- The distribution increased 20% effective in the current calendar year.
- The debt ratio will remain at a midstream industry leading 2.0 or lower.
- Common unit purchases will continue opportunistically.
- EBITDA is forecast to grow.
- Not much capital expenditures is needed in the near future to accommodate growth plans.
- This idea was discussed in more depth with members of my private investing community, Oil & Gas Value Research. Learn More »
Rattler Midstream (RTLR) announced a partial restoration of the distribution to $1.20 per share. That is in addition to guiding to still more growth in the latest fiscal year. Management reported adjusted EBITDA of slightly less than $300 million for the fiscal year. But then guided to adjusted EBITDA of at least $320 million in the future. There were also some common units purchased in the latest quarter. All the time this is going on, management plans to keep the key debt ratio at 2.0 under the guidance.
Most know that the major customer, Diamondback Energy is investment grade. Therefore, the financial strength of the subsidiary is effectively capped at a decent rating because of the rating of the major customer (and parent company). This is an unusually sound company that offers investors both growth and a very lucrative distribution for the current fiscal year.
I follow a lot of midstream companies. No midstream company I follow has a debt ratio this low. Midstream companies are often thought of as the utility companies of the oil and gas industry. This company has the additional advantage of an investment grade parent company that is among the best managements I follow. This is the kind of thing that lowers the risk of investing considerably.
Any talk of the partnership not being able to pay the distribution is absurd on its face. When the debt ratio is below 2.0, the market is wide open for the company to borrow. Therefore, this company has a lot of flexibility to debt finance the capital budget while paying a larger distribution. Here it is the choice of management to run the midstream partnership conservatively. That is a very important distinction from those that "have" to cut the dividend because of financial issues.
The common units have begun to recover in price along with much of the midstream industry. But the guidance of some growth in EBITDA and cash flow assures investors of a continuing stream of future distribution increases along with some capital appreciation. That is a very rare combination that can prove lucrative for the income investors.
Despite the extremely low leverage, the common unit price still yields a very attractive distribution that is likely to invite more appreciation in the future. Now midstream companies like this one that are controlled by the main customer are often run very conservatively. Distribution cuts can occur if management decides that the cash has a better use elsewhere. Long term, management appears to want to keep that financial leverage very low.
Management will likely continue to repurchase shares on an opportunistic basis. That could add a percentage or two to the guided company growth rate depending upon how much of the authorized repurchase is executed. The nice part about share repurchases is that same money can be used instead to grow the business should a suitable acquisition or business opportunity present itself.
Rattler does not completely service all of the Diamondback Energy (NASDAQ:FANG) acreage. Therefore, growth rate of Rattler is likely to differ from the growth rate of Diamondback for the time being.
The best news is that the major cash expenditures both for joint venture projects and for Rattler's own operations are done. As is shown above, Rattler has considerable capacity to grow without needing a lot of cash expenditures.
Similarly, many of the joint venture pipelines are reporting something along the same lines. They are filling up as Permian production increases. However, that will take a while. As it does, the cash flow growth will continue with some minimal capital expenditures.
It is going to take a considerable amount of time before this midstream company needs a major capital expenditure to support the growth of Diamondback Energy. At one point, the midstream partnership funded several joint ventures at one time while building supporting infrastructure for Diamondback Energy. All those expenditures are unlikely to happen at one time in the future.
One of the larger issues that will impact the Permian as it did Eastern Oklahoma a few years back is the earthquake issue that is caused by deep water disposal wells. The industry is tackling the issue by recycling the water rather than disposing of it and getting more clean water.
Clearly with the number of earthquakes in Texas making this an issue similar to what happened previously in Oklahoma, the situation needs to be dealt with before it gets as bad as it did in Oklahoma. The industry needs to demonstrate that it learned from the previous experience. The slide above appears to show that the industry is coming to that realization.
Water is already scarce in the Permian because much of the Permian is located in an area where it does not rain much. Therefore, whatever water becomes available (in whatever condition it is in) is probably best used and reused. It might even be a good idea to treat the remaining water to send to either farms or cities in the area so the stress on the water supply is reduced.
Diamondback Energy is pursuing a growth strategy in an attempt to reduce its own production costs. Many companies with this setup view the distributions received from a "captive midstream" like this one as a reduction of transportation costs. So, Rattler is an important part of Diamondback Energy's low-cost strategy.
Rattler does participate in several projects that include customers besides Diamondback. In theory, this could lead to Rattler growing to the point where it completely offsets the transportation costs incurred by Diamondback through the distributions returned. To say that would make for an interesting presentation completely understates the potential accomplishment.
I cover several of these captive midstream companies that have one major customer. All are run extremely conservatively. In some cases, the past few years have caused the major customer to hit the "pause button" when it comes to growth plans. Here, Diamondback is likely concentrating on consolidating recent acquisitions because they were fairly large.
But that does not mean that growth needs to stop for the midstream company. There is a lot of Diamondback acreage that this midstream company does not serve. That will provide additional growth opportunities in addition to the growth guided by the parent company.
The preliminary guidance is for some growth. That growth may come into better focus as the year unfolds. The first quarter will be an early report on the progress made by the midstream after some disposals and a dropdown. That could foretell a different future growth rate from the parent company (which is highly likely).
That means that Rattler is likely to grow faster than Diamondback Energy for the foreseeable future. It is very rare for an income vehicle to show steady growth at the rate of current guidance.
Younger investors may elect to "DRIP" the returns because they don't need the distribution at the current time. Meanwhile, older investors can elect to spend a likely growing cash flow. In an era when inflation is likely an issue, this is an income investment idea that is likely to provide some inflation protection. So, these common units are likely to be of interest to a wide variety of investors for years to come.
I analyze oil and gas companies, and related companies like Rattler Midstream in my service, Oil & Gas Value Research, where I look for undervalued names in the oil and gas space. I break down everything you need to know about these companies -- the balance sheet, competitive position and development prospects. This article is an example of what I do. But for Oil & Gas Value Research members, they get it first and they get analysis on some companies that is not published on the free site. Interested? Sign up here for a free two-week trial.
This article was written by
Long Player believes oil and gas is a boom-bust, cyclical industry. It takes patience, and it certainly helps to have experience. He has been focusing on this industry for years. He is a retired CPA, and holds an MBA and MA.He leads the investing group Oil & Gas Value Research. He looks for under-followed oil companies and out-of-favor midstream companies that offer compelling opportunities. The group includes an active chat room in which Oil & Gas investors discuss recent information and share ideas. Learn more.
Analyst’s Disclosure: I/we have a beneficial long position in the shares of RTLR FANG VNOM either through stock ownership, options, or other derivatives. 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.
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