Article Thesis
Western Midstream Partners, LP (NYSE:WES) is not among the largest energy or midstream companies, but it offers one of the highest dividend yields that is available today, at 8.5%. While shares have rallied substantially over the last year, they still aren’t expensive today. For someone looking for a high yield from a company with a K-1, Western Midstream Partners remains a solid choice.
Company Overview And Macro
Midstream companies are active in gathering, compressing, transporting, and storing natural gas, and they also move crude oil and refined products. Some are more focused on natural gas, such as Kinder Morgan (KMI), while other midstream players are primarily active in liquids.
Western Midstream belongs to the midstream companies that are active in both natural gas and liquids (crude oil and NGLs), and it also moves gathers and moves water, which isn’t very common among midstream players. While many other midstream companies are doing business with many different companies, such as oil and gas producers, Western Midstream primarily works with Occidental Petroleum (OXY), which is the biggest customer by far. OXY also owns around half of Western Midstream Partners’ shares; thus, the two companies are closely tied.
For midstream companies, commodity prices are not very important. Their revenues can be fee-based, e.g. they get a fixed amount of dollars per unit of natural gas moved from A to B, or commodity prices are a flow-through item, e.g. when midstream companies buy commodities in place A, move them to place B, and sell them there. In that scenario, both revenues and costs are moving in the same direction when commodity prices move, thus profits and cash flows are not heavily impacted by commodity price movements. Instead, gathering, processing, and transportation volumes are oftentimes more important compared to the value of the commodities that are being gathered, processed, and transported. While upstream producers are highly impacted by commodity price movements, midstream companies are way more insulated. This means that they don’t benefit as much when energy prices rise, but they also are pretty insulated when prices decline, such as during a recession or the COVID pandemic when lockdowns caused oil prices to fall pretty hard.
The war in Ukraine has forced the EU to become independent of Russian energy, which naturally means that Europe has to import its energy commodities elsewhere, as Europe does not produce a lot of oil and natural gas. The United States has become a key supplier of both oil and natural gas (in its liquified form) for its partners across the Atlantic, which naturally is good for energy producers in North America. With rising demand from export markets, North American producers have a good reason to produce oil and natural gas at a strong pace, which results in strong transportation volumes for North American midstream companies. The entire industry has benefited from that, including Western Midstream Partners. Since the macro picture of strong export demand hasn’t changed, I expect more of the same going forward.
In fact, with GDP growth in the EU being forecasted to accelerate from 0.4% in 2023 to 1.0% in 2024 and to 1.6% in 2025, it is likely that the continent’s energy hunger will grow further — which could result in even higher exports from North America, which, in turn, would be good for North American energy producers and the companies that help them move their products — including WES.
On top of that, there is another macro trend that could help Western Midstream and its peers going forward. AI has gotten massive attention, but investors mostly focus on tech companies as potential beneficiaries. But since AI data centers require massive amounts of electricity 24 hours a day, 365 days a year, natural gas demand could see a significant boost. Using natural gas for electricity production is cheap, way cleaner than using coal, and it is available all the time, unlike, for example, solar. With electricity consumption soaring, the natural gas industry could benefit significantly from the ongoing AI theme — this includes midstream companies with natural gas assets, such as Western Midstream Partners.
Western Midstream: Appealing Execution
Going from the macro view to the company view, let’s take a look at Western Midstream’s most recent quarter and the outlook for the current year. WES started the year strongly, showcasing revenue growth of 21% and generating a new Q1 record-high EBITDA of a little more than $600 million. This was driven by strong underlying business growth. Thanks in part to the macro tailwinds for the US energy industry, Western Midstream hit new records when it came to natural gas throughput levels on a company-wide basis and in the Delaware Basin specifically. While crude oil and NGLs throughput was down sequentially, that was due to a couple of non-core asset sales. When we focus on the company’s operated assets only, throughput in the liquids segment was up as well, indicating a positive environment and business performance.
Unlike many other midstream companies, Western Midstream didn’t report a distributable cash flow number, but we got a $400 million operating cash flow result and a free cash flow result of $225 million for the first quarter. While cash flows can be impacted by working capital movements throughout the year, the company’s guidance for the current year gives us a pretty good indication of what its cash flows could look like during the remainder of the current year. Western Midstream guides for growth in the double-digits for natural gas, produced water, and crude oil & NGLs throughput; thus, it looks like the company will continue to capitalize on the aforementioned industry tailwinds.
These will help the company grow its EBITDA to $2.2 billion – $2.4 billion this year, while free cash flow is guided at $1.05 billion to $1.25 billion. In the most recent earnings call, the company’s CEO Michael Ure stated (emphasis by author):
Also, based on the latest producer forecasts, we expect these throughput trends to continue throughout the year. Thus, we now expect higher average year-over-year throughput growth rates for all products, and we expect to end up near the high end of our previously disclosed adjusted EBITDA and free cash flow guidance ranges.
Based on this statement, I believe that $2.35 billion in EBITDA and $1.2 billion in free cash flow are reasonable estimates for this year, as the original guidance midpoints for both metrics should be beaten if nothing unforeseen happens (such as operational problems at an important asset).
WES Offers A Strong Yield
The company also guides for at least $3.20 per share in distribution, which gets us to the next point: Western Midstream’s attractive shareholder returns. The $3.20 per share level will be hit if the dividend is kept stable at the current level of $0.875 per share per quarter, which is substantially higher than the payout from the first quarter, as WES raised its dividend by a hefty 52% in April. On a forward basis, the dividend is thus $3.50 per year, but since the Q1 payout was lower, total dividends in the current fiscal year will likely be $3.20 instead of $3.50, unless there is another dividend increase later this year, which I do not expect.
For someone buying today, the Q1 payout isn’t important, of course, as that one has passed anyway. Instead, someone buying today will be interested in what payout they can expect over the next year; thus, we can calculate the current dividend yield with a $3.50 per share number, which gets us to a yield of 8.5% — which is highly attractive. Even other high-yielding midstream names such as Energy Transfer (ET) or Enterprise Product Partners (EPD) are currently offering somewhat lower yields of 7.9% and 7.1%, respectively. Upstream and downstream companies tend to invest more in their operations, which is why they mostly have lower yields as well, meaning Western Midstream Partners is one of the highest-yielding names in the entire energy industry (upstream, midstream, and downstream) today.
When it comes to dividend coverage, the dividend looks reasonably safe. Using the $3.20 per share guidance for the current year, the dividend should cost the company around $1.22 billion in 2024, which is basically in line with the company’s free cash flow guidance. This means that Western Midstream could theoretically pay for all of its growth spending without using debt, but that is not really necessary. Leverage is low, at 3.0x EBITDA; thus, there wouldn’t be any problem in financing a portion of the company’s growth spending. WES could thus pay out even more than its free cash flows if it wanted to.
WES: Up A Lot But Still Attractive
Over the last year, WES has gained 53%, not accounting for dividends. Naturally, this has made shares more expensive both in absolute terms and in relative terms, as cash flows and EBITDA did grow, but not this massively. But despite the fact that Western Midstream Partners is now more expensive than a year ago, it is still attractively priced: The earnings multiple for the current year is 10.0 and the enterprise value to EBITDA multiple is in the single-digits as well. Waiting for a better entry point could pay off as not everyone likes to buy close to the 52-week-high, but for a long-term-oriented investor, buying this very high-yielding midstream company today should still work out fine.
Note that WES issues a K-1 — some investors like that as it can be a tax advantage, but it also is more work, which is why some investors don’t like K-1-issuing investments.
