2023-10-26 06:14:05 ET
Summary
- Western Midstream has lowered its 2023 guidance, but this should be from a temporary issue.
- Western Midstream's acquisition of Meritage was done at an attractive price and will contribute to future growth.
- WES stock looks inexpensive versus peers and has a safe and growing distribution with an over 8% yield.
Western Midstream (WES) has generated an over 17% return since I said it was one of the cheapest stocks in the midstream space and placed a "Buy" rating on the stock in March . Let's catch up on the name.
Company Profile
As refresher, WES is a gatherer and processor (G&P) the largely operates in the Delaware and DJ basins. It also just made an acquisition to expand its footprint in the Powder River Basin. Prior to the acquisition, about 50% of its adjusted EBITDA was set to come from the Delaware and 33% from the DJ.
WES' contracts are largely fee-based, and its cash flows are highly supported by minimum volume commitments (MVCs) or cost-of-service contracts. Parent Occidental Petroleum (OXY) is its largest customer.
Reduced Guidance and Acquisition
Despite its solid stock performance, not everything has been unicorns and rainbows for WES since I last looked at the name. In conjunction with its Q2 earnings report, the company lowered its 2023 guidance. It now expects adjusted EBITDA to be between $1.95-2.05 billion, down from a prior outlook of $2.05-$2.15 billion. Free cash flow is now projected be between $900 million to $1.0 billion, down from a previous forecast for $1.125-1.225 billion.
On its Q2 call , CEO Michael Ure said:
"While the Delaware Basin natural gas and crude oil and NGLs throughput increased on a sequential quarter basis, these increases were below our initial expectations, primarily due to producer operational challenges that appeared during the second quarter. Based on our analysis, producer operational challenges include delays in wells coming to market, unplanned maintenance and base well performance issues. Several new wells that came online during the second quarter outperformed relative to initial expectations, and this outperformance led to challenges across the production chain, specifically with producer-based wells. Based on discussions with our producers and after analyzing their revised forecasts, we expect these issues to be temporary in nature, but will continue into the second half of 2023. As such, we expect total average year-over-year throughput growth to increase at a slower pace than initially expected."
While the lowered guidance was disappointing, the upshot is if that if you are going to lower guidance, it being because new wells outperformed expectations and caused some production chain issues is probably one of the better reasons. New well outperformance usually leads to greater volumes, not less, so this should be a short-term issue. Given that it happened in the Delaware, the most prolific basin in the country, I wouldn't be too worried about it.
Following its Q2 results, WES announced the acquisition of Meritage Midstream Services II in September and closed the deal earlier this month. WES paid $885 million for the business, which it said was between a 5-6x multiple on 2024 adjusted EBITDA before any cost or operational synergies. It issued $600 million in 6.35% senior notes to help fund the deal.
Meritage will bring with it 1,500 miles of high and low pressure gas gathering pipelines in the Powder River Basin, along with about 380 MMcf/d of gas processing capacity, ~400 MMcf/d C02 treating capacity, and a 120 mile NGL pipeline. It also includes ~1.45 million dedicated acres of rich gas.
The Meritage assets nicely overlap with WES' existing system in the basin. This should help create operating efficiencies and allow it to compete for any nearby undedicated acreage. The deal comes at an attractive price, and once synergies are applied it should look even better.
The Powder River Basin is a bit of an underrated basin in my view, and one that is still more of an emerging basin. It's not the Permian, but it has some top producers operating in the play, including EOG ( EOG ) and Devon ( DVN ). The Mowry section of the play has shown to be quite prolific, and it looks like a lot of WES' combined gathering assets are in the strong southern part of the basin.
EOG talked about the PBR earlier this year on its Q1 earnings call , with EOG EVP of Exploration & Production Jeffrey Leirzell, saying:
"We have outstanding results there in the Powder River Basin right now, and it's some of the lowest finding costs that we're seeing there in the whole portfolio...The wells are performing as we expected. In Q1, we've completed about 15 gross wells, which 2/3 of those were Mowry. And we're seeing a lot of benefits also by getting some consistent activity up there in the Powder. We're running a consistent 2 to 3 rigs and 1 full frac spread with that, which is really allowing them to kind of push their efficiencies. And then we also have a lot of confidence in the play just with the overall performance and stuff as with the Mowry. And then from there, as we talked about, we want to go ahead and gather the data in the upper overlying formations like the Niobrara, so we can develop that later in the future."
Given the strong results coming out of the PRB and the inexpensive valuation that WES is paying I really like this deal. The PRB will still only be about 10% or so of its EBITDA, but it will give the company some more basin diversification.
Valuation
WES stock currently trades at about 7.6x the 2024 EBITDA consensus of $2.24 billion, and 7.3x the '25 consensus of $2.32 billion. The $600 million in debt from the bond offering after the quarter has been added to its EV.
Its FCF yield is over 11% for 2024. The stock yields 8.3% based off its base distribution of $2.30.
WES is among the cheapest stocks in its peer group, although I see no reason why this should be the case give its ties to OXY, strong balance sheet, coverage ratio, and position in the Delaware.
Conclusion
WES continues to remain one of the cheapest midstream companies in the space. While the reduced full-year guidance was disappointing, I really like the Meritage acquisition it just closed, which should help power growth next year.
The company continue to have one of the best balance sheets in the midstream space with low leverage (3.3x) and termed out debt at attractive rates. The added debt from the Meritage acquisition shouldn't move its leverage much, if at all.
Given its current contract structure, coverage ratio, and balance sheet, WES is one of the best and safest high yield investment options out there in my view. My $35 price target is a modest sub 9x multiple on 2024 EBITDA and around where many of its peers currently trade. Combine that with an over 8% yield and WES remains a "Buy."
The biggest risks to the name would be a crash in the price of oil that would cause drilling activity to slow and for it to collect only its MVC payments. I find that unlikely to occur anytime soon.
For further details see:
Western Midstream: Meritage Acquisition Should Drive Growth