Description

Antero Midstream (AM) is a midstream operator which services the gathering, processing and transportation needs of Antero Resources (AR), a major producer of natural gas and natural gas liquids. AM was last written up on VIC five years ago. The next three years were challenging for AM and AR to say the least due to depressed prices for natural gas and natural gas liquids. Both companies have since improved their balance sheets.

AM offers a reasonable current yield of 6.5% with a high likelihood of a dividend increase in late 2024 or 2025. 

As a midstream operator, AM performs an essential role in gathering and processing AR’s production. AM is heavily dependent on Antero Resources. Antero Resources is likewise heavily dependent on AM. Antero Resources owns 29% of AM and has significant control over the operations of AM. There is significant management overlap between the two companies.

Since AM derives substantially all of its income from AR, it’s important to understand AR’s position. AR’s operations are concentrated in the Marcellus and Utica basins in Northern West Virginia and Southeast Ohio respectively. AR’s cost structure is favorable compared to other natural gas producers. (In Q1, AR remained profitable despite natural gas prices at 4 year lows.) Production at AR has increased slightly over the past several years, and is expected to be flat in 2024. AR has positioned itself to benefit from the LNG export terminals which are expected to open over the next few years.

Natural gas prices have been pressured by the unusually warm winter and increased production of associated gas. Increased demand for electricity in the US and increased access to export markets (where natural gas trades at a significant premium to US prices) should allow AM to maintain healthy volumes going forward. 

Low natural gas prices in late 2019 and early 2020 caused both Antero entities to decline sharply. AM fell as low as $2 in 2020. There were serious concerns that AR would file bankruptcy. AR and AM revised their gathering and compression agreement in late 2019 to offer AR a volume rebate on low pressure gathering through December 2023. The rebates, which peaked at $51.5 million in 2023 expired last year.

AM maintained its quarterly dividend at $.3075 until the first quarter of 2021, when it was reduced to the current level of $.225 per quarter. At $.90 per year, the current dividend represents a 6.5% yield. Unlike many entities in the midstream space, AM is a C-corp, with no annual K-1. The dividends paid in recent years have been primarily treated as a return of capital, with 69% of dividends paid in Q1 treated as return of capital. 

AR’s gathering and compression contracts with AM don’t expire until 2038. The water contracts expire in 2035. AM receives fees based on the volumes which AR produces subject to minimum volume commitments. Water volumes are driven by the number wells drilled by AR and the length of the laterals in each well. AR has been increasing the lateral length over time, and drilling multiple wells from a single pad. This increases the efficiency for AR, and profitability for AM, since less pipe is required to service wells which are concentrated on a single pad. 

AM currently has $3.2 billion of debt including $600 million borrowed in January with a 6.625% coupon and an 8 year maturity. The major bond maturities range from 2026 through 2032. Management’s guidance for 2024 calls for free cash flow before dividends of between $550 and $590 million. At the midpoint of guidance, the company expects to have $140 million of free cash flow available after dividends, of which approximately $110 million would be required to reduce debt to the 3 times EBITDA target. The company is currently slightly above its target debt level of 3 times EBITDA, but should reach the target later this year. Once the target is reached AM would have room for either a dividend increase or additional share buybacks.

Management has been very clear about its desire to return capital to shareholders. The company is expected to reach its target debt level in 2024 and have the ability to either increase the dividend or repurchase shares. Restoring the dividend to the pre-Covid level of $1.23 per share would require approximately $160 million and result in a 9% yield at today’s price. 

Risks

The natural gas market is currently oversupplied and current pricing could result in a repeat of 2019, although both the Antero entities and the industry seem a lot more rational than they were five years ago.

While Antero Midstream and Antero Resources are separate public companies, there is a risk that management will favor AR over AM.  Paul Rady, the Chairman of both companies has a significantly larger economic stake in AR.

Catalyst

Expiration of the 2019 rebate agreement will boost earnings in 2024.

Increased LNG export capacity.

Potential dividend increase.