By: Dividend Sensei
Risks To Consider
Low risk doesn’t mean no risk, and it’s important for Antero Midstream investors to know what could go wrong in the future. The biggest fundamental risk is the total reliance on Antero Resources to supply the gas and NGL growth that will grow the MLPs’ cash flow over time. While Antero Resources is seeing booming profitability now and is well on its way to becoming a low risk gas producer, should energy prices crash then its growth potential could become severely impaired.
The good news is that based on its current breakeven price and balance sheet, the company wouldn’t be at risk of bankruptcy. Nor would it become unprofitable to continue producing gas from existing completed assets. That means that in another energy crash (say caused by a global recession) Antero Resources would remain profitable and continue producing at current levels. That in turn would mean that Antero Midstream’s DCF would likely remain safe and the payout would survive. However, without strong production growth from Antero Resources, it’s MLPs’ growth potential would fall significantly resulting in slower payout growth than currently expected.
The other risk to be aware of is a potential simplification of Antero Midstream’s corporate structure. On February 26th Antero Midstream announced the creation of an independent special committee to review all options for maximizing unitholder value for both MLPs. The review remains underway and there is no guarantee that anything will come of it, given that Antero Midstream’s growth is under a self funding business model. However, in the event that management wants to lower its cost of capital by eliminating the IDRs (which would make future growth more profitable) than two things might happen.
The first is that AM buys out AMGP’s IDRs with an all stock deal. That would reduce its cost of capital but also dilute existing investors and lower the coverage ratio resulting in slower than expected payout growth for the new few years. However, the MLP’s long-term distribution growth rate would actually benefit from not having to pay 50% of every payout hike to AMGP. What about AMGP investors in that scenario? Well since this MLP owns nothing but AM’s IDRs, that asset would then be traded for units of AM as dictated by the buyout terms. Ultimately this means that AM would be effectively buying AMGP and owners of the GP would be trading a lower yielding but very fast growing payout for a higher yielding but slower growing one.
The other potential form a corporate simplification could take, and what I consider more likely, is that AMGP might buyout AM, in a similar deal to what Tallgrass Energy just did. Tallgrass Energy GP bought out Tallgrass Energy Partners (c-Corp conversion for the MLP). As a result investors in the new TGE enjoy a safe 8% yield with 8% dividend growth. In such a scenario AMGP would likely greatly boost its distribution (move forward the next year’s worth of growth). Such a deal would be a taxable event for AM investors who would then have to pay the capital gains on the ROC tax liabilities they’ve accrued over time. AMGP investors would not be facing a tax bill but would instead wind up in a similar situation as the first simplification scenario, a much higher yield but with likely lower (but close to 10%) long-term dividend growth.
The overhang of this special committee is likely what is causing Antero Midstream’s price to languish despite its continued torrid growth rate. In the event that management doesn’t simplify the structure of these MLPs then the price will probably skyrocket as the uncertainty vanishes. If there is a simplification then investors will likely also benefit, as Tallgrass shareholders did when that uncertainty evaporated (TGE price up about 20% since c-Corp conversion). Basically, if you are considering investing in Antero Midstream just be aware of a potential future merger of these two MLPs, and make sure you’re comfortable with the potential outcomes of either simplification scenario.
Bottom Line: Antero Midstream GP Offers Everything A High-Yield Income Growth Portfolio Could Want
Antero Midstream GP Holdings represents the ultimate hidden gem among high-yield hyper growth income stocks. The low risk, self funding business model that Antero Resources and Antero Midstream are pursuing means that this MLP (which doesn’t use a K1) has far less growth execution risk than most fast growing peers. And while there is certainly some risk associated with a potential simplification of the corporate structure, even in a worst case scenario investors will end up owning one of America’s best high-yield income growth stocks. One that is likely to generate: generous, safe, and fast growing income (and market crushing returns) for the next decade.