There's No Avoiding The Growth Prospects Of Rattler Midstream

|
About: Rattler Midstream LP (RTLR), Includes: FANG
by: Michael Ambrozewicz
Summary

Rattler Midstream's IPO debut on the Nasdaq Global Select Market was the largest energy IPO in 2019 thus far after raising $750 million.

The former subsidiary of Permian producer Diamondback Energy possesses an outstanding and growing amount of infrastructure in providing midstream services in the Permian Basin.

Increasing global demand for US oil and natural gas exports and a growing FCF position sustain the company's growth prospects and accompanying cash flow and earnings going forward.

Overview

After debuting on the Nasdaq Global Select Market on May 23, 2019, Rattler Midstream Partners LP (NASDAQ: RTLR) has been significantly underfollowed by investors and analysts. Raising over $750 million is no easy feat and a lack of recognition despite being the largest energy IPO in 2019 thus far indicates that it’s still a good time for investors to get on board. Coverage of RTLR is rapidly picking up, with numerous targets being estimated by equities research analysts at Barclays, Royal Bank of Canada, JPMorgan Chase, Bank of America, Piper Jaffray Companies, Credit Suisse, Goldman Sachs, and Citigroup.

The former subsidiary of Diamondback Energy (NASDAQ: FANG) is expected to enter into positive cash flow territory by the end of 2020 and possesses a plethora of growth prospects in the form of existing contracts, stakes in new oil pipelines, and global demand for US oil and natural gas. Buying shares below $20 represents a steep discount. Hold at your discretion, but the real potential for large returns on RTLR shares is the 12 to 24-month range where prices will reach the $30 to $35 range. For those looking longer term, RTLR will be a stable and high-growth company for many years to come.

An Undercovered IPO

Source: Yahoo Finance.

After debuting at $18.06, a 3.2% premium on its list price, shares of RTLR have hovered between $18 to $20 as the stock sets itself onto the radar of institutions and individuals. RTLR earned $6 million on revenues of $184 million in 2018, up heavily from $21 million on revenues of $39 million in 2017. Analysts also expect RTLR to report full year sales of $409.80 million for 2019 and sales of $508.92 million for the following financial year. However when factoring in RTLR's growth prospects, sales are set to extend even further than these general estimates.

RTLR’s IPO came amidst Diamondback Energy spinning off its midstream assets after years of constructing accompanying midstream infrastructure over the past five years to support its operations in the energy-rich Permian Basin. Diamondback Energy has experienced exponential growth in both revenue and earnings since 2016 as demand for oil and natural gas exports continues to increase, a trend that will only continue as oil tensions rise abroad. Side-by-side, Diamondback Energy and RTLR have both posted significant year-over-year growth in revenue and earnings as investments in infrastructure begin to materialize for both entities. With a 19% return on Diamondback Energy thus far in 2019, expect RTLR to perform similarly going forward.

RTLR successfully raised over $750 million in its highly anticipated IPO by pricing shares at $17.50, the middle of its previously indicated $16 to $19 range per unit. 38 million units in total were released, significantly more than the originally planned offering of 33.3 million units. The company's balance sheet is also extremely healthy with assets doubling in the past year alone, with PP&E increasing from $255 million to $550 million. EBIT also increased from about $24 million to just under $83 million thanks to increasing volumes which are on pace to increase exponentially over the next 12 to 24 months as major pipeline projects come online.

Diamondback Energy

Source: Yahoo Finance.

Rattler Midstream

Source: Yahoo Finance.

RTLR’s Deserving Growth Prospects

RTLR possesses not only major pipelines, but other vital assets in the gathering of oil, natural gas, and water produced from Diamondback’s wells in the Permian Basin. Rattler’s pipeline network is also expanding with announced interest in the EPIC project and Gray Oak project in the Permian region. RTLR’s 10% interest in the EPIC pipeline represents a future stake in transporting 600,000 barrels of oil daily from the Permian to Corpus Christi, Texas. The Gray Oak pipeline seems more promising, with the ability to eventually transport up to 900,000 barrels of oil daily from the Permian to Corpus Christi. RTRL collects fees for volumes of oil, natural gas, and water flowing through its pipeline network and accompanying infrastructure, enabling the company to collect a growing and sustainable stream of cash flow as these new projects materialize.

The sustainability of RTLR’s future cash flow streams is further bolstered by its long-term contracts with Diamondback Energy. Indeed, the relationship with Diamondback Energy, a top-tier Permian producer with 628,000 gross leasehold acres in the region, is vital in terms of securing future growth. Diamondback has its own plans to complete 290-320 wells annually from 2019 to 2022 in its effort to run 18 to 22 drilling rig programs annually.

This amount of activity is a key catalyst in driving significant volume growth for RTLR and the water and hydrocarbon midstream assets it has under its name. Several 15-year fixed-fee contracts in providing Diamondback with midstream services for over 204,000 acres in the Delaware Basin and 222,000 acres in the Midland basin are therefore a major competitive advantage for RTLR as they give the company the ability to protect itself against margin pressure and pricing.

Source: Diamondback Energy.

In 2019, RTLR expects its volumes to increase another 29% after already experiencing a tripling in earnings due to increasing volumes from Diamondback. Despite the young age of this soaring energy company, these volumes strengthen RTLR’s cash flow position which is expected to breach into positive territory by 2020. This positive FCF enables RTLR to invest heavily in expanding its infrastructure not only through pipelines, but other midstream revenue-generating assets including oil storage terminals and natural gas processing plants.

RTLR’s investment in the EPIC and Gray Oak long-haul pipelines are also set to increase the company’s cash flow. Phillips 66 Partners (NYSE:PSXP), developers of the Gray Oak pipeline, expects operations to begin by the end of 2019. Meanwhile, the EPIC oil pipeline expects its operations to commence in January 2020, and is beginning to lean towards increasing capacity to over 900,000 barrels daily with additional pumps and storage tanks. The growth potential of the Permian Basin is why projects like these are constantly being announced and why Diamondback continues to drill wells in the region at a torrid pace.

The energy-rich Permian Basin will only continue to grow in the imminent future given energy tensions in the Middle East, ongoing US trade disputes with Iran and China, and OPEC’s commitment to keep oil supply down. Export-demand for Permian Basin resources has exponentially grown since the beginning of Trump’s presidency in 2016 with no sign of slowing down regardless of whether the Democrats or Republicans wins the upcoming election.

Challenges

The growth potential of RTLR seems almost too good to be true. Why don't more companies get involved in the midstream industry in the Permian region? The answer is: they do. The Permian Basin has been in need of relief in the form of midstream services for quite some time now with many midstream companies racing to build pipelines. Midstream giant Energy Transfer (NYSE: ET) and its partners Magellan Midstream (NYSE: MMP), MPLX (NYSE:MPLX), and Delek US Holdings (NYSE:DK) all sanctioned the Permian Gulf Coast pipeline in the later half of 2018. It seems like large-scale projects like these are being announced daily in the region as demand for energy exports increases. The race to transport oil and natural gas from the Permian Basin to the Texas coast means RTLR will need to effectively strategize by continuing to express interest in future pipeline projects and securing long-term contracts in order to stay relevant in the industry.

Buy, Buy, Buy

The undercoverage of RTLR is almost a blessing in disguise for analysts and investors who haven’t yet realized the tremendous growth potential of the midstream operator. RTLR’s earnings and cash flow have already increased significantly and will only continue to benefit from contract-backed oil and gas volumes from Diamondback Energy and investments in long-haul pipelines and other midstream assets. Exports from the Permian Basin will only continue to increase given global trade tension and worldwide energy concerns.

A positive and increasing FCF will help RTLR secure these sources of cash flow for many years to come through investments in greater long-haul pipelines, with additional room for new sources of revenue including oil storage terminals and natural gas processing plants. The growth prospects of RTLR and the company's strong financial position secured by long-term contracts warrants shares to trade at a premium relative to its competitors.

RTLR is securing contracts to be the midstream provider of choice in the Permian region, and with assets increasing exponentially along with earnings, a target of $30 to $35 per share is appropriate especially as volumes begin to increase as pipeline projects in the Permian region go online. Buying RTLR shares in the $18 to $20 range is a bargain as these shares outperform towards the $30 to $35 range over the next 12 to 24 months with further room for growth going forward.

Image result for rattler midstream Source: Rattler Midstream.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.