2023-11-22 09:52:30 ET
Summary
- Antero Midstream is expected to experience significant free cash flow growth due to the completion of infrastructure and the ability to fill up capacity.
- Antero Resources is focused on acquiring suboptimal holdings to add to its current acreage. The growth is therefore slow as the company has reached the mature stage.
- Antero Midstream's concentration on the rich gas part of operations allows for faster growth compared to Antero Resources.
- The debt ratio is very low for a midstream company.
- The dividend yield is historically high and reflects little to no growth expectations.
For years, Antero Midstream (AM) was a rapidly growing midstream operator with one main customer (who was also growing rapidly) with a big capital budget for the size of the operation. Now that the main infrastructure has been built out, all this company needs to do is fill up the capacity. Some minor capital requirements (compared to what came before) is all that is left. Most midstream companies have a lot of operating leverage because it is easy to build more than needed capacity and fill it up later. That continues to be the case here. Therefore, there is a lot more free cash flow growth ahead.
It goes without saying that if Antero Resources (AR) were to make a large acquisition, that free cash flow growth scenario would likely change. But right now, the chances of that appear to be remote. Antero Resources has, instead, largely been pursuing the acquisition of suboptimal holdings that it can profitably add to the current acreage. Antero Resources also has a joint venture that is also serviced by Antero Midstream. So far, it looks like slow growth from the whole organizational operation with an occasional opportunistic acquisition by the midstream company that would likely speed free cash flow growth.
New Guidance
Generally, the guidance has been adjusted upward all year. Management appears to be likewise optimistic about the next fiscal year.
Free cash flow is a recent addition to the many features of this investment idea. It will be growing rapidly (after dividends) on a percentage basis due to the recent change from negative to positive.
Mr. Market is all about free cash flow regardless of the future consequences (until you get to the future). Here that free cash flow comes with one of the lowest debt ratios in the midstream business. Therefore, any dividend decisions are likely made with the idea of keeping the balance sheet very strong to keep flexible options available.
Strong Finances
Back in fiscal year 2022, management had the opportunity to acquire some capacity that became available. The strong balance sheet enabled the company to complete that acquisition using all debt. Integrating that capacity and optimizing operations allowed the debt ratio to decline significantly this fiscal year even with that additional debt from the acquisition.
Management has long had a goal of a debt ratio of 3.0 before the dividend increases. Currently that debt ratio is 3.4. it is not that far to get to a debt ratio of 3.0 because it was not that long ago when the debt ratio was 3.6 (roughly). So, there is material progress in the right direction.
Growth Rate
Antero Midstream does not service all of Antero Resources operations. Instead, the midstream is concentrated on the rich gas part of the operations. This part can grow faster than the overall company for the foreseeable future. That means that Antero Midstream can grow faster than Antero Resources (especially if an opportunistic acquisition happens in the future).
Antero Resources is one of very few Marcellus operators that can get the production out of the oversupplied Marcellus basin to more profitable markets. That is because of how Antero Midstream was constructed. Many other operators are now playing "catch-up" as a result to achieve better pricing for their production.
The Future
There is a good chance that Antero Midstream can grow faster than Antero Resources for some time into the future. The reason is that there is quite a bit of the Antero Resource operations that the midstream company does not service but potentially could.
There is also a chance that as the Marcellus acreage matures, the midstream operation could at some point diversify away from Antero Resources to the point where Antero Resources would remain a major customer but there would be other major customers. This could particularly happen if Antero Resources were acquired in the future but the midstream operation was not.
Because the midstream is growing faster than its major customer, there is very good chance that double digit growth will continue well into the future. An opportunistic future acquisition could temporarily accelerate that growth.
The dividend is dependent upon capital needs. Right now, those capital needs are small. However, captive midstream companies like Antero Midstream are managed very conservatively with balance sheet strength the major concern. Therefore, investors that need income to live off of would probably need to look elsewhere as this management will switch the dividend to other uses should other priorities determine that is the best way to go.
Still the dividend will likely remain a better part of the total return of the company that will include growth of the business as well. The combined return should be a compound long-term return in the teens from both growth and the dividend distribution.
Should management cut the dividend at any time, that would likely mean the money is redirected towards future growth. Therefore, the total return is likely to remain in the same range. The composition of that return would change through a reduction in the distribution accompanied by an acceleration in growth.
The superior return on capital is likely to remain as long as the two companies can coordinate activities. This is something that needs to be constantly monitored as any change in this could affect return on investment.
The stock itself remains a strong buy on the idea that continued growth should result in a long-term combined return in the teens. How much of that is dividend and how much is growth could vary over the long-term. Right now, the dividend yield along is as much as many investors report for a long-term average return. Yet midstream companies are known as the utilities of the oil and gas industry because they have far less risk than many upstream companies.
The stock price has had a good year. It would not be unreasonable to wait for a pullback to purchase some stock as this issue has been largely trading in a range for some time. The stock is at a yearly high price right now. The attitude towards the stock in this volatile low visibility industry could easily change tomorrow.
The debt ratio here is comparable with some of the best midstream companies that I follow because of the conservative management of a typical captive midstream company (which has only one customer). The continuation of the relationship with Antero Resources can be a risk in the future if Antero Resources is acquired but Antero Midstream is not. Right now, the whole immediate scenario for the next five years looks very positive. But this is a very low visibility industry with a lot of volatility.
Midstream company stocks are known for following upstream stock patterns throughout the business cycle even though most midstream companies have "take or pay" contracts that limit downside of earnings. However, right now the whole industry is historically cheap. That should change as the very challenging 2015-2020 period fades into the past.
For further details see:
Antero Midstream: Free Cash Flow Growth On Steroids