Antero Midstream: Decent Dividend But Rich Premium (NYSE:AM)

Investment Rundown

Seeking out a strong and reliable dividend-yielding business is no easy task. A company may have sound dividend yields but it may also be supported by issuing shares or taking massive amounts of debts instead ultimately leading to a high leverage ratio. The last report from Antero Midstream Corporation (NYSE:AM) showcased resilience in the FCF of the business as the FCF grew by 31% YoY. The market has been bullish on the prospects of the company the last couple of months but I think that despite the improvements, the share price doesn’t constitute a good entry price, unfortunately. For this reason, I am rating AM a hold until the price corrects and reaches my preferred target range of $9 – $10.

Company Segments

AM operates both low-pressure and high-pressure gathering pipelines, primarily catering to its parent company, Antero Resources (AR), which holds a 29% stake in AM. The majority of the midstream company’s contracts are structured as fee-based or service-based agreements, often with inflation escalators. From its parent company, AM typically receives 33 cents per thousand cubic feet for low-pressure gathering and 20 cents per MCF for compression services. When serving third-party clients, the fees tend to be higher, providing an additional revenue stream for the company.

As an interesting side note as well, the company has diversified into the water business, generating approximately $4.21 per barrel from fresh-water delivery in the last quarter. This water segment now constitutes roughly 15% of the company’s overall revenue, contributing to its overall financial stability and growth potential.

The asset growth of AM is trending upwards right now and is approaching $6 billion quite quickly. This has quite potentially affected the company FCF which has been trending upwards over the last several years. Some of the key objectives for the company have been to reduce the debt levels and deliver stable FCF and distributable cash flows as well.

With a 5-year outlook of the EBITDA growing by 2 – 4% annually, I think that AM could maintain the current dividend. In the last 12 months, the dividends paid have been $434 million in total. The yield sits above 7% right now and has been growing quite well over the last few years. Over the last 5 years, it has averaged a nearly 20% annual increase in the dividend, but I think it is important to realize that the dividend is also down from the highs it had in 2020 at $1.23 per share for the full year. The pricing environment I think needs to improve for AM to be able to increase the FCF further. There is a general push towards more renewable energy projects in the world but I think that for the coming decades, we will see a continued rise and stable usage of both oil and gas. Seeing as the main part of investing in AM is about capturing the dividend yield, seeing steady growth to it I think is what would support further share price appreciation.

Valuation

As for the company’s EPS estimates, they have been revised down in the last few months which doesn’t seem to have affected the share price that much. I think as the broader market is experiencing some turmoil right now, investors are seeking out more stable and income-based opportunities, where AM fits the criteria quite well. I am worried though that in the short term the price may correct, but this could be a potential buying opportunity if it reaches the target range I have of $9 – $10 per share. The reason for this range is that back in May this was the last support line for the share price as seen in the chart above the paragraph here. Finding a support line like this is important as it gives a very good idea about where the share price may land if there is a broader market correction. Furthermore, around this price range AM trades at a similar earnings multiple as the rest of the energy sector. When investing you want to get a fair price, and AM doesn’t necessarily display the qualities that would justify a premium multiple. FCF are for example negative and net income has not grown that much since 2021. I still see growth in the coming years, but not enough that paying a 34% premium is worth it right now. If we see a correction I think this is potentially where we might end up.

I have made it quite clear my buying range is between $9 – $10 per share, which equates to a p/e of roughly 10. AM has a dividend which makes looking at the earnings the best way to gauge value here in my view. This p/e range would provide no premium to the sector and also leave an even higher dividend yield, closer to 10%.

Looking At The Dividend

In the last couple of years, the dividend yield has largely decreased for the company, a result of the share price appreciating. With a yield of over 7% though I think that a lot of investors are still quite interested in the company and the prospects of making it a dividend income addition.

Where I remain slightly worried about the dividend is the dilution of shares that has occurred over the last few years. If AM is compelled to dilute shares to support the payment of the dividend it is really not very sustainable and we may get a cut to it should things get out of hand, like even higher interest rates, pressuring the net income. The dividends the company pays out are significant but seem to have largely been supported by strong FCF throughout the cycle. If however, AM is having to issue shares to be able to support the dividend I find that the actual value of the company is quite poor. It seems though that in a recent quarter it has stopped and I will be looking at this particularly in the coming quarterly reports from AM.

Risk

One of the prominent risks facing AM is the possibility of a general market downturn, which could adversely affect the company. Another risk is the potential impact on its dividend stemming from significant declines in natural gas prices that might lead AR to reduce its output. Such a scenario could negatively affect cash flows and free cash flow generation. Considering the recent improvement in free cash flow, the market appears to anticipate its continuation. Therefore, any failure to sustain this positive trend could result in a substantial decline in the company’s share price.

Considering the rapid increase in AM’s share price over the past few months, there is a potential concern that if the upcoming quarters reveal a plateau in cash flows, a significant correction could be on the horizon. It’s worth noting that AM currently trades at a substantial 88% premium above the sector’s p/fcf median. This elevated valuation leaves room for significant downside risk, particularly if the company’s financial performance does not align with market expectations.

Final Words

For investors who seek a value play in the energy sector that also pays out a dividend, I think that AM isn’t necessarily the best option right now. The company does pay out a strong dividend yield of 7%. However, the price has accumulated quite quickly over the last few months and it has entered a zone where I would consider it slightly overvalued. Until the share price reaches my preferred buying range of $9 – $10 where the p/e would be more in line with the broader sector median I will maintain a hold rating for AM.