Description

Investment thesis

Altus Midstream is a busted SPAC in a forgotten industry that is currently emerging from the dead. It owns high-quality, low-cost, and newly-constructed oil & gas pipelines and has a rock solid balance sheet. With a recently-initiated dividend policy and improving trading liquidity, the company stands to benefit from improving flows from income-oriented investment funds. The stock is very cheap at a 24% 2021 FCF yield and a 12.1% dividend yield. This is based on the company’s 2021 guidance that we believe is overly conservative and will be increased in H1 2021.

Company background

Altus was formed in 2018 through the merger of a Kayne Anderson sponsored SPAC and Apache’s gathering and processing assets in the Permian. The company also received options for four JV stakes in to-be constructed long-haul pipelines. Apache still owns 79% of the company. At the time, Altus was projecting $500m to $600m of EBITDA for 2021. 50% of this was to come from its gathering and processing assets in the Alpine High play at the edge of the Permian. The other 50% was going to come from the JV pipelines. At the time, Apache was projecting a lot of production growth for Alpine High of which Altus stood to benefit through its G&P assets. However as often happens in oil & gas, the field didn’t prove out to be that lucrative and was much more “gassy” than Apache had projected. Apache stopped its drilling program in the Alpine High in Q1 2020. Instead of $250m to $300m of EBITDA for the G&P assets, Altus is now expecting $50m of EBITDA for these assets in 2021. And its likely that EBITDA will decline further from that level.

High-quality JV pipelines

While Alpine High was a total disaster within the industry, it is well known that gathering & processing assets are tied to the success of the underlying field and can become stranded if the operator stops drilling. Now that this has happened and with the valuation being less than a fourth of the IPO price, Altus is actually a much higher quality investment with the majority of cash flows coming from its JV pipelines. We think these assets have been overlooked as Altus is known in the industry for the Alpine High failure. These assets are compromised of 2 natural gas pipelines that are fully subscribed for the next 10 years, one NGL pipeline and one crude pipeline. All 4 pipes are newly constructed and flow from the Permian to the Gulf Coast. We have financials for three of the four pipelines. The last one, the Permian Highway Pipeline, finished construction and was placed in service on January 1 this year. 

The two natural gas pipelines are some of the best assets within the entire oil and gas space. They are fully subscribed for 10 years, low cost, and are taking volume out of the most economic basin in the US. They are also newly constructed which means that they will have very limited capex over the next years.

Altus’s 15% stake in the EPIC crude oil pipeline represents tremendous upside. The pipeline has volume risks and underperformed in 2020 due to oversupply in the Permian. It also has debt at the JV level (the other JVs do not) which meant that it didn’t pay distributions to Altus in 2020. The company’s 2021 guidance assumes 0 distriubtions and 0 EBTIDA from this pipeline. However given the pipeline’s lower tariffs than the competition (primarily older pipelines owned by Plains), we think the pipeline is likely to generate significant cash flows for Altus in the medium and long-term as above-market contracts for competing pipelines expire slowly over the next three years.

Lastly, Altus owns a 33% stake in the Shin Oak NGL pipeline. This asset also underperformed on volume in 2020. We think this presents a tremendous entry point from depressed levels in one of the most difficult years in decades. Guidance is low in regards to Shin Oak based on management commentary and based on the fact that NGL volumes have been steadily recovering since management initiated guidance. Our VAR also confirms the high quality and strong competitive position of this asset.

Misunderstood capital structure

One of the most attractive aspects to us is the capital structure. Altus has $580m in debt (this will be slightly higher at the end of Q4 due to the finishing of construction on the Permian Highway Pipeline). So debt is 2.3x 2021 EBITDA (mid-point of guidance). Even if one of its assets were to blow up, the company would still be comfortably below its 5x debt covenant. In such a scenario, FCF would still be very meaningful compared to market cap and the company would not need to pay back any debt. On top of this debt, Altus has a 7% preferred of $660m. The 7% interest on the preferred will go to 10% in 2024. Including the preferred, debt is 5.0x 2021E EBITDA. While the cost of the preferred is fairly high, we think it is still highly attractive to Altus shareholders at current prices. The preferred represents no liquidity or solvency risks but tremendous upside through a leveraged equity. It seems that the market is confused about the preferred and believes the company should redeem which they can only do at a premium that results in a 13% return to preferred holders. We see no benefit for ALTM to redeem the preferred until it trades at or below a 13% FCF yield. Management knows this and won’t redeem unless the share price materially increases.

2021 guidance

We believe 2021 guidance is low for three reasons: 1) volumes at Alpine High are trending higher than forecasted, 2) NGL volumes have materially rebounded since guidance initiation and 3) the Permian Highline Pipeline started service on January 1 vs later in Q1 which guidance assumes. We think guidance will be raised early in 2021. Given Altus’ low float (79% owned by Apache), these positive catalysts will have an outside effect on the stock price similar to how the negative news from Alpine High overly effected the stock on the downside.

Valuation

Given the strong balance sheet and limited capex from its newly constructed pipelines, we think it makes the most sense to value Altus on FCF to equity. Post completion of the Permian Highway Pipeline FCF will be almost identical to company guided DCF. For valuation purposes we are using the high end of company guidance of $190m of FCF ($11.69/share) in 2021. $50m of this FCF comes from the gathering & processing assets that in order to be conservative we assume are a declining asset. We value this at 4x FCF. The remaining $140m FCF stream is highly valuable and should trade at a premium to the rest of the midstream space, which is undervalued in itself. We assume a 15x FCF multiple. We think this is justified due to the pipelines being newly constructed, offering highly competitive rates, the natural gas pipelines being fully subscribed for 10 years, the free upside from the EPIC crude oil pipeline and significant upside from NGL volumes at Shin Oak. This results in a valuation of $142/share resulting in 185% price upside and a weighted average 2021 FCF multiple of 12.1x. We believe this is what Altus is worth today. On top of this we are receiving $6.00 in annual dividends, currently a 12.1% dividend yield, while we wait for the market to recognize this value. 

Catalyst

- 2021 guidance raise

- Initiation of first quarterly dividend in company history