Over the past day, investors on the Robinhood platform have been hot for a natural gas pipeline company called Antero Midstream (AM). In one day, according to Robintrack, the number of Robinhood accounts holding Antero Midstream jumped more than any other stock, from 15,500 to 30,000.
Oil and gas analyst Paul Sankey noted the odd popularity in his morning email today, saying, “I’m mystified.”
What could the Robinhooders like? Momentum maybe. At $6.83 per share midday Friday, Antero Midstream has nearly trebled in value since March. More fundamentally, they may appreciate Antero’s recent efforts to cut spending and boost distributable cash flows. Plus, given strength in natural gas prices (if you can call $3 per mmBtu strong), and a deep slowdown in oil drilling, there’s good reason to believe gas companies in the Marcellus shale have better days ahead. Assuming AM manages to continue its 30.8 cents in quarterly dividends, its implied yield would be 17.7%.
However, cautions Sankey, buying AM doesn’t really make that much sense — once you look at the value proposition offered by its parent company, Antero Resources (AR, $3.47). While Antero Midstream moves the gas and owns the pipes, Antero Resources drills and fracks the gas, and owns the reserves.
Antero Resources also owns a 29% equity stake in Antero Midstream. This is where it gets interesting. Given current equity valuations, Resources stake in Midstream is worth $944 million, which is more than the entirety of Resources’ current $926 million market cap.
On its face, that makes it look like Antero Resources should be the stock getting the Robinhooders excited. The company is America’s third-biggest producer of natural gas (after EQT and ExxonMobil XOM ), doing 3.5 billion cubic feet per day.
Be careful there as well. AR shares have already quintupled since March, when they bottomed out on fears of bankruptcy amid the initial Covid-driven collapse in energy demand. S&P Global Ratings has Antero Resources on negative credit watch, with concern that it could end up in “selective default” on some of its bonds. Antero is in the process of holding a dutch auction for some of its notes due 2022 and 2023, with an expectation that holders may receive at little as 72 cents on the dollar. Still, that’s up a lot from the 30 cents at which Antero Resources bonds were trading in March.
Antero Resources isn’t safe yet. Even after completing $750 million in asset sales and $250 million in refinancings, it still carries $3.25 billion in debt and more than $2 billion in associated lease obligations. That’s a big liability burden. But is it so big that the implied value of its equity (after backing out its 29% of Antero Midstream) should be less than $0?
Sankey (ex-Deutsche Bank, newly of Sankey Research) says that the long-term economic case for natural gas remains strong. California’s combined blackout and wildfire crises “underline the need for baseload natural gas fired power genertion to offset renewaables growth. There is essentially a choice between nuclear and natural gas, and way less demand. Way less demand is not popular among consumers.”
For years the pure-play natural gas producers like Antero lagged oil-focused competitors in the Permian and Bakken. But that paradigm has switched. As oil drillers cut back their new drilling to save cash, it has meant a dramatic reduction in supplies of so-called associated gas — the natural gas that comes up the well along with the more valuable oil. Decades ago drillers would just flare off this associated gas. These days it provides a large portion of national supplies. Associated gas from the oily Permian basin of Texas grew from 1 bcfd to 6 bcfd by 2019, before falling off this year.
Thanks to Covid-19 demand destruction, U.S. gas production has tumbled from an all-time high of 94 billion cubic feet per year last November, to around 86 bcfd now, according to S&P Global Platts. The number of active rigs in the U.S. is down by 465, or 74%, since the Covid-19 pandemic.
Naturally, this frees up potential market share for Antero Resources, which figures it can keep its output flat by drilling 65 new wells per year — for about $600 million in capex per year, less than half its run rate a few years ago, but a modest enough pace to ensure enough free cash flow that the company can live within its means, and its debt load.
If buying AR is a good way to get exposure to AM, do you really want to own AM? Considering that Antero Resources is by far the biggest gas provider to Antero Midstream, slow growth on the resources side could make it tough for Midstream to grow its own business. However, the company, in its recent investor presentation, explains that low or even no growth might be ok, because of how it has eliminated its capital spending. Antero Midstream spent billions constructing 430 miles pipelines and processing plants from 2012 to 2017 (it switched in 2019 from being an MLP into a C-Corp). Now those are in operation, and there’s no other long lead time projects on the board. Midstream expects its capital spending to decrease 68% this year over 2019, to around $200 million. Distributable cash flow is up 600% this year to $600 million. Is it enough to defend that 17% dividend (30.8 cents per quarter)?
Analysts at Tudor, Pickering & Holt, in their research note this morning, said AM is overvalued, and growth challenged:
“Recently updated investor deck provided a first look at 2021 capital budget expectations, with indicated $175-200mm representing a 10% y/y decline (at the midpoint) though low-teen’s FCF yield still falls short of elevated dividend payout (17.6%). While incremental improvements to cash flow profile and sponsor liquidity screen positively, lack of upstream activity follow-through to a rising natural gas strip results in little benefit to AM earnings profile. Further equity upside likely limited as 2021 EV/EBITDA valuation of ~8.0x screens toward the upper bound of G&P peers while FCF yield trends toward the bottom of the group, reducing viability of material deleveraging in a low-growth environment.”
As for Sankey, he suggests a better option is pipeline behemoth Enterprise Product Partners EPD , a more diversified company, with only a 10% yield. “I always maintained, retail buyers are smart. I’m just not sure why they aren’t loading up with Enterprise Product Partners right now. Maybe 10% yield is not enough. It’s plenty for me.”