Heavy Investments And Expansion Risks Cloud Future Profitability And Investor Confidence

Key Takeaways

• Heavy capital expenditures on acquisitions and expansions may strain free cash flow, affecting net margins due to high upfront costs.
  
• Reliance on new operations and projects introduces operational risks, potentially impacting revenue stability and growth projections.
  
• Kinetik Holdings' strategic expansions, investments, and operational resilience indicate strong potential for increased revenues, higher ROI, and enhanced shareholder value.

Catalysts

Operates as a midstream company in the Texas Delaware Basin.

• The Durango acquisition and subsequent investments in expansions like Kings Landing II indicate a heavy capital expenditure outlook that could strain the company's free cash flow in the short to mid-term, potentially impacting net margins due to the high upfront costs associated with these expansions.
  
• Expanding operations in New Mexico and undertaking projects such as the pre-FID work for Kings Landing II involve significant growth capital, which could impact earnings if the projected increases in processed gas volumes and associated revenue do not materialize as expected.
  
• The reliance on the New Mexico operations for future growth, given its relatively recent expansion there, introduces operational risks and uncertainties around volume growth and margin expansion that could affect the company's revenue stability and growth projections.
  
• Incorporating over 70 new employees from Durango and undertaking deferred maintenance projects for standardization to Kinetik’s safety and environmental standards could lead to short-term increases in operational expenses, impacting net margins until these investments result in efficiency gains.
  
• The strategic focus on short-dated conversion cycles for deploying capital suggests potential volatility in earnings and revenue, depending on the successful and timely execution of these projects, which could affect investor confidence and impact the stock's valuation.

Assumptions

• Analysts are assuming Kinetik Holdings's revenue will grow by 21.7% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 21.3% today to 9.1% in 3 years time.
• Analysts expect earnings to reach $226.8 million (and earnings per share of $1.56) by about October 2027, down from $294.2 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 37.0x on those 2027 earnings, up from 10.3x today. This future PE is greater than the current PE for the US Oil and Gas industry at 10.4x.
• Analysts expect the number of shares outstanding to decline by 2.73% per year for the next 3 years.
• To value all of this in today's dollars, we will use a discount rate of 7.87%, as per the Simply Wall St company report.

Risks

• The Durango acquisition and operations expansion in New Mexico, including the development of Kings Landing II to double processing capacity, present a significant increase in processing and treating capacity, which could lead to higher revenues through new volume-backed agreements and expanded services. These developments could enhance Kinetik's position across the Delaware Basin, potentially boosting revenue and adjusted EBITDA.
  
• Kinetik's strategic investments, such as the $1 billion strategic investment at a low to mid-single digit adjusted EBITDA multiple, indicate a potential for high return on investments, which could lead to an improvement in net margins over the long term.
  
• The company's ability to recover swiftly from operational challenges such as weather disruptions and integrate acquisitions smoothly demonstrates strong operational resilience and efficient management, which could support sustained earnings growth.
  
• With revised upwards 2024 adjusted EBITDA and capital expenditure guidance reflecting earnings outperformance, there's evidence of underlying business strength that could contradict expectations for a share price decrease, by potentially resulting in upward revisions of future earnings expectations and share price valuations.
  
• Kinetik's disciplined capital allocation approach, focusing on allocating capital to the highest return opportunities, suggests a strategic management of resources that could lead to enhanced shareholder value through improved net margins and earnings, countering the belief in a potential share price decrease.

Valuation

• The analysts have a consensus price target of $46.48 for Kinetik Holdings based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $52.0, and the most bearish reporting a price target of just $43.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $2.5 billion, earnings will come to $226.8 million, and it would be trading on a PE ratio of 37.0x, assuming you use a discount rate of 7.9%.
• Given the current share price of $50.51, the analyst's price target of $46.48 is 8.7% lower. 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.