2023-09-06 11:20:13 ET
Summary
- The Williams Companies, Inc. is a reliable midstream player in the energy sector, offering stable income opportunities.
- The company benefits from the increasing need for energy infrastructure and the transition towards cleaner energy sources.
- Despite a 12% rally, the stock still has upside potential and remains a promising investment option for income-oriented investors.
Introduction
Over the past few weeks, we've discussed a wide range of income opportunities in the energy space. This includes upstream giants like Cenovus Energy ( CVE ) or Devon Energy ( DVN ). What sets these companies apart is their ability to shower investors with cash when oil prices are elevated.
While that perfectly fits my thesis, it's not something all investors are looking for. Some want income that doesn't rely on the price of crude oil futures - and that's perfectly fine.
In this case, the midstream industry has got your back!
While upstream is dependent on the price of commodities they pump out of the ground, midstream companies rely on transported volumes, as they essentially own toll roads for commodities - to put it bluntly.
Eland Cables
This lets investors benefit from increasing North American energy production and (export) demand without exposing them to wild price fluctuations.
It also limits the upside potential a bit in a strong energy bull case, but that's part of the deal.
One of my favorites in this industry is The Williams Companies, Inc. ( WMB ) , a company I started to cover in June.
Back then, I wrote an article titled " A 6% Yield You Can Count On - Williams Companies ." Well, that 6% yield has now turned into a 5.2% yield, as WMB shares have appreciated 12.7% over the past three months.
Hence, I'm now going to re-assess the situation, as a 5% yield may not be enough for some.
Before we continue, please be aware that WMB is a C-Corp. Unlike many midstream companies that identify as Master Limited Partnerships that issue K-1 forms, WMB is a normal C-Corp.
This may have benefits or disadvantages depending on your own preferences and/or tax situation. So, please keep that in mind when making investment decisions in the midstream space.
Now, let's get to it!
A Reliable Midstream Player
With a $42 billion market cap, The Williams Companies is a dedicated energy firm committed to leading the way in providing essential infrastructure for the safe and reliable delivery of natural gas products, driving the transition towards a cleaner energy economy.
In this case, I'm paraphrasing its 10-K .
Essentially, the company is connecting energy producers to customers, benefitting from the increasing need for energy infrastructure and the energy transition that benefits cleaner energy sources - this also includes natural gas.
During its 2Q23 earnings call , the company made clear that its long-term strategy revolves around the crucial role of U.S. natural gas infrastructure in meeting current and future energy demands.
It stressed that natural gas is an essential partner in the growth of renewables and electrification. Despite the expansion of solar and wind capacity, the country experienced record natural gas power demand in July, reflecting its reliability in meeting summer power loads.
To meet the country's growing power demand, which includes data centers and electric vehicles, and to accelerate wind and solar power generation, increasing natural gas infrastructure capacity is imperative.
Adding to that, the Biden administration's support for the completion of the Mountain Valley Pipeline underscores the importance of natural gas infrastructure.
That said, Williams' operations span 14 key supply areas, delivering natural gas gathering, processing, and transmission services, as well as NGLs (Natural Gas Liquids) fractionation, transportation, storage services, and marketing solutions to over 700 customers.
With an extensive network of over 33,000 miles of pipelines in 25 states, 29 natural gas processing facilities, 7 NGL fractionation facilities, 24 million barrels of NGL storage capacity, and 290.4 Bcf of natural gas storage capacity, the company is one of America's largest midstream giants.
Thanks to its midstream business, the company's financials are not very volatile. It makes money when customers use its pipelines and has both fee-based and noncash commodity-based contracts in its gathering business, where it uses hedges to offset certain commodity pricing risks.
It also helps that 80% of its customers are investment-grade companies, lowering the risks that its customers run into trouble when economic conditions show a meaningful deterioration.
68% of its customers are utilities/power customers, which adds to its low-risk profile.
The chart below shows the company's steadily rising capacity and adjusted EBITDA compared to the volatile price of gas and crude oil.
It also helps that the company has a very healthy balance sheet .
As of June 30, the company has a 3.65x leverage ratio, a 4.8% weighted average (fixed rate!) yield on its debt, and a weighted average maturity for its debt of 11.2 years.
This year, the company has just $600 million in maturities. It has a BBB credit rating, which I expect to be boosted to BBB+ over the next two years.
As a result, we shouldn't expect another dividend cut.
Since the challenging environment of 2015/2016, WMB has consistently raised its dividend.
Over the past five years, the average annual dividend growth rate was 6.4%.
Earlier this year, the company hiked its dividend by 5.3%.
On an AFFO (adjusted funds from operations) basis, the company has a 2.23x coverage ratio, which is up from 2.19x in 2Q22.
WMB's dividend is its second-highest priority after protecting its balance sheet.
The current yield is 5.2%, which may be a drawdown, as some high-quality stocks in the industry have higher yields.
For example, Energy Transfer ( ET ) is yielding more than 9%. This is an MLP. Enbridge ( ENB ), the Canadian C-Corp midstream giant, is yielding more than 7%.
Even some beaten-down utility giants are now yielding close to 5% in this environment. I'm not making the case that WMB's yield is too low, but I would understand it if people were to avoid WMB to buy higher-yielding alternatives.
Having that said, it helps that the company is doing a tremendous job capitalizing on ongoing energy trends.
WMB's Business Is Roaring
WMB is doing well. Very well.
In the second quarter, adjusted EBITDA showed a strong quarterly increase of 8%, maintaining an 8.6% compound annual growth rate over the last five years. On a side note, please note that the overview below also shows the dividend coverage ratio I just discussed.
This impressive performance was achieved despite a 61% decrease in natural gas prices in the first half of 2023 compared to the prior year.
Gathering volumes reached a new record, increasing by 6%, contributing to a year-to-date adjusted EBITDA growth of 13%.
Furthermore, adjusted EPS increased by 5% for the quarter, with a year-to-date growth of 23%.
During its earnings call, the company highlighted that the MountainWest acquisition led to binding precedent agreements for a significant expansion on the Overthrust Pipeline, surpassing original expectations, particularly due to coal-to-natural gas conversions in the western states.
The Transco segment also continues to thrive, driven by increasing demand and environmentally conscious projects. A non-binding open season highlighted strong customer demand, reinforcing Williams' reputation for reliable capacity delivery.
Furthermore, projects like the aforementioned Mountain Valley Pipeline and Regional Energy Access are expected to fuel future growth.
The Gulf of Mexico segment anticipates significant growth in deepwater operations and Transco expansions.
Going forward, Williams expects shareholders to benefit further from its substantial growth backlog. This includes seven out of nine major pipeline projects scheduled for the fourth quarter of 2024, building on a solid foundation of a sustainable-based business.
This also includes the massive bull case from rising LNG exports.
Despite the strong start to 2023, the company did not raise its full-year guidance, which remains in the range of $6.4 billion to $6.8 billion for consolidated adjusted EBITDA.
During its earnings call, the company emphasized that the guidance already includes a range of $200 million above the midpoint.
Factors influencing this decision include the possibility of hurricane outages in the third quarter affecting deepwater operations and the potential for further downward shifts in natural gas prices that could unfavorably impact upstream joint ventures.
While these scenarios are not deemed highly likely, the company wants to remain prepared.
Nevertheless, the company expressed confidence in its base infrastructure businesses' continued performance, aiming for growth in 2024 and significant growth in 2025.
In other words, if natural gas prices stabilize and we get a muted hurricane season, we could see better-than-expected results in the second half of this year.
Valuation
WMB is up more than 12% since my prior article. Back then, I wrote that the company was 15% to 20% below its fair value. The company is expected to gradually increase free cash flow to $3.2 billion in 2025, which would imply a 12x free cash flow multiple.
Historically speaking, WMB used to trade close to 14x EBITDA.
This gives the stock roughly 17% upside to its fair value. However, in this case, I'm incorporating growth over the next two years.
The current consensus price target is $37.60, which is 9% above the current price.
I will maintain a Buy rating based on its valuation and growth opportunities.
However, after its 12% rally, it's not a no-brainer anymore. A 5%ish yield isn't something to get very excited about in this industry, and other pipeline owners also have similar growth opportunities.
If the opportunity were to present itself, I would recommend waiting for a correction before buying WMB.
It would make the risk/reward a bit juicier.
Takeaway
The Williams Companies stands as a reliable player in the midstream energy sector, offering investors a stable income opportunity.
With a robust infrastructure network and a focus on natural gas, the company is well-positioned to benefit from the growing demand for cleaner energy sources.
WMB's financial stability, low-risk customer base, and consistent dividend growth make it an appealing choice for income-oriented investors.
While its current 5.2% yield may not be the highest in the industry, WMB's strong performance and growth prospects justify consideration.
However, given its recent rally, waiting for a potential correction could enhance the risk-reward balance.
With a fair value estimate suggesting around 17% upside, The Williams Companies, Inc. remains a promising investment option for those seeking a dependable income stream in the dynamic energy sector.
For further details see:
Buying Income: What To Make Of Williams Companies' 5% Dividend