Antero Midstream (AR 6.20%) offers one of the highest-yielding dividends around, with it currently up to a jaw-dropping 24%. The main reason the energy company's payout has risen to such heights is that its shares have cratered about 80% this year. Driving that decline is the slump in natural gas prices, which is having a significant impact on the operations of its parent Antero Resources (AR 6.20%).
Antero Resources, however, recently announced several actions it plans on taking to improve its financial profile, including signing agreements with Antero Midstream. Those transactions lead the midstream company to believe that it can maintain its sky-high payout. However, that doesn't mean it will.
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Drilling down into the numbers
Antero Midstream is providing some assistance to its parent in the form of reducing the fees it collects for gathering natural gas produced by Antero Resources' wells. This move will reduce the company's revenue by $45 million to $50 million next year. In exchange, the two companies extended their contract by four years. Antero Midstream also plans to reduce its 2020 capital spending budget by $75 million to $100 million, bringing the range down to $300 million-$325 million. These actions will support Antero Resources' plan to grow its production by 8% to 10% per year through 2021 so that it can fulfill its long-haul pipeline capacity contracts.
Antero Midstream also agreed to repurchase $100 million of its stock from Antero Resources. That move will save it about $20 million in dividends, which it would have paid to its parent at the current rate.
Add it all up, and these moves will have a positive effect on its cash flow by about $60 million to $65 million in 2020. The company believes it can generate enough money to cover its high-yielding payout by 1.1 times in the coming year.
Is the payout safe or not?
While Antero Midstream is targeting to maintain its current dividend rate of $1.23 per share, that payout is on shaky ground. That's because the company has a tight dividend coverage ratio, given that most rivals target coverage of at least 1.2. It will therefore have to borrow nearly all the money needed to finance its expansion projects.
On one hand, it can afford to take on more debt since it has a low leverage ratio. In its view, that metric will be in the mid- to high 3 times net debt-to-adjusted EBITDA next year after factoring in its growth-related spending. That's a comfortable level for a midstream company, since most target a leverage ratio of less than 4.0 times their debt-to-EBITDA.
However, Antero Midstream can't continue racking up debt to finance growth. Unfortunately, that's what's on track to happen. It still expects to spend between $300 million and $400 million on capital projects per year in 2021 and 2022. Meanwhile, it anticipates that its dividend coverage to be in the range of 1.1 to 1.3 in 2021 and 2022 under its updated forecast. As a result, leverage will probably keep rising.
Antero Midstream could this still opt to reduce its payout so that it can retain more cash. Given what its shares yield, it could potentially create more value for its investors by temporarily eliminating the dividend and using some of that money to steadily buy back its stock from Antero as well as on the open market. Once its valuation improves, it could reinstate a payout at a more comfortable level that would allow it to retain enough cash to help finance a significant portion of its expansion-related spending so that it can maintain a low leverage level.
Don't bank on this yield
Antero Midstream initially expected to enrich income investors by delivering high-octane dividend growth. However, weaker natural gas prices have put pressure on its parent, which has forced both companies to shift gears a couple of times. Given their inability to execute on their plans in the past, there's no guarantee they'll be successful this time around. This yield seems like it's too good to be true, since it remains on shaky ground.
