Oil giant Occidental Petroleum (NYSE:OXY) needs to sell a boatload of assets to help pay for its acquisition of Anadarko Petroleum. Among those it hoped to unload was its controlling stake in master limited partnership (MLP) Western Midstream (NYSE:WES). However, with the midstream company's valuation sinking in recent months, Occidental has pressed "pause" on that plan. As a result, Western Midstream will remain public at least until next year.
With some near-term clarity and a much lower valuation, investors might be wondering if it's now a good time to buy shares of this high-yielding MLP. Here's a look at the cases for and against buying Western Midstream after its failed sale.
The case for buying Western Midstream
The main draw with Western Midstream is its big-time distribution. At more than 10%, the payout certainly catches the attention of income-seeking investors. Western Midstream currently believes it can increase that payout by 5% to 6% this year, while maintaining a coverage level of around 1.15. Although that's a bit aggressive, given that most MLPs aim to have coverage levels well above 1.2, the company's payout seems sustainable in the near term.
The main reason Western Midstream's payout is now in the double digits is the decline in its market value. Units of the MLP tumbled in July after the company cut its full-year forecast, due to the impact lower natural gas prices were having in its operating regions. Between that and the failed sale process, units have fallen more than 15% for the year and are now more than 32% below their 2019 high -- quite a bit cheaper.
The case against buying Western Midstream
While Western Midstream's valuation has come down, it's not exactly a screaming bargain. The company is on track to generate between $1.675 billion and $1.725 billion in adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) this year, down from its initial forecast that it would produce between $1.8 billion and $1.9 billion. Given its current enterprise value of $18.3 billion, the MLP sells for around 10.8 times earnings. That's close to the midpoint of its peer group, where valuations range between 8.5 times and 12.8 times earnings.
Meanwhile, there's some concern about its current financial profile. As noted, the company only expects to cover its high-yielding distribution 1.15 times this year, which is well below the comfort zone of most peers. Many are aiming to push their coverage levels closer to 2.0, enabling them to retain more cash to help finance expansion projects. Western Midstream, on the other hand, will need to sell equity to finance its growth, given that it doesn't retain much cash. However, with its market value falling, issuing new units is getting more expensive. To ensure that it has enough funding for growth projects, Western Midstream might need to reduce its distribution.
Finally, its longer-term future remains unclear. While parent Occidental Petroleum shelved plans to sell Western Midstream this year, it will likely restart the sales process next year. That's because Occidental wants to get Western's $7.5 billion in debt off its books, which it can do by selling its stake in the MLP below 50%. That sale would also bring in cash to pay off some other debt.
While Occidental is holding out for a higher price, one might never arrive. If Occidental gets desperate, it might sell at an unappealing price. That could leave Western Midstream investors with an unattractive return if they're forced to sell to the eventual buyer.
Verdict: Western Midstream isn't worth the risk
On the one hand, Western Midstream pays an enticing distribution that yields more than 10%. On the other, its middle-of-the-pack valuation and concerning financial profile aren't compelling enough reasons to buy -- and there's uncertainty about what Occidental will do next.