Introduction
I am a huge fan of natural gas. I believe it's one of the best things "ever," as it is a clean-burning alternative to coal, a relatively cheap commodity making the energy transition easier, and a great way for investors to make money.
As we can see below, in 2008, natural gas accounted for roughly a fifth of the U.S. power generation. Last year, that number was 43%, pushing coal to less than 20%.
On top of that, it's now getting support from a somewhat unexpected driver.
As reported by TC Energy (TRP), one of the world's largest midstream companies, artificial intelligence and data centers will send natural gas demand much higher.
Gas demand for electricity to run data centers will increase by as much as 8 billion cubic feet a day by 2030, Stanley Chapman, TC Energy's executive vice president and chief operating officer of natural gas pipelines, said in an earnings call. That's equal to 21% of current US demand for the fuel in electric generation. - Via Bloomberg (emphasis added)
In other words, a fifth of current demand will be added by 2030 through data centers alone!
With that said, there are multiple ways to invest in natural gas.
- Upstream - companies that produce natural gas.
- Midstream - companies owning infrastructure needed to ship and process natural gas.
- Downstream - companies turning natural gas into value-added products like liquified natural gas, ready to be shipped to customers all over the world.
While I like companies in all three segments, this article is about midstream.
Midstream allows investors to benefit from long-term growth in demand without exposing them to natural gas price volatility.
As midstream companies own pipelines, they are paid based on throughput instead of the actual dollar value of the commodities flowing through their network.
Although this limits the upside in a time when natural gas prices are rising, it brings a lot of safety to the table, making the midstream segment a great place for income-focused investors.
That's where The Williams Companies (NYSE:WMB) comes in, a midstream giant that has returned 20% since I covered it on September 6.
Including dividends, the company has returned almost 100% over the past five years, as it benefits from a wide range of tailwinds.
In this article, I'll update my thesis using new developments in the natural gas market and the company's just-released quarterly earnings.
So, let's get to it!
In The Right Place At The Right Time
As strong as natural gas demand may be, prices do not reflect it - at least not yet. NYMEX Henry Hub prices are currently hovering close to $2 per MMBtu, which is similar to subdued levels in 2015, the pandemic, and way below the prices we saw in 2022.
The good news is that WMB's stock price does not care, as the chart in the introduction showed.
That's because WMB is a midstream company with limited exposure to the prices of natural gas.
This also means that if natural gas prices start to rise, investors will likely find more potential returns in natural gas producers. However, that's a discussion for another article.
What matters is that WMB benefits from rising natural gas demand.
I can make the case that WMB benefits from rising demand pretty easily, as WMB is the backbone of the U.S. natural gas industry. It's so large that higher demand will automatically translate to higher volumes.
Using the data in the overview below, we see that the company handles roughly a third of natural gas in the United States. Let me say that again. A third of all natural gas molecules flow through WMB's network!
These volumes are handled by a network consisting of more than 33 thousand pipeline miles in 24 states, serving major supply regions, including the Marcellus Basin, which is the biggest natural gas basin in the United States.
Using the data below, we see the tremendous benefits that come with a fee-based model, which has allowed the company to maintain consistent EBITDA growth during natural gas price shocks, as volumes usually remained very resilient.
With regard to the bigger picture, during its 1Q24 earnings call, the company added some color to my demand growth comments in the introduction of this article.
The company sees multiple tailwinds for natural gas, including low prices and its reputation as a practical, low-cost, and clean energy solution, making this commodity a key player for many decades to come.
Using S&P Global (SPGI) data, the company expects electricity demand growth to be three times stronger compared to pre-pandemic levels.
This requires investments in new infrastructure.
Since 2013, natural gas demand has risen by 43%. Infrastructure to deliver has grown by just 25%. Storage capacity has risen by just 2%.
In fact, in certain areas of the U.S., takeaway capacity is so bad that regional natural gas prices are negative.
The Permian is "desperately awaiting new eastbound takeaway later this summer," S&P Global analysts wrote April 23. They expect Matterhorn's effective capacity to "grow to its potential gradually through late 2024 and 2025," as demand ramps up from two new LNG terminals in Texas, Golden Pass LNG and Corpus Christi LNG Stage III. - S&P Global
With this in mind, let's take a closer look at its financials and what these may indicate for shareholder returns.
Firing On All Cylinders
Williams had a perfect start to this year, with a record for contracted transmission capacity, led by its Transco asset, the largest and fastest-growing natural gas pipeline in its portfolio.
Additionally, Williams closed a significant acquisition of natural gas storage assets from Hartree partners, expanding its portfolio with six underground storage facilities in Louisiana and Mississippi, making them the largest storage owner on the Gulf Coast.
Even better, because of the aforementioned underinvestment in natural gas storage, the company is now seeing the benefits of this underinvestment as newly acquired storage facilities are being re-contracted at rates exceeding expectations.
As a result, first-quarter EBITDA came in at $1.9 billion, 8% higher compared to the prior-year quarter, despite a 25% year-over-year decline in natural gas prices due to mild weather.
Growth was also provided by a significant contribution from fee-based infrastructure businesses, which saw an almost 13% increase.
- Adjusted EPS increased by 5%, maintaining a robust 5-year compound annual growth rate ("CAGR") of 19%.
- Adjusted EBITDA has been compounded at 8% since 2018.
- Available funds from operations ("AFFO") grew by just over 4%.
The dividend coverage ratio, which is based on AFFO, was strong at 2.6x, indicating a well-covered dividend.
The dividend is also protected by a healthy balance sheet, as debt to adjusted EBITDA remained within expectations at 3.79x. While this number is higher on a year-over-year basis, the company expects this number to drop back to 3.6x in 2025.
It has an investment-grade credit rating of BBB from Standard & Poor's, which makes sense as the company has a good leverage ratio of less than 4x EBITDA, a weighted average coupon rate of less than 5%, and a weighted average maturity on its debt of almost 11 years.
This buys the company a lot of time in the current environment of sticky inflation and elevated interest rates.
When combining a healthy coverage ratio, a strong balance sheet, and consistent earnings growth, we get an attractive dividend.
After hiking its dividend by 6.1% on January 30, the company currently pays $0.475 per share per quarter. This translates to a yield of 4.9%.
The dividend has been hiked for six consecutive years with an increasing growth rate, as the five-year CAGR is 5.4%, using Seeking Alpha data.
After maintaining a healthy balance sheet, dividend growth is its second-most important capital allocation priority.
While a 4.9% dividend yield is subdued compared to the 6-8% yields of peers like Antero Midstream (AM) and Kinder Morgan (KMI) - among many others - it needs to be said that growth is very consistent and often higher than expected, which bodes well for WMB's valuation.
Future Growth & Valuation
As I already briefly mentioned, due to its strong performance, the company revised its financial guidance. Williams now expects to achieve results in the upper half of the adjusted EBITDA range for 2024.
This means the company is looking for more than $7 billion in adjusted EBITDA, likely to be followed by a $400 million surge in 2025.
It also needs to be said that guidance is usually very reliable.
On the predictability front, we have met or beat analyst estimates for 33 quarters in a row now and beat the estimate 2/3 of the time over this 8-year period. - WMB 1Q24 Earnings Call
During its earnings call, the company highlighted its transmission and storage businesses as key drivers of future growth, with favorable effects expected from recent acquisitions.
Meanwhile, the transmission in the Gulf of Mexico segment was highlighted for its significant improvement, driven by contributions from acquisitions and higher revenues.
Now specifically for 2024, our transmission in Gulf of Mexico business is tracking a bit ahead of plan with a good first quarter and expectations of continued best-in-class execution on our many key high-returning organic projects, as well as immediate results from our Gulf Coast storage acquisition with strong performance expected going forward. - WMB 1Q24 Earnings Call
Moreover, the company is working on a Transco expansion, which is one of its 20 high-return projects.
This 3.1 billion cubic feet per day expansion translates to 15% growth in fully contracted long-term capacity that will come online over the next few years.
This pipeline expansion will add tremendous growth and takeaway capacity to major LNG terminals on the Gulf Coast.
Currently, 14.3 billion cubic feet per day of LNG capacity is already operational within the Transco footprint.
On top of that, 11.6 Bcf/d is under construction, with almost 14 Bcf/d in projects awaiting the final investment decision.
Analysts agree with the company's upbeat outlook.
Using the FactSet data in the chart below, analysts expect the company to gradually grow operating cash flow ("OCF") per share to $4.81 in 2026.
Currently, WMB trades at a blended P/OCF ratio of 8.4x, which I consider to be too low. Going forward, I'm applying a 9.5x multiple, which I believe to be more appropriate for a company that has a well-covered dividend, strong growth in AFFO, and projects that are expected to add substantial throughput capacity in the years ahead.
Even better, unlike in the past two decades, the natural gas industry is a lot healthier, including strong demand growth, more mature assets (less capital spending requirements), and much better balance sheets.
As such, I expect WMB to return >10% annually in the years ahead, including its 4.9% dividend.
Takeaway
Investing in natural gas, particularly through midstream companies like The Williams Companies, offers stability and growth potential in light of (rapidly) rising demand.
Despite subdued current prices, WMB benefits from its position as a key player in the U.S. natural gas industry, with a massive network and resilient fee-based revenue model.
Recent financial numbers support its strength, with record EBITDA and healthy dividend coverage.
Looking ahead, WMB's expansion projects, favorable industry dynamics, and analyst expectations suggest elevated future returns - despite its already impressive recent performance.
With a well-covered dividend and promising growth projects, WMB presents an opportunity for income-focused investors seeking consistent returns in what I believe to be a highly attractive industry.
Pros & Cons
Pros:
- Stable Income: WMB offers a robust dividend yield of 4.9%, supported by consistent dividend growth over the past six years and a healthy payout ratio.
- Resilient Business Model: As a midstream giant, WMB benefits from a fee-based revenue model, protecting investors from natural gas price volatility.
- Strong Financial Performance: Record EBITDA, solid dividend coverage, and a healthy balance sheet reflect WMB's financial strength and reliability.
- Positioned for Growth: With significant expansion projects in the pipeline (pun intended) and very favorable industry trends, WMB is poised to capitalize on rising natural gas demand.
Cons:
- Limited Price Upside: Investors looking to bet on rising natural gas prices are better off buying upstream companies, as midstream companies are less sensitive to pricing.
- Industry Risks: While demand for natural gas is growing, regulatory changes or shifts in energy policies could impact WMB's operations.
- Demand Fears: Although WMB has a very resilient business model, potential recessions could result in investors predicting lower natural gas demand.
Test Drive iREIT© on Alpha For FREE (for 2 Weeks)
Join iREIT on Alpha today to get the most in-depth research that includes REITs, mREITs, Preferreds, BDCs, MLPs, ETFs, and other income alternatives. 438 testimonials and most are 5 stars. Nothing to lose with our FREE 2-week trial.
And this offer includes a 2-Week FREE TRIAL plus Brad Thomas' FREE book.
