2023-11-01 08:34:21 ET
Summary
- The Williams Companies, Inc. is a promising investment option, with a dividend yield of over 5% and a management focus on returning large amounts of free cash flow to shareholders.
- WMB has a strong track record of generating free cash flow and growing its dividend, indicating the potential for a strong return on investment.
- WMB operates in a market environment with high demand for natural gas, and projections suggest that demand will continue to increase, making it a lucrative investment opportunity.
Investing in gas is still very much possible and one of the better options right now is The Williams Companies, Inc. (WMB) a massive enterprise valued at over $42 billion. In most recent news the company managed to win a lawsuit of $495 million about a failed Energy Transfer deal. This is a short-term victory for the company, but in the long term, the company looks appealing as an investment. As a dividend income opportunity it yields over 5% right now and with a clear priority from the management team to return large amounts of FCF to shareholders I see this leading to a potential market-beating annual return buying at these prices. WMB trades under its historical p/e and in line with its EV/EBITDA which is putting WMB up as an appealing addition right now. It's not impossible that WMB can reach an FCF of $3.2 billion by 2025 if natural gas prices continue to improve the way they have been. At that point WMB should be fairly trading at a p/fcf of 14x it puts a price target of $36 by 2025. The short-term upside is therefore roughly 5% but when accounting for a 5% dividend we land at an annual return of 7.9% which is a rate I am happy to buy into.
Since 2018 WMB has managed to generate $8.4 billion in FCF with $1.5 billion spent on buying back shares and yielding investors a very strong return. It has also meant that the dividend has been growing at a CAGR of 6% over the last 5 years. During this period the EBITDA has grown very well too, exhibiting an 11.67% annual YoY growth rate since 2018. I mention these numbers to paint the picture that WMB still has a lot of potential to yield a strong ROI and has the track record to prove its expansions in both the top and bottom lines.
A Market Environment Briefing
WMB proudly maintains a broad operational footprint, spanning 14 strategically important supply areas. In these regions, the company excels at offering a comprehensive array of services, encompassing the gathering, processing, and transmission of natural gas. Williams also stands as a key player in the Natural Gas Liquids market, providing services such as fractionation, transportation, storage, and cutting-edge marketing solutions to address the diverse requirements of its extensive clientele, which comprises over 700 valued customers.
The company has made it clear that it places importance on the pivotal role played by U.S. natural gas infrastructure in addressing both present and future energy requirements. This focus on natural gas infrastructure is not just a short-term goal; rather, it represents a comprehensive, forward-thinking strategy that anticipates the ever-evolving landscape of energy needs and underscores the company's commitment to sustainability, reliability, and long-term growth. So far it has played out very well for the business seeing as the assets have exhibited a 6.69% annual growth rate since a decade ago.
The midstream sector presents a lucrative opportunity for investors in search of stable income, thanks to its track record of reliable performance. Midstream companies play a pivotal role in the efficient transportation of essential resources from one location to another, and they earn revenue by charging fees for these services. The cornerstone of the business model in the midstream sector often revolves around fee-based structures, underpinned by take-or-pay contracts that ensure a minimum level of revenue, irrespective of market fluctuations. With that said, the outlook for the industry continues to look very solid as most anticipate that natural gas will still be in high demand even as more and more investments are pouring into renewable and green energy.
I think another bullish tailwind for the company is the fact that even if projections anticipate stronger natural gas demand, these projections seem to have historically been quite short of the actual demand. Since 2014 for example the estimated forecasts of gas demand have been around 3 Bcf/d lower than the actual results. This isn't to say it will continue this way, but I do think it speaks to the resilient demand.
One of the key drivers behind increased natural demand is the increased necessity of higher electricity being generated. Natural gas in the US is by a large portion going towards generating electricity. As more and more homes are being built in the country more and more are being connected to the grid and that places higher demand. Of all the natural gas in the US, roughly 38% is going towards generating power. Natural gas is a proven and reliable way of generating power and I don't think the shift towards renewables is going to be fast enough that it will put gas companies out of business in the next decade, nor the coming 3 - 4 decades either. In 2022 around 13.8% of the US energy came from renewables, but the sheer amount of capital to make that a predominantly majority is not something that can be achieved in the short or medium term. This all just translates to gas companies like WMB still being faced with high demand and the possibility of returning large chunks of FCF to shareholders and yielding a strong ROI for them.
Results And Outlooks
The last quarter for WMB resulted in adjusted EBITDA of $1.611 billion, an 8% You growth rate, but on a YTD change, it was in the double digits at 13%. The earnings are heavily tied to positive movements in natural gas prices and it's hard to anticipate the future prices for them. All one can do there is base their forecast on continued demand for the commodity. In 2022 for example I don't think anyone could have seen the rapid natural gas price increase that occurred because of the war in Ukraine. In 2021 that was not on anyone's radar and spikes like that are likely to occur going forward, but ultimately lead to a steady uptrend in prices I think. With that said, I think the priority should lie on how well WMB can deliver cash flows to its investors and raise the dividend. This can only really be done sustainably if the leverage ratio remains within a reasonable area. On this front, WMB has done a very good job in my opinion, as it has declined to 3.5 in terms of debt-to-adjusted EBITDA, down from 3.82 a year prior. This could not have come at a better time as the interest rates have during that period risen at almost unprecedented levels too. This has limited the impact on the bottom line for the company and has been a key contributing factor to the rise in the share price these last 12 months. Investors are looking for a haven of sorts that can also yield a strong dividend sustainably.
As I have mentioned the dividend is a very appealing factor in buying into WMB I think we should take a closer look at it and the outlook for it as well. In the previous segments, we have gone over the fundamental demand that exists for natural gas right now. Right now WMB has amassed 26.1 Bfc/d in LNG projects and has another 14.7 Bfc/d in the pipelines awaiting FID within the Transco footprint. This is underscoring the fact that WMB likely has additional FCF on the horizon. If WMB reaches the $3.2 billion of FCF in 2025 that translates to FCF per share of $2.62. The FWD dividend for WMB is $1.79 right now, and if that FCF target is reached it can cover the dividend by a large amount. The FCF payout ratio would equate to 54%. I do anticipate that WMB can still manage to grow its dividend by at least 6% during those 2 years and that results in a dividend of $2.01 or an FCF payout ratio of 70%. This is not an alarming amount and still leaves a significant amount of capital left over for the company to expand its business through pipeline growth and more LNG projects.
The price targets for the company currently indicate a 7.07% upside with the median target at $37.39 by 2024. If you remember then my price target for 2025 is lower than this and closer to $36 and I have done that as I remain more cautious given the rapid increase the share price has had this year and to maintain a reasonable valuation assumption too. At a $36 price target WMB trades at p/fcf of 14 should they achieve the forecasted FCF I have by 2025. Furthermore, should WMB see quick progress on their LNG projects in the pipelines I can see the earnings reasonably growing as well in the next few years. Right now WMB is trading below its average earnings multiple by roughly 13%. By 2025 I can see the EPS expanding to $2.19 which is slightly higher than the market assumptions, but I would argue that given the capital WMB is using to buy back shares and expand its pipelines it's a reasonable assumption.
WMB has normally been trading at a p/e closer to 20 so applying that multiple to the EPS forecast of 2025 I have nets us a price target of $43 instead. Adding that to $36 which is for the p/fcf, we get an average target of $39.9, a short-term upside of 14.2% when not accounting for the dividend, or an annual return of 12.23% when also accounting for the 5.13% dividend yield. This is certainly enough for me to justify a buy rating here seeing as the average growth of index funds is closer to 10.7% .
Financial Position
The last 10Q by the company has revealed that the financial position of the company has made very strong improvements in a rather short period since the end of 2022. The cahs now is $400 million higher and assets like property, plant, and equipment are $3 billion higher. With an appreciation ROA as shown above this is a welcomed improvement and one that has shown to have a strong impact as well.
As has been discussed before, the leverage ratio right now for WMB has improved quite well and the long-term debts are now at $21.5 billion. Current debt is at $2.8 billion right now though, but that seems manageable when EBITDA is over $6 billion TTM . For the coming report, I will be looking at the paydown of these debts and how well WMB can also raise its cash position. Having a strong capital cushion like that in times of higher interest is going to serve them very well I think and could lead to a higher p/b being justified.
Risks
WMB faces a challenging landscape due to a substantial debt burden and an ambitious capital expenditure program. This exposure leaves the company vulnerable to inflation risks across multiple fronts, encompassing materials, labor, and capital costs. Inflation in these areas can significantly impact the company's bottom line and overall financial health.
Debt/Capital (Macrotrends)
Moreover, WMB operates in an environment where activist and regulatory resistance to pipeline projects looms as a persistent concern. This resistance takes various forms, including opposition from environmental activists advocating against all hydrocarbon-related endeavors. Additionally, some groups vigorously challenge pipeline rights of way, adding complexity to expansion efforts. Furthermore, the landscape is further complicated by the presence of anti-hydrocarbon sentiment among federal and state policymakers and regulators, which can introduce regulatory hurdles and uncertainties.
Key Notes
WMB has shown to be a very solid dividend payer over the last few years and is growing at what I consider a very satisfactory rate of over 6%. I see this being continued as FCF expansion is likely given the prospects of further LNG projects that WMB has. The 2025 target price for me sits at $39.9 yielding a strong 12.23% annual return from today's price levels. For this reason, I am a buyer of WMB and my rating will be as such too.
For further details see:
The Williams Companies: A Well Run Business With Plenty To Give