Strategic Expansion And Cost-Saving Innovations Fuel Growth In Natural Gas Sector

Key Takeaways

• Enhanced revenue prospects through volume expansion in key basins and strategic cost savings aim to improve net margins.
  
• New commercial contracts and achieving leverage targets ahead of schedule underscore earnings stability and drive for shareholder value.
  
• Strategic initiatives and capital allocation toward expansion could strain Western Midstream Partners’ financial stability if efficiency gains and market conditions fail to meet expectations.

Catalysts

Operates as a midstream energy company primarily in the United States.

• The increasing throughput in the Delaware and DJ Basins for natural gas and the record total operated crude oil and NGL throughput indicate potential revenue growth through volume expansion, enhancing Western Midstream's revenue prospects.
  
• Cost savings of over $15 million in both operating expenses (OpEx) and capital expenditure (CapEx) through enhanced data-driven sourcing strategies and operational improvements, which could improve net margins by reducing operational costs.
  
• New commercial contracts and amendments in the DJ and Uinta Basins, including take-or-pay agreements, which ensure steady revenue streams, potentially increasing earnings stability and predictability.
  
• Investment in compression and additional liquid stabilization capacity required by the new agreements will lead to capital expenditures in 2025, but these are expected to drive higher processing volumes and revenue growth.
  
• Achieving a 3x leverage target ahead of schedule allows for an optimized capital allocation strategy focusing on organic expansion, accretive M&A, and potentially increased distributions, enhancing earnings and shareholder value.

Assumptions

• Analysts are assuming Western Midstream Partners's revenue will grow by 6.5% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 43.2% today to 37.5% in 3 years time.
• Analysts expect earnings to reach $1.6 billion (and earnings per share of $4.05) by about November 2027, up from $1.5 billion today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 12.5x on those 2027 earnings, up from 9.7x 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 grow by 0.29% per year for the next 3 years.
• To value all of this in today's dollars, we will use a discount rate of 8.0%, as per the Simply Wall St company report.

Risks

• The asset divestitures that occurred in the first and second quarters lowered adjusted gross margin by about $9 million, which indicates a potential for reduced profitability if divestitures continue or if they fail to generate expected efficiencies from remaining operations.
  
• Incremental operating expenses were reported to be higher in the second quarter, with expectations for this trend to continue into the third quarter, particularly due to seasonal effects on utilities and maintenance. This could decrease net margins if costs continue to rise or are not offset by corresponding revenue increases.
  
• The significant investment in transformation and operational efficiency improvements, including over $15 million in cost savings across OpEx and CapEx, must continue to generate substantial cost reductions to maintain or improve profit margins, presenting a financial risk if these savings do not materialize as expected.
  
• New commercial agreements requiring expansion capital mostly for compression and additional liquid stabilization capacity at Chipeta, with incremental capital needs mostly occurring in 2025, might increase capital expenditures. This could affect free cash flow and potentially limit financial flexibility if projected revenue from these investments does not meet expectations.
  
• Achieving a 3x leverage target and reallocating capital towards expansion, M&A, increasing distributions, and buybacks could strain financial resources, especially if market conditions change. There’s a risk to earnings and financial stability if capital is not allocated efficiently or if market conditions deteriorate.

Valuation

• The analysts have a consensus price target of $40.36 for Western Midstream Partners 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 $45.0, and the most bearish reporting a price target of just $37.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $4.1 billion, earnings will come to $1.6 billion, and it would be trading on a PE ratio of 12.5x, assuming you use a discount rate of 8.0%.
• Given the current share price of $37.75, the analyst's price target of $40.36 is 6.5% 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.