Western Midstream (WES -0.03%) pays its investors an attractive dividend that yields 8.3%. That's well above average; the dividend yield on the S&P 500 is about 1.5% these days.
And that already high-yielding payout is likely to head even higher after Western Midstream sealed a deal to buy Meritage Midstream Services II for $885 million in cash. The acquisition will boost its free cash flow, giving Western Midstream the flexibility to increase its payout after it closes the transaction later this year. It will make the pipeline company an even more attractive option for income-seeking investors.
Drilling down into the deal
Western Midstream has agreed to acquire privately held Meritage Midstream Services II in an all-cash deal. The midstream company operates a large-scale natural gas gathering and processing business in Wyoming's Powder River Basin. It owns 1,500 miles of natural gas gathering lines and 380 million cubic feet per day of natural gas processing capacity. It also owns the 120-mile Thunder Creek natural gas liquids (NGL) pipeline.
Meritage's asset footprint is highly complementary to Western Midstream's position in the Powder River Basin:
Image source: Western Midstream.
The deal will transform Western Midstream into a larger regional player, putting it in a stronger position to compete for business to continue expanding in the resource-rich area, which is attracting increased investment from oil and gas companies.
This is the second notable midstream deal in the Powder River Basin in the past few weeks. Energy Transfer recently agreed to acquire Crestwood Equity Partners in a $7.1 billion deal. That transaction expanded Energy Transfer's midstream footprint to the Powder River Basin while enhancing its positions in the Williston and Delaware basins. That was Energy Transfer's second deal of the year. Those acquisitions are giving the midstream giant additional fuel to achieve its strategy of increasing its more than 9%-yielding distribution by 3% to 5% per year.
The fuel to boost its already sizable payout
The company provides natural gas gathering and processing services to several oil and gas producers under long-term, fixed-rate contracts with meaningful minimum volume commitments. Those agreements supply it with relatively steady cash flow and increased business from the Meritage deal will give Western Midstream more cash flow to support its distribution.
Western Midstream expects to raise its quarterly base distribution by $0.0125 per unit ($0.05 annualized). That would push its distribution payment to $0.57 per quarter ($2.30 annualized), increasing its yield to 8.5% at the current unit price.
The company recently boosted its base distribution payment by 12.5%. It delivered that raise after securing several long-term agreements to process up to 950 million cubic feet of natural gas per day. In addition, the company's falling leverage ratio as it repays debt and declining unit count as it repurchases units gave it additional confidence to increase its payout.
On top of that attractive base distribution, Western Midstream will also pay an enhanced distribution if it has excess cash available and has a leverage ratio below its annual target. It paid an enhanced distribution of $0.356 per unit in early 2023 based on its 2022 cash flows. While it likely won't pay an enhanced distribution in 2024 because its leverage ratio is currently at 3.3 (slightly above its 2023 target of 3.2, and that's before the Meritage deal), it could pay more of them in the future. Meanwhile, its continued earnings growth, deleveraging, and repurchases could give it the fuel to keep pushing its base distribution higher.
An enticing income stock
Western Midstream is using its strong balance sheet to acquire Meritage Midstream. The deal will enhance its position in the Powder River Basin while growing its free cash flow, which will allow the pipeline company to give its investors another raise.
More dividend growth seems likely as the company continues to execute its strategy. On top of that, it offers additional income potential through possible future enhanced distributions. Those payouts make it an enticing stock for income-seeking investors to consider.
