Antero Midstream’s Impressive 9% Yield is Set to Grow

Antero Midstream’s Impressive 9% Yield is Set to Grow

Price $10.14                          Recent Purchase                        June 2, 2021

  • Antero is set to grow its already impressive 9% yield.
  • Incremental volumes over existing infrastructure will cause free cash to explode.
  • We see the likelihood that that dividend will be 25% higher in 5 years.
  • Dividend growth and revaluation should drive double-digit total returns over the next few years.

Investment Thesis

Antero Midstream stock price presents an opportunity after dividend reduction. The temporary dividend reduction to fund near-term capital expenditures with high Return on Investment (ROI) will cause free cash to expand rapidly in the 3–5 year time frame and will allow the company to increase its dividend. We believe this increase in free cash and dividends will drive the stock higher.

What is a “Midstream” company?

Midstream is a fairly simple concept once you de-jargon it. Essentially, midstream companies work as the teamsters for natural gas, utilizing pipelines, trains, trucks, and barges to transport natural gas from upstream to downstream (thus the name). But midstream may also include things such as natural gas refining, compression stations, water pipelines, and water recycling. They usually make their money through flat fees, making an attractive way for a conservative approach to investing in oil and gas (O&G) with less exposure to price fluctuations.

What is Antero Midstream?

Antero Midstream (AM) is an affiliate of Antero Resources (AR) which owns 29% of AM and is its primary customer. Antero Resources handle the drilling and extraction of natural gas and natural gas liquids (NGLs), and Antero Midstream handles the transportation, refining, compression, and water supply; thus the name midstream. It uses its 468 miles of current pipeline space to transport Antero Resources’ natural gas and natural gas liquids (NGLs) to various downstream firms. Natural gas is used in electricity generation, heating, and manufacturing — which most people know. But NGLs are increasingly being used as a petroleum alternative, to make things such as synthetic rubber, plastic bags — even detergent. There is certainly no shortage of uses for it and no shortage of demand for transportation of it from the well-to-end stream. 

What makes Antero Midstream interesting, is its impressive leverage numbers and its 5-year-horizon plans. Antero Midstream is a company 100% funded by fees paid to it, meaning it has very little exposure to the commodity price risk. It also had an agreement with Antero Resources that requires 70% utilization at all times, meaning even if Antero Resources were to fall below this utilization, it would still be required to pay the fees as though it were.

Its rivals and comparables in the natural gas transmission sector tend to operate parallel, instead of in direct competition, as most of the land Antero Midstream operates on is owned by Antero Resources. The company’s high dividend yield and ESG commitment make Antero Midstream an attractive investment.

Antero Presentation May 2021

ESG with a solid Bond Yield

While natural gas certainly is not solar or wind, it does have a lower pollution footprint than coal and crude oil.  In many cases, natural gas-fired plants are either replacing coal or used as an intermittent backup for the unreliable green energy sources of solar and wind. Antero has consistently demonstrated a commitment to remaining as clean as possible in the sector which has been peppered with scandals and pollution problems. To help mitigate this, Antero Midstream maintains a hefty network of pipelines and water treatment plants that were able to cut 471,000 truck trips (saving Antero Resources about $0.50/barrel), recycle about 83% of their water usage, and have a sub 0.1% methane leak rate. These are some of the lowest in the industry and to keep their commitment, they have an ESG committee, with an impressive goal to reach carbon neutrality by 2025.

Strategy

Antero Mainstream wants to reduce its operating leverage, which is already below its peers in midstream companies. They are currently at about 3.7x, want to be under 3x by 2025, which they plan to reach by increased expansion to their access to wells. Its affiliate, Antero Resources, has direct control over 2,000 undeveloped but “premium” locations, and a recent partnership with Quantum Energy for further expansion. 

Quantum Energy Partnership

Quantum will fund 20% of Antero Resources’ capital spending through 2021, and 15-20% of development capital thereafter. This does include a drilling carry to Antero Resources, provided that Quantum hits certain targets. This additional development will drive higher volumes Antero Midstream significantly increasing fees. Moreover, these volumes would use their excess capacity and bolster revenues with marginal increases in capital expenditures. Free cash flow is expected to explode. Antero Midstream expects to receive about $200 million in additional cumulative free cash flow from 2021-2025 based on this partnership.

Risk

Antero is managing its controllable environmental risks responsibly. Associated regulatory environmental risks will continue to rise as the world tries to reduce carbon output, and as the world changes footing to renewables.

While Antero Midstream’s (AM) dependence on Antero Resources (AR) for volume and growth is a risk to be watched, AR’s 29% ownership and its need for AM to have a healthy stock to raise capital to facilitate AR’s expansions make any draconian moves unlikely. Additional regulatory barriers to pipeline construction or freezes on the development of new wells are the two biggest risks to volume for AM.

Metrics

Antero Midstream has a dividend yield of about 9%, with some fluctuation. This is above average for the energy sector and midstream corporate pipeline industry. The dividend is easily covered even after capital expenditures used to fund expansion. These expansions are expected to net them ~15% in return on invested capital, which will likely be transferred to the shareholders in the form of dividend increases.

6/4/2021 Price

Current Yield

E2021 Yield

Price to Earnings Ratio

E2021

E2022

E2023

ANTERO MIDSTREAM

(AM)

10.05

8.9%

8.9%

13.4

12.6

11.6

ENBRIDGE INC

(ENB)

38.87

7.2%

7.6%

14.5

12.2

12.1

EQUITRANS MIDSTREAM

(ETRN)

8.98

6.8%

6.8%

10.0

7.7

7.2

WILLIAMS COS INC

(WMB)

27.60

5.9%

6.6%

22.4

21.6

21.1

KINDER MORGAN INC

(KMI)

18.80

5.8%

5.8%

17.6

20.9

18.8

 

Antero Midstream recently cut its dividends in a move to save cash to internally fund expansion projects. This is related to AR’s new drilling partnership with Quantum, in which it has increased its budget for capital projects from $240 to $260 million. The stock has only partially recovered from the sharp decline during the COVID-19 crisis.