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Both Energy Transfer (NYSE:ET) and Antero Midstream (NYSE:AM) are high yielding midstream businesses. However, while their current yields are attractive, investors in both businesses endured a steep payout cut in the wake of the COVID-19 outbreak and energy market crash. ET halved its distribution from $0.305 per quarter to $0.1525 beginning with its 11/19/20 payout and AM slashed its quarterly dividend from $0.3075 to $0.225 beginning with its 5/12/21 payout.
That said, both businesses have made solid fundamental progress since those payout cuts and stand on firmer fundamental footing today with positive outlooks for the years to come. Overall, we prefer ET over AM at the moment, and share three reasons why in this article.
#1. Better Diversification
AM has a solid portfolio of fully integrated midstream assets that is 85% focused on natural gas processing and gathering in the U.S.’s lowest cost natural gas basin. Furthermore, its sole client – Antero Resources (AR) – is retaining a lot of cash flow and using much of it to pay down debt aggressively in pursuit of an investment grade credit rating. As a result, it should not have any issues with having its midstream contracts honored for the foreseeable future. That said, AM’s business is quite small in scale and is very concentrated in terms of geography and counterparties, as it is largely dependent on a single basin and a single counterparty.
In contrast, ET has one of the best diversified midstream businesses out there with a fully integrated portfolio of midstream assets that include nearly 120,000 miles of pipeline across 41 states and a strategic footprint in all of the major production basins in the United States. It also generates a well-balanced income stream from a variety of business segments, including natural gas midstream, intrastate and interstate transportation and storage, crude oil, NGL and refined product transportation and terminaling, NGL fractionation, and various acquisition and marketing assets. As a result, ET transports roughly one-quarter of all U.S. natural gas, over one-third of all U.S. crude oil, and exports approximately one-fifth of worldwide NGL exports. On top of that, its cash flow profile is very stable, with about 90% of its 2022 expected adjusted EBITDA coming from fixed-fee contracts.
As a result, ET exposes investors to far less downside risk than AM, resulting in a superior risk-reward on a fundamental level.
#2. Better Payout Growth Potential
ET also offers investors vastly superior payout growth potential relative to AM.
AM’s management stated on its latest earnings call that during Q2 its free cash flow was just enough to cover its dividend. As a result, at present there is no room to increase the dividend without taking on debt to do so. Given that AM’s credit rating is a mere BB from S&P, AM is not in a position where it wants to do that.
In fact, even though management expects to finally begin generating positive free cash flow net of dividends in the second half of this year, it is not planning on raising the dividend in the near term. Instead, it plans on deleveraging aggressively in order to improve the credit rating and further strengthen the balance sheet overall by reducing its leverage ratio from 3.6x to below 3.0x.
As management stated recently:
Looking to the back half of the year and beyond, we expect to generate increasingly positive free cash flow after dividends. This is driven primarily by declining capital as we completed some key growth projects such as the Castle Peak station in the first half of the year. This allows us to begin paying down debt and reducing our leverage towards our 3x target.
Looking to 2023, we expect the EBITDA growth and declining capital to result in significant free cash flow after dividends. This trajectory is expected to continue further into 2024 and beyond as volume grows, the fee rebate with AR expires and capital declines. The increasing free cash flow after dividends will result in increased debt paydown and reducing our leverage towards our 3x target. We expect to achieve this 3x leverage target in 2024, at which point we will evaluate further return of capital strategies.
In contrast, ET is in the midst of a rapid distribution growth spurt, which is being fueled by a significant amount of free cash flow generation net of distributions. As management stated on its latest earnings call:
On July 26, we announced a quarterly distribution of $0.23 per common unit or $0.92 on an annualized basis, which represents a more than 50% increase over the second quarter of 2021.
As a reminder, future increases to distribution level will be evaluated quarterly with the ultimate goal of returning distributions to the previous level of $0.305 per quarter or $1.22 on an annualized basis…we will continue to evaluate returning additional capital to our equity unitholders through distribution growth on a quarterly basis.
While AM is not even considering increasing its dividend until 2024 at the very earliest, ET has already increased its quarterly distribution by over 50% in a single year and could very likely increase it by a further 33% in the coming quarters. This overwhelmingly more bullish outlook for ET’s distribution growth should provide it with a much stronger equity price catalyst relative to AM, making it a more attractive near-term bet.
#3. Much Better Value
While ET’s vastly superior diversification relative to AM results in lower downside risk and its convincingly more compelling near-term payout growth potential also provides it with a greater short-term upside catalyst, ET’s long-term upside potential is also superior to AM’s in our view. This is largely due to the fact that its valuation is more attractive at the moment.
Whereas AM’s price to 2022E DCF ratio is 7.4x and its price to 2023E DCF ratio is 7.0x, ET’s price to 2022E DCF is a mere 4.7x and its price to 2023E DCF ratio is only 4.6x. Furthermore, ET’s EV/EBITDA ratio is only 7.79x right now whereas AM’s is 8.67x.
Investor Takeaway
Between its diversification that is among the best in the industry and stronger balance sheet that give it a lower risk profile than AM, its much strong near-term distribution growth potential, and its considerably cheaper valuation, ET is a much more compelling midstream investment than AM is in our view.
The only reasons why we think AM might be worth buying either instead of or in addition to ET is due to the fact that it is more of a pure play on natural gas, and it also issues a 1099 tax form in contrast to the K1 tax form that ET issues. We rate ET a Strong Buy and AM a Buy right now.
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