.

Summit Midstream Partners, LP management has shown a commitment to doing this and we believe it can do so. We'd like to see the company hold off on new acquisitions, regardless of how opportunistic, until it can get its debt under control. We expect additional rewards could be driven by share buybacks in the meantime. However, management's strong history makes us opportunistic for the future.

Thesis Risk

Unfortunately, Summit Midstream Partners is mainly a sit and wait game. Investors hate that. That means that we expect the stock to underperform until it substantially improves its balance sheet, which could take several years. While we expect the rewards to be outsized, this time delay, and the cost of failed execution, could hurt the company substantially.

Conclusion

Summit Midstream Partners, LP's management team has shown a continued ability to perform. It rolled over a massive debt load and used the drop in value of debt to opportunistically repurchase its debt at lower levels. Despite massive interest obligations, the company expects to generate well over $100 million in 2023 FCF that can go towards paying down debt.

Summit Midstream Partners, LP recently made an opportunistic acquisition that we feel was risky given the financial position. At the end of the day, it depends on the market strength, and whether Summit Midstream Partners, LP can utilize its FCF to continue to pay down the debt. We expect the prices to remain higher, but it's worth paying close attention to.

Let us know your thoughts in the comments below.

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