Summary
- Western Midstream Partners is forecasting flat to slightly down EBITDA in 2023 despite throughput volume growth.
- The $0.36 special distribution expected this year will be paid only because management counted asset sale proceeds in available cash.
- Completion of the debt payoff and buyback program over the next couple years will result in flat distributions in 2023-24 including specials paid in 2024-25.
- Available cash should improve considerably in 2025 resulting in a big base distribution increase that year and larger special payable in 2026.
Weak Earnings Growth In 2023 Despite Higher Throughput
As I mentioned last quarter , Western Midstream Partners ( WES ) has evolved into a steady performer after getting its balance sheet in order in 2020-21. At that time, I noted that slowing growth and higher costs would cause 2022 results to come in at the low end of guidance. This turned out to be the case when the partnership reported 4Q and FY results.
Still, WES continued to invest for the future, buying the half of the Ranch Westex gas processing plant in the Delaware basin of Texas that it did not already own. The partnership is also growing organically as it began construction on Train 3 of the Mentone gas processing plant, also in the Delaware basin. WES also sold its half of the Cactus crude oil pipeline from the Permian to the Gulf Coast.
Looking forward to 2023, WES is projecting EBITDA to be flat to slightly down from 2022. Throughput of crude, gas, and water will all be up this year but the lost equity income from Cactus pipeline will be a headwind. Cactus was responsible for 65 mbd of WES crude throughput in 2022. The partnership will also be ramping up capital spending as it completes Mentone Train 3. This is expected to result in slightly lower free cash flow in 2023. WES therefore left the base distribution unchanged at $2.00 this year.
Distribution Outlook
The $0.36 special distribution expected this year is good news and results in a forward yield of 8.8%. It is however largely due to the partnership deciding to include net cash from asset sales as part of the cash available for distribution.
WES now has $762 million remaining on the $1.25 billion buyback through the end of 2024. They also completed the last $213 million of debt payoff in January 2023. While this is great for distribution growth in later years, I expect the base distribution to remain at $2.00 through 2024 and the next two special distributions will be lower than this year's.
An updated earnings model is shown below. With the lower free cash flow this year, combined with the cash used by debt paydown and buybacks, I am forecasting a special of just $0.10 per unit in 2024. I am assuming capex comes back down in 2024 after the completion of Mentone Train 3, however this is a risk. WES is already offloading some gas volumes to other processers, so when Mentone 3 comes on, it could fill up quickly. That would lead to the need for another new processing unit before 2025 if output in the basin continues to grow. The good news is that this would also mean faster throughput growth for WES, however.
Conservatively, I am assuming EBITDA growth returning to 5% per year starting in 2024 with continued throughput growth from the Train 3 startup and new well activity upstream in the Delaware basin. As mentioned on the earnings call, WES expects to tie in 340 wells in the Delaware this year, up from 246 added in 2022. This will supply the volume growth in the subsequent years. Management also noted the increased permitting activity in Colorado's DJ basin observed in another article , however it does not sound like this will make a meaningful contribution to earnings anytime soon. The existing well output in the DJ is declining and these new wells, when they come on in the second half, are just expected to mitigate the decline. Additionally, there are some contracts currently yielding below the minimum volume commitments where the increased volume would not contribute to increased income.
The improved cash flow should allow a special of around $0.34 to be paid in 2025, similar to this year's levels. More importantly, the end of the buyback program should allow a considerable increase in the base distribution. I am projecting a 50% increase to $3.00 per unit which still leaves $454 million, or about $1.27 per unit available for a special in 2026.
Note that the projected debt/EBITDA is within the partnership's stated threshold for a special distribution. In 2023 I am forecasting leverage of 3.1, within the limit of 3.2. In 2024, my forecasted leverage is just under the target of 3.0. WES does have a large tranche of debt (~$1.1 billion) due in 2025, but with the leverage down below 3, I expect them to refinance, leaving cash available to return to unit holders.
With these yields, WES looks fairly valued based on the next 2 years of distribution, but cheap based on what the partnership will be able to pay out in 2025.
An Update On Bond Yields
Last quarter I noted that the debt of WES had become more competitive with the equity yield, with bonds maturing in 2028 yielding around 6.5%. These bonds are now yielding around 6.3%. The drop is similar to that of the 5-year Treasury, leaving the spread about the same.
The long term debt due in 2048 has fallen even more in yield. In November, these bonds were yielding 7.0-7.2%. This has dropped to 6.6-6.7%. The market clearly appears more comfortable that WES will be around for the long run.
While I'm not opposed to holding bonds for diversification and hedging against stock market downturns, the equity looks relatively more attractive this quarter. Looking past the expected lower special distribution in 2024, the equity yield looks much better. For those who still want some bond allocation, I would continue limiting maturities to 5 years or less and waiting for the Fed Funds rate to get closer to the forecasted peak above 5%.
Conclusion
Western Midstream is taking a pause in earnings growth in 2023 as lost income from the Cactus pipeline sale is offsetting throughput growth. As a result, the partnership expects no increase in the base distribution this year. Looking beyond this year, the startup of Mentone Train 3 combined with an end to the share buyback and debt reduction programs will allow a higher special and much larger base distribution in 2025.
The partnership's debt yields have come down slightly since last quarter in line with the general interest rate environment. The equity now looks relatively more attractive especially considering the future distribution growth. Still, I do not expect much movement in the price in 2023 due to the weak earnings growth this year. Current investors should continue to Hold the units and new investors should look for opportunities to add if general market weakness takes the price lower.
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Western Midstream Partners: Earnings Growth On Hold In 2023