2023-03-07 11:14:24 ET
Summary
- The risks to Western Midstream Partners, LP from Occidental Petroleum are gone and the company's assets remain strong.
- It's no longer a bargain bin company, but Western Midstream Partners, LP can still comfortably afford double-digit shareholder yields.
- The company's debt repayments and share repurchases should help the company to maintain strong long-term shareholder returns making it a valuable investment.
Western Midstream Partners, LP ( WES ) has had a more volatile ride than most due to being heavily tied to Occidental Petroleum (NYSE: OXY ). However, even with the company's strong growth in share price, it's still heavily undervalued, generating strong and reliable double-digit cash flow. The company has appreciated since we last recommended it , but we still see it as a valuable long-term investment.
Western Midstream 2022 Performance
Western Midstream had a strong 2022 by nearly all counts.
Western Midstream Partners, LP paid $736 million in base distributions as part of its core 7.4% dividend rate. At the same time, it managed to both retire just over $500 million in debt and repurchase almost $500 million of common stock. That equates to a comfortable double-digit dividend yield for investors. The company expects to announce a $140 million enhanced distribution on top.
The company has amended its agreements with Occidental Petroleum and continues to make decisions to optimize its entire portfolio, such as divesting its Cactus II interest. Across most metrics, the company beat its guidance, but it did come in at the lower end of the guidance.
Western Midstream 4Q 2022 Performance
Specifically, for the most recent quarter , the company performed well, although some weakness in the markets was clear.
The company managed to move 4.2 billion cubic feet / day of natural gas and 622 thousand barrels a day of crude oil / NGLs, although with a slight QoQ decline in adjusted gross margins. The company also managed to move 851 thousand barrels / day of produced-water, a business for the company that's expected to grow more than 20% going into 2023.
Obviously margins here are lower, but it's also a much lower risk business.
Western Midstream 2023 Outlook
The company's 2023 guidance still looks overall promising, but it does face some additional risk.
It's worth noting here that the company has $6.5 billion in net debt, which costs it several hundred $ million in annual interest. However, it's also taken the company back to its net leverage ratio target of 3.1x, enabling increased shareholder returns. For 2023, the company expects $2.1 billion in midpoint EBITDA, a 1% decline.
The company expects growth rates in volumes for crude oil, natural gas, and water to range from the low-single digits to mid-20s % with minimal price sensitivities. Capital expenditures are ramping up slightly to $625 million, resulting in a large decline in free cash flow ("FCF") to $1.175 billion at the midpoint, but still enough for more than 10% in shareholder returns.
The company's size makes its share repurchases valuable. The repurchases both pay down its future dividend obligations and help its overall portfolio.
Our View
Western Midstream definitely trades at a loftier valuation than when it could be picked up for just a few $ / share.
However, the company has continued to generate strong cashflow and used that cash to generate shareholder returns across the board. Now that the company has reached its leverage targets, we expect it to only selectively retire its debt as it comes due if required. The company has the FCF outside of that to drive substantial returns.
As an illustration, let's say the company grows FCF by roughly 3% annualized with some modest investments in growth capital. Let’s also say it continues its 7.5% dividend yield and repurchases 4% of shares annually, both numbers it can afford with its current cash flow. That combination enables total shareholder return of ~15% annualized while enabling dividing growth of ~4% annualized without costing the company anything more.
That means that not only can this company drive strong total shareholder returns, but it can also be a strong source of income in a portfolio.
Thesis Risk
The largest risk to our thesis is long-term volumes. Trading at just a hair over 10% annualized returns is strong in this market, however, it relies on Western Midstream Partners, LP maintaining or potentially growing its volumes. Some of the company’s operations are still heavily tied to Occidental Petroleum’s volumes, for example. Long-term changing supply and demand could also affect the company here and hurt its ability to drive returns.
Conclusion
Western Midstream Partners, LP has faced a lot of noise over the past few years, resulting in the company’s share price reaching a bottom of the barrel just over $3 / share. We expect that noise in regards of a potential Occidental Petroleum forced sale of the company will always be there and provide overhang to the stock. However, the company’s management has continued to do everything right, and Western Midstream Partners, LP now has a much higher valuation as a result.
Western Midstream Partners, LP is focused on both aggressively repurchasing shares and maintaining what’s an incredibly strong dividend of more than 7%. That combination will enable the company to generate double-digit shareholder returns, with a strong income based component, making Western Midstream Partners, LP a valuable addition to any portfolio. Let us know what your thoughts are in the comments below.
For further details see:
Western Midstream Is A Strong Pure-Play Midstream Stock