2023-12-24 10:53:00 ET
Summary
- Antero Midstream is a high-yielding stock with a 7% yield and a total return of over 26% since May.
- The company operates in the energy infrastructure sector and benefits from long-term, fixed-fee contracts.
- Antero Midstream has the potential for dividend growth in 2024 and is undervalued, with a fair long-term value close to $20.
Introduction
On December 15, I wrote an article titled " Betting Big: Fed Mayhem And My Personal Picks For 2024. " As the title suggests, in that article, I discussed the recent decision of the Fed to hint at a more dovish approach in 2024 and what I'm looking to buy in the new year.
Although I'm not a traditional "value" investor, I'm increasingly focusing on undervalued value opportunities in light of the current stock market valuation, which makes it likely that future total returns could be subdued.
This shifts the focus to dividends, as we can expect that dividends will be a bigger part of the future total return.
As we can see below, after the Great Financial Recession, cheap rates and low valuations provided investors with elevated capital gains, causing dividends to take a backseat.
Given my view that inflation and rates will remain elevated on a prolonged basis (with ups and downs - I'm taking average rates and inflation), I believe that emphasizing high-quality income is a great strategy going forward.
Having said that, as most of my readers may know, I'm a very picky investor, especially when it comes to stocks with high yields.
I believe that it is very easy to buy investments with a high probability of long-term underperformance when searching for juicy income.
So many companies with elevated yields have very slow growth (like tobacco stocks) or severe cyclical risks (like banks and BDCs).
I also make the case that younger investors should prioritize growth over income.
However, as one of the "younger" investors below 30, I still want some higher-yielding stocks for the aforementioned reasons (valuation and the expected total return mix).
That's where Antero Midstream ( AM ) comes in, a stock I briefly mentioned in my 2024 outlook article.
On May 30, I started covering this stock. Back then, it had a 9% yield. Now, it still has a juicy yield of 7% and a total return of more than 26% since May!
In this article, I will explain why I believe that this stock is one of the best income stocks on the market.
So, let's get to it!
Buying Energy Infrastructure
Antero Midstream is a midstream company, which means it owns assets that transport energy.
Essentially, midstream companies connect upstream companies (drillers) to downstream companies (refiners) and their customers.
However, unlike most stocks in this segment, AM is NOT a Master Limited Partnership, which means it is taxed just like a regular C-Corp.
This is a major benefit for me, as I'm a European investor, which makes buying MLPs quite tricky.
In the case of Antero Midstream, the company operates and develops assets in the Appalachian Basin, serving Antero Resources ( AR ), one of America's largest natural gas producers with a deep inventory of more than 20 years and very low breakeven prices, allowing it to produce natural gas at subdued prices.
The company's portfolio includes gathering systems, compression facilities, water handling, and blending facilities, along with interests in processing and fractionation plants.
Acquisitions in recent years include Marcellus gas gathering and compression assets from Crestwood and Utica compression assets from EnLink.
These strategic additions enhance the company's capacity and support Antero Resources' production and completion activities.
As of December 31, 2022, the gathering and processing systems cover 390 miles of low-pressure pipelines, 230 miles of high-pressure pipelines, and 4.6 Bcf/d of compression capacity.
On top of the massive resources of its largest customer and shareholder, the company operates under long-term, fixed-fee contracts, minimizing direct exposure to commodity price risk.
Contracts for gathering and compression services extend through 2038 and water services through 2035.
Needless to say, I expect new contracts after that, as it makes no sense for Antero to use other midstream operators.
It also means that Antero Midstream has some of the lowest competition risks in the industry.
Furthermore, Antero Midstream benefits from Antero Resources' major footprint in the liquid natural gas industry. 75% of its natural gas is sold out of the basin to the LNG Fairway, making AR a backbone of North American LNG supply.
Also, roughly half of Antero's volumes are liquids, which come with higher margins than natural gas.
While Antero Midstream benefits from these developments through stability, it does not benefit from potentially higher natural gas prices. If you want to bet on that, investors should opt for upstream producers like Antero Resources and its peers.
Antero Midstream benefits from a number of things:
- Its capital requirements are falling due to a more mature asset base. This frees up cash for debt reduction and dividend growth.
- While potentially elevated natural gas prices may not have a major impact on its income, it does secure product flows.
- I believe that the aforementioned valuation developments could cause a rush toward higher-yielding stocks - especially if the Fed is forced to cut rates, increasing inflation risks again.
- Antero Resources is growing its output, which increases volumes for Antero Midstream.
Essentially, AM's consistent growth is underscored by double-digit year-over-year throughput growth, with gathering volumes surpassing 3 Bcf a day and representing 3% of the total natural gas production in the United States (that's how big AR is).
The company's scale and operations have significantly expanded since 2021.
Hence, the organic growth strategy, coupled with the replenishment of the multi-decade inventory, positions AM for continued expansion and success in the midstream sector.
What To Make Of Antero Midstream's Dividend?
Antero Midstream's dividend has risen sharply between 2017 and 2020. In 2021, it cut its dividend due to very low natural gas prices and elevated debt levels. It had to protect its balance sheet.
Since then, the dividend has remained unchanged.
The good news is that the period of elevated debt and dividend-cut risks is behind us.
To give you an example, Antero Midstream experienced significant financial success during 3Q23, generating a record $251 million in EBITDA, reflecting a 12% year-over-year increase.
The company achieved $138 million in free cash flow before dividends and $30 million after dividends, contributing to a reduction in leverage from 3.7x to 3.4x (EBITDA). The company has no debt maturities until 2026.
Even better, the company marked its fifth consecutive quarter of generating positive free cash flow after dividends.
Year-to-date, Antero Midstream surpassed its original free cash flow full-year guidance midpoint of $105 million, reaching $107 million in just three quarters.
This success was attributed to outperformance in the base business, synergies from acquisitions, and capital budget optimization.
Looking ahead to 2024, Antero Midstream anticipates a further increase in free cash flow after dividends.
This strategic positioning aims to achieve a 3x leverage target and enhance the return of capital to shareholders, which is very important to keep in mind.
Once the company has achieved its 3x leverage target, higher dividends will be unlocked, which could be very good news for investors.
Why?
Because the company is in a great position to boost its dividend.
Since 3Q22, the company has been generating positive free cash flow without a single quarter of negative free cash flow.
Next year, free cash flow is expected to rise to $660 million (from $570 million in 2023E). In the year after that, free cash flow is expected to reach $700 million.
As the company has a $6 billion market cap, these numbers imply a 2024 free cash flow yield of 11% and a 2025 free cash flow yield of 11.7%.
This means two things:
- The current 7.1% dividend yield is protected by a lot of free cash flow, which means there's enough room for debt reduction to start hiking the dividend in 2024. In other words, it's a high-yield stock with significant dividend growth opportunities. That is very rare.
- Due to these elevated free cash flow expectations, the company has a clear path to a double-digit yield, which also bodes well for its valuation.
An Attractive Valuation
On top of having an attractive yield, I believe that AM is significantly undervalued.
Using the data in the overview below:
- The company is trading at a blended P/OCF (operating cash flow) multiple of 8.0x.
- Historically, the company has traded at a normal multiple of 11.1x OCF.
- This year, OCF is expected to rise by 9%, followed by 12% growth in 2024 and 2% growth in 2025.
- A (gradual) return to its fair valuation by incorporation of its OCF growth rates would indicate a fair value of $20 per share. That's roughly 60% above its current price.
With that said, the current consensus price target is $13.20, which is 5% above the current price.
While I am not making the case that AM will rise by 60% within the next two years, I am saying that AM is attractively valued, which should help the stock outperform its peers and the market.
Although I haven't figured out exactly how I'm going to incorporate AM into my portfolio (in light of existing energy and high-yield positions), I will more than likely be a buyer next year for my own portfolio and family portfolios.
Takeaway
Supported by Antero Resources, AM benefits from stable, long-term contracts, insulating it from commodity price risks.
Its strategic expansions, coupled with a robust financial performance, signal a return to dividend growth in 2024.
With a current 7.1% yield and promising free cash flow projections, AM presents a rare combination of high yield and growth prospects.
For further details see:
Dividend Investors Take Note! 7%-Yielding Antero Midstream Is One Of My Favorites For 2024