Kinetik Has Continued Growth Potential, But Be Careful Of Dilution (NASDAQ:KNTK)

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Kinetik Holdings (NASDAQ:KNTK) is a new multi-billion player in the midstream industry, formed by the merger of Altus Midstream – APA Corporation’s (NYSE: APA) midstream holdings – and EagleClaw Midstream. The company has become a mid-size player in the midstream space, and as we’ll see throughout this article, with its unique and integrated asset portfolio, it has the ability to generate substantial returns.

Kinetik Holdings Transition

Kinetik Holdings is in the midst of a transition now that it’s merged. We see continued consolidation as a hallmark of the midstream industry.

Kinetik Holdings Transition

Kinetik Holdings

Kinetik Holdings has reliable fee-based contracts. The company has significant benefit with the spare capacity on its pipeline and a conservative financial policy. The company is committed to its $6 annual dividend, more than 9%, with 5% annual growth starting next year. That shows the company’s strong dividend and its continued potential to drive shareholder rewards from this.

The company is working towards a 3.5x leverage target, a strong affordable target, and is committed to achieving investment grade credit ratings. We expect more consolidation for the company going forward, especially as many midstream names remain cheap.

Kinetik Holdings Assets

Kinetik Holdings has an impressive asset portfolio with substantial growth potential.

Kinetik Holdings Assets

Kinetik Holdings

The company is the 4th largest Permian Basin processor with 2 Bcf / day in nameplate capacity and 850 thousand dedicated acres. The company also has a much smaller fee-based crude / water system. From the Delaware Basin, the company has the GCX and PHP pipeline stakes that will likely see steady utilization along with its other export pipelines.

Especially with the global growth in LNG demand the potential for new terminals, we expect demand for the company’s assets to grow. There’s two important things that we want to highlight here.

(1) Integration. The company’s merger was fairly recent and the company is working on integrating and combining various assets when looking for synergies. We expect that to have some upfront capital requirements but generate very high returns on investments.

(2) Spare Capacity. The company’s system, partially due to overbuild, is now much larger than it needs to be. The 1.9 Bcf/day nameplate capacity only has ~1.1 Bcf/day moving through it. That means you’re reaping the financial rewards of the overbuild, as volumes increase, revenues and earnings will increase with minimal additional capital requirements.

This nameplate capacity can provide hundreds of millions in additional FCF.

Kinetik Holdings Balance Sheet

Kinetik Holdings has a strong and improving balance sheet.

Kinetik Holdings Balance Sheet

Kinetik Holdings

Kinetik Holdings is focused on redeeming its Series A preferred and achieving a 3.5x leverage target with investment grade credit ratings. It’s worth noting in 2022 the core shareholders are all dripping (i.e. diluting the stock) which we see as a significant downside, even if the same option is available to all other shareholders.

However, the preferred redemption will simplify the capital stack. The company expects strong dividend coverage, but again this is a poor metric when counting the DRIP.

Kinetik Holdings key highlights

Kinetik Holdings

Kinetik Holdings expects adjusted EBITDA of roughly $790 million with $135 million in capital expenditures. The company’s strongest segment is expected to be natural gas. Again these earnings are before the company’s spare capacity showing the importance of the company not only having spare capacity but utilizing it.

It’s worth noting the company’s maintenance capital is incredibly small ($15 million), and the company is spending $55 million on growth and $55 million on integration. These are short-term capital expenses that will generate strong shareholder rewards.

Kinetik Holdings Financial Potential

Overall, Kinetik Holdings has strong shareholder return potential.

The company has roughly $800 million in annual EBITDA with the ability with its continued growth capital and spare capacity to push that well over $1 billion. The company turns that into hundreds of millions in DCF with a relatively low debt ratio. The company can comfortably pay its almost 10% dividend forming a primary return of shareholder returns.

If the company can continue spending roughly $50 million in annual growth capital and increasing its dividend at 5% annually, it can comfortably generate double-digit shareholder rewards. The company doesn’t need to do anything else. We do expect increased consolidation and synergies, that show the company’s financial potential.

Overall this is a unique new company with the ability to generate continued growth and double-digit shareholder rewards.

Kinetik Holdings Risk

Kinetik Holdings risk is minimal. The company has minimal financial risk, strong backing, and strong growth and synergies. Spare capacity not only lowers risk from volume declines but it adds growth opportunity. However, the company is still susceptible to price declines and the resulting volume declines hurting the company.

The company suffered from APA Corporation declining rig counts in Alpine High and there’s no guarantee that in a tough environment it doesn’t happen again.

Conclusion

Kinetik Holdings has a unique ability to generate substantial shareholder rewards. The company is already paying a 9% dividend with a commitment of a 5% dividend growth starting in 2023. On top of that the company is continuing to invest in both synergies and growth capital spending which will provide additional growth.

Long-term, Kinetik Holdings is a valuable investment. The company’s dividend alone makes it a worthwhile investment on its own. More so, the company has recently had a successful merger and given the strong financial backings from Blackstone, etc., we expect increased synergies and growth.

Let us know your thoughts in the comments below.

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