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Antero Midstream: A 26% Yield Midstream Company That Could Blow Up

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About: Antero Midstream Corporation (AM)
by: Value Kicker
Value Kicker
Long only, value, growth at reasonable price, CFA
Summary

Antero Midstream is offering a crazy high yield of 26.02% due to a variety of market factors.

Going through the different risk factors we can see that the company is definitely in the high risk category due to its high debt.

Still the market is pricing the company for bankruptcy, and that isn't necessarily the case. At these depressed prices it's worth the risk.

In my research on midstream companies as investments, I always try to seek large dividends that I can prove to be more stable than what is currently being evaluated by the market. So imagine my surprise when I stumbled upon Antero Midstream Corporation (AM) with its eye-watering 26.02% yield. Usually, yields this high are for companies that are close to being insolvent or facing structural issues. However, looking at Antero Midstream, that doesn’t seem the case. Sure, the company is in the natural gas industry which is facing a major downturn and can be considered high risk, but so are Kinder Morgan (KMI) and Enbridge (ENB) and those stocks seem to be doing fine. Could a combination of a confusing business reorganization, one-time impairment charge, and the exit of a major shareholder be the main drivers for this decline? In that case, Mr. Market is wrong. Or is there something we are not seeing?

Antero Midstream is a growth-oriented natural gas midstream company formed to own, operate and develop midstream energy infrastructure primarily to service Antero Resources (AR). This iteration of the company was formed from the merger of the GP and the MLP into a C-corp, so no K-1s necessary! The company’s main assets are pre-dominantly pipelines and compression/processing plants located in the Appalachian Basin’s Marcellus Shale and Utica Shale located in West Virginia and Ohio.

As mentioned in my previous articles, I view midstream companies as bonds or preferred shares substitutes based on the business structure of paying out the majority of its cash flow. Therefore, I will compare the yield of Antero Midstream to bonds of equivalent ratings (taking into account the additional risk of owning stock as well the additional growth potential). I will be using Moody’s Methodology for evaluating Midstream Energy companies. Using the same methodology that a credit issuer does provides me a complete, structured and organized way of evaluating the safety of the yield, which in the case of Antero is really all that matters.

Source: Moody’s Midstream Energy Rating Methodology (Registration required)

Scale

Scale is the first factor evaluated in the Moody’s methodology and it is deemed to be important as the size of a Midstream company is correlated to the safety and stability of the distributions paid.

Size typically plays an important role in gauging the credit strength of a midstream company, because it influences many of the core attributes that drive its resiliency to stress. These attributes may include, among other aspects, operational and financial flexibility, economies of scale, and the breadth of a company’s product and service offerings, customers and market reach. Operations of larger midstream companies tend to weather temporary disruptions better, owing to a generally broader mix of product and service offerings, geographical spread and exposure to producing basins

Source: Moody’s Midstream Energy Rating Methodology (Registration required)

Moody’s evaluates Scale in two ways 1) Based on Net PPE and 2) based on EBITDA. Reviewing the company’s latest financials, Antero Midstream has a Net PPE of $3.2 billion putting it in the lower end of the score with a B rating. The company also has a 9-month 2019 EBITDA of $252 million after adjusting for the one-time $400 million impairment charge in the Clearwater facility. Annualizing that figure we can get a 2019F EBITDA of $336 million which once again puts us on the lower range in the Moody’s methodology. These two sub-factors give us an overall rating of “B” for scale which not too surprising as Antero Midstream primarily services a single customer in a concentrated geographical area.

Source: Moody’s Midstream Energy Rating Methodology (Registration required)

Business Profile

According to the Moody's methodology, the business profile of an MLP is correlated to the safety and stability of its distributions. Along the Midstream Energy value chain, certain types of businesses carry higher risks. Historically the Natural Gas Gathering and Processing business is considered higher risk and volatile due to commodity price and volume risk. Natural gas gathering and processing is exposed indirectly to commodity price risk as when natural gas prices are weak, producers are inclined to reduce their drilling investment. When processing spreads are low, producers are inclined to minimize the percentage of their production that is processed, subject to ongoing compliance with pipeline content specifications.

Source: Moody’s Midstream Energy Rating Methodology (Registration required)

In the case of Antero Midstream, the company has hedged natural gas prices until 2021 however hedging prices can only do so much as volumes would be under pressure as margins. This is why the company has been extremely aggressive in its cost-cutting activities going so far as to idle an entire water treatment facility and eat an impairment charge of $400 million. Given that Antero Midstream and Antero Resources are joined at the hip, Natural Gas prices would spell trouble for the company. I am expecting this company to have a very high price and volume risk, therefore, assigning a rating of “Ca”.

Source: Investor presentation August 2019

Financial Analysis

For Midstream companies evaluating distributions, leverage and coverage measures are important indicators of a company's financial flexibility and long-term viability. This is evaluated by looking at the EBITDA/Interest Expense, Debt/EBITDA ratios and (FFO – Maintenance Capex)/Distributions. Using the available company data, we can see these ratios are 3.4, 7.6 and 0.8 respectively. Based on Moody’s methodology, Antero Midstream has a Ba rating on EBITDA/Interest Expense ratio a Ca rating on Debt/EBITDA ratio and a B rating for (FFO – Maintenance Capex)/Distributions.

Examining the financials, what worries me the most is the size of the debt at $2.5 billion vs an EBITDA of $336 million. I suppose an argument can be made in rolling over that debt perpetually given the current interest rate environment and the fact that Antero Midstream has a Net PPE of $3.2 billion which is enough collateral. Still, the best pathway for the company is some improvement in Natural Gas prices in the next two to three years.

Source: Author’s calculations using company 10-Q

Conclusion

Going through each of Moody's factors, we arrive at a final score for Antero Midstream at 16.6 indicating a Moody’s rating of high Caa/ Low B. Looking at the scorecard, I think this score is well-deserved given the company’s risky profile and large debt. The issue then becomes price as the market is pricing the company as if it were going bankrupt. The company’s current 26% yield is higher than similar Junk bond yields of 12.5% and even higher than the 15% junk bond yield during the Euro crisis. In fact, the only time the junk bond benchmark has been higher was during the 2008 financial crisis. The company has also survived at least one period of falling Natural Gas prices, which leads me to believe that the company can avoid bankruptcy should Natural Gas remain at these depressed levels.

Source: (ICE BofAML US High Yield CCC or Below Option-Adjusted Spread)

Another risk to consider is that the company could be cutting its dividend in order to save cash. However, it seems the company is going with a different approach of buying back shares at these depressed levels which would decrease future dividend obligations. I feel though a potential dividend cut sis already priced in at these levels.

Overall the company is definitely a high-risk play and not for the faint of heart. Still, I believe at these rock-bottom prices, the risks outweigh the rewards. I recommend building a position in this stock.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in AM over 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.

Additional disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in NVTA over 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.