2023-05-04 09:03:29 ET
Summary
- 2023 remains a low-growth year for Western Midstream Partners but strong producer forecasts provide upside to future years.
- WES issued $750 million of new debt recently, making it unlikely they will hit the leverage targets specified in their enhanced distribution policy.
- An increase in the base distribution seems likely in 2025 along with resumed debt reduction in 2025 and 2026.
- The 7.8% yield is well-covered and likely to rise in a couple years. It now clearly beats the partnership's bond yields.
Slow Growth in 2023 But The Future Is Looking Better
Western Midstream Partners ( WES ) released 1Q 2023 results in line with what I expected last quarter . The partnership showed slow, steady volume growth in the Delaware Basin of West Texas with gas throughput up 3% in the basin compared to 4Q 2022. Overall throughput for the partnership was down, however. WES's second-largest basin, the DJ in Colorado, continues to show declining volumes. The partnership's other assets in Utah and Wyoming were impacted by weather conditions. Finally, WES no longer has the equity income from its share of the Cactus pipeline it sold last year.
In April, WES secured 300 MMcf/d additional firm volume commitment in the Delaware basin from its majority owner Occidental ( OXY ). WES continues to expand capacity in the area, as I noted last quarter with the addition of a third processing train at its Mentone gas processing plant. Still, upstream producers continue to increase their volume forecasts, resulting in further growth for WES once we get through this year.
Additionally, we continue to see strong producer forecasts from our Delaware Basin customers, which may require us to increase our processing capacity at our West Texas complex to satisfy future volume growth. We will update the market in due time of any changes that could potentially affect our previously disclosed capital expenditures and Free cash flow guidance ranges.
Source: CEO Michael Ure, WES 1Q 2023 earnings release
WES did not adjust any financial guidance for the year relative to what they rolled out last quarter. The comments on future volume growth and a change in the outlook for special distributions is the main reason for this update.
Distribution Outlook
In 2022, WES rolled out its enhanced distribution policy where it pays a special distribution once a year if excess cash is left over after dividends, buybacks, and debt payoff, subject to hitting a debt/EBITDA leverage target.
WES had $141 million of excess cash in 2022 and met the leverage target, resulting in a special distribution of $0.356 to be paid on 5/15/2023. This is in addition to the regular quarterly distribution on $0.50. The flattish earnings growth this year and the lower leverage target already made a special distribution unlikely next year. However, WES has issued debt recently which puts the leverage target out of reach. The partnership paid off $213 million of debt in January and is now considered investment grade by both S&P and Moody's. After the end of the quarter however, WES issued $750 million of 6.15% senior notes due in 2033.
Based on the leverage targets, this takes special distributions off the table for at least two years. I still believe WES has the capability to increase its base distribution 50% in 2025 to $0.75 quarterly. That would finally exceed the payout available from the partnership prior to 2020. I have updated my earnings model based on the information in this quarter's release.
Earnings Model Update
I revised down the EBITDA forecast for 2023 by $32 million based on lower oil and gas prices than the assumptions in the guidance issued last quarter. While most of the business is fee-based and independent of product prices, there is still some impact as indicated in the guidance.
Based on the optimistic commentary about increasing upstream forecasts, I increased assumed EBITDA growth in 2024 to 10%. It then grows 5% each year thereafter. Because some extra capex is likely needed to process these volumes, I increased capex to the top of the guidance range in 2023 and left it there in 2024.
Even with this EBITDA growth, the added debt keeps leverage above target in 2023 and 2024, resulting in no special distribution in the following years. Still, WES is able to complete the $1.25 billion share buyback it announced in 2022 and increase the base distribution in 2025. After adding debt in 2023, I now assume that WES pays off its maturing bonds in 2025 and 2026 without refinancing.
If the exiting special distribution policy remains in place, there is the possibility of a small one in 2026, however yields are already attractive without a special. At the current $2.00/year base distribution, WES yields 7.8%. If increased to $3.00, the yield would be 11.6% based on the current price.
Bond Update
Since last quarter, Moody's has increased WES's credit rating from Ba1 to Baa3, making the debt investment grade. Bond yields have dropped considerably, especially for maturities under 10 years. They are now in the 5.4%-5.8% range, about 50 basis points less than they were at the time of my last article. The longer maturities have not dropped much but remain below the equity yield.
The well-covered higher yield and potential for growth make the equity of WES a better deal than the bonds at this time.
Conclusion
Western Midstream still looks like it will have slow growth in 2023, but optimism from upstream producers suggests a resumption of growth in 2024. It's not clear yet why WES issued $750 million in new debt this year. It's possible they want to maintain flexibility to ramp up capex to capture throughput faster, or to act on M&A opportunities. Perhaps they just expect rates to go up or credit availability to tighten. In any case, the added debt causes the partnership to exceed the maximum debt/EBITDA leverage that would allow a special distribution under their policy. Because of this, I no longer expect any special distributions from WES until 2026 at the earliest. Nevertheless, WES has the capability to increase its base distribution in 2025 while paying off debt due that year if they want.
Unit prices have dropped slightly since I last wrote about WES and rated it a Hold. At the lower price, the forward yield has improved to 7.8%. This could increase to as much as 11.6% if they raise the base distribution 50% in 2025 as I think they can. These yields are significantly above WES bond yields, and the bonds have no growth potential. Despite the lower chance of a special, future earnings growth will lead to an eventual base distribution increase. This makes the partnership units a Buy.
For further details see:
Western Midstream's Special Dividend Won't Be Repeated Soon