Calculated Moves Secure DKL's Future In The Permian Basin With Promising Profit Margins

Key Takeaways

• Extension of the contract with DK and acquisitions, including the W2W pipeline, enhance Delek Logistics Partners' revenue streams and asset quality.
  
• Investments in new gas processing plants and acquiring H2O Midstream are expected to significantly boost future cash flows and operational efficiency.
  
• High reliance on acquisitions and specific contracts could pose risks to financial health, operational success, and earnings stability amid market and regulatory uncertainties.

Catalysts

Provides gathering, pipeline, transportation, and other services for crude oil, intermediates, refined products, natural gas, storage, wholesale marketing, terminalling water disposal and recycling customers in the United States.

• The extension of the contract between DKL and DK to up to 7 years removes uncertainty and ensures stable, long-term revenue streams, positively impacting future earnings stability and growth.
  
• Acquisition of DK's interest in the W2W pipeline without significant balance sheet strain enhances DKL's asset quality and its position in the Permian Basin, expected to drive up revenue through increased throughput and service capabilities.
  
• The investment in a new gas processing plant with over 20% cash on cash returns, set to complete in the first half of 2025, will substantially boost future cash flows and EBITDA by catering to the high demand and subscription rates from producers.
  
• Acquiring H2O Midstream for $160 million of cash and $70 million preferred, immediately accretive to EBITDA and free cash flow, expands DKL's midstream service capabilities and operational efficiency, likely to attract more customers and enhance revenue synergies.
  
• Improved management of liquidity and leverage, with leverage ratios improving from 4.84x at the end of '22 to 3.81x at the end of the second quarter of '24, indicating a stronger balance sheet that could support further growth initiatives and potentially drive up the company's valuation through reduced financial risk.

Assumptions

• Analysts are assuming Delek Logistics Partners's revenue will grow by 1.6% annually over the next 3 years.
• Analysts assume that profit margins will increase from 12.5% today to 20.8% in 3 years time.
• Analysts expect earnings to reach $228.6 million (and earnings per share of $4.46) by about September 2027, up from $130.7 million today.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 15.0x on those 2027 earnings, down from 15.5x today. This future PE is greater than the current PE for the US Oil and Gas industry at 10.1x.
• Analysts expect the number of shares outstanding to grow by 7.9% per year for the next 3 years.
• To value all of this in today's dollars, we will use a discount rate of 8.66%, as per the Simply Wall St company report.

Risks

• The dependency on the successful integration and performance of newly acquired assets such as H2O Midstream could lead to less than expected synergies and benefits, impacting EBITDA and cash flow positively projected from these acquisitions.
  
• The financing of acquisitions and investments, if not managed prudently, may increase leverage beyond comfortable levels, thereby affecting the company's balance sheet health and potentially its credit ratings, which could impact interest costs and net margins.
  
• The extent of the contract extension and terms with DK and the reliance on the Wink to Webster pipeline suggest a significant concentration risk. If these agreements do not yield the expected returns or face operational challenges, revenue and EBITDA growth could be negatively impacted.
  
• Execution risks associated with the completion and operational success of the new gas processing plant, which is already highly subscribed, could delay projected cash returns of more than 20%, adversely affecting net income and potentially causing earnings volatility.
  
• Market conditions and regulatory changes in the energy sector, especially concerning midstream operations in the Permian Basin, could introduce unforeseen challenges to revenue growth and operational margins, impacting earnings negatively.

Valuation

• The analysts have a consensus price target of $45.33 for Delek Logistics Partners based on their expectations of its future earnings growth, profit margins and other risk factors.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $1.1 billion, earnings will come to $228.6 million, and it would be trading on a PE ratio of 15.0x, assuming you use a discount rate of 8.7%.
• Given the current share price of $43.05, the analyst's price target of $45.33 is 5.0% higher. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.