Last month, Antero Midstream (NYSE: AM) completed its simplification transaction. The deal saw two midstream entities created by natural gas producer Antero Resources (NYSE: AR) combine into one single company that will reduce not only complexity but also costs.
The combined company currently expects to pay between $1.23 to $1.25 per share in dividends this year, which implies an attractive yield of 8.8% at the current price. That high-yielding payout likely has income-seeking investors wondering if they should buy the new Antero Midstream.
A look at the new Antero Midstream
Antero Midstream controls a sizable infrastructure platform to support the growth of Antero Resources in the Marcellus and Utica shale region. It has an integrated asset footprint focused on four activities:
- Delivering water used to frack wells and treating produced water.
- Gathering natural gas from wells and compressing it for processing.
- Processing the natural gas to extract natural gas liquids (NGLs).
- Fractionating the NGLs into higher valued products like ethane and propane.
The company does those last two activities as part of a 50-50 joint venture with MPLX (NYSE: MPLX). It also owns a minority stake in a long-haul pipeline that moves gas out of the region.
While Antero Midstream gathers and processes some third-party volumes, Antero Resources is its main customer. That has both positives and negatives. On the plus side, the relationship provides steady growth since Antero Midstream builds all the infrastructure assets needed to support its parent's expansion. On the other hand, Antero Resources recently tapped the brakes on its growth ambitions, which will negatively impact Antero Midstream.
The company currently expects to invest about $2 billion over the next four years on expanding its midstream footprint to support Antero Resources' anticipated growth, including investing $500 million into its joint venture with MPLX. This investment level should support an 18% to 25% compound annual growth rate in Antero Midstream's distributable cash flow. That should allow the company to increase its dividend 29% next year and boost it another 20% in both 2021 and 2022. The company expects to cover this fast-rising dividend with cash flow by 1 to 1.2 times, though that's down from the 1.2 to 1.4 ratio it anticipated before Antero Resources tapped on the brakes of its drilling plans. Leverage, meanwhile, should fall from a conservative 3.25 this year to an even better ratio in the low-to-mid twos by 2022.
The bull and bear case
Antero Midstream offers investors an ultra-high-yielding dividend that it expects to increase at a high-octane rate over the next few years. If the company hits its dividend growth target, investors who buy today could collect nearly twice as much income in 2022. Further, the company would have a rock-solid balance sheet given its anticipated low leverage ratio.
However, the sustainability of that payout is questionable since Antero Midstream could be paying out nearly all its cash flow in dividends, especially if it grows at the low-end of its range. Another concern is that the company is highly reliant on one customer (Antero Resources) and one activity (natural gas gathering and processing). That puts it at risk of missing its dividend growth forecast if Antero taps the brakes again, especially since coverage expectations have already narrowed considerably. Those factors make it a much higher risk opportunity compared to rivals that offer similarly high yields but with better coverage ratios and more diversification.
MPLX, for example, currently yields 7.8% and while its parent Marathon Petroleum is a major customer, it's not dependent on that company to drive growth. That's because MPLX has a sizable gathering and processing business not only in the Marcellus and Utica but in the Permian Basin and a meaningful logistics and storage business, which includes its participation in long-haul pipeline projects developed by others. While MPLX won't grow its payout anywhere near as fast as Antero Midstream, the company has a much lower payout ratio, which enhances its long-term sustainability.
Verdict: Antero Midstream isn't a buy
Antero Midstream promises an ultra-high-yield that it can grow at a high-octane rate. For some income-seekers, that enticing reward is worth the risk. However, there's increasing concern that the company won't be able to grow its payout as fast as expected because Antero Resources has slowed its drilling pace. That's why I think investors should hold off on buying Antero Midstream right now and wait to see if it reduces its reliance on Antero by adding more third-party customers to its systems and invests further down the midstream value chain in additional long haul pipelines. In the meantime, investors might want to consider MPLX, which I think is a top high-yield stock to buy right now.
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