A close-up shot of a large pipeline pumping crude oil and pipe valves in a petroleum trust.

Antero Midstream (NYSE: AM) is a midstream operator facilitating the collection, processing, and transportation requirements of natural gas and natural gas liquid producer Antero Resources (AR). The natural gas producer has significant control and a 29% stake in AM, which derives most of its income from AR. Antero Resources has operations in the Marcellus and Utica basins in Virginia and Ohio, respectively, with a relatively favorable cost structure, which has helped it remain profitable in Q1 2024 despite natural gas pricing dropping to four-year lows. Here, we summarized a May bullish thesis published by Arturo on Value Investors Club.

The bullish case sees several catalysts, such as the expiration of a 2019 rebate agreement and enhanced LNG export capacity, boosting AM’s 2024 earnings and widening the scope for management to authorize share buyback programs and hike dividend payouts to investors. AM offers a current yield of 6.5%, with growing optimism around a hike late this year or in 2025. Both Antero companies fell steeply when natural gas prices dropped in late 2019, pushing AR close to bankruptcy. The Antero entities amended their collection and compression agreement to introduce a volume rebate to AR for low-pressure collection, which reached $51.5 million last year. The contract expired in December 2023 and will improve AM’s cash flow. The companies also suffered as natural gas prices tanked in the following years due to unusually warm winters. However, AR’s production has increased recently and is well-positioned to benefit from LNG export terminals scheduled for launch in the coming years. Elsewhere, rising electricity demand in the US and growing access to export markets can also help AM retain healthy volumes henceforth.

AM is a C-corp whose dividends to shareholders in recent years were mostly treated as a return on capital. Management’s 2024 FCF guidance before dividends was between $550-$590 million, with $140 million in FCF expected to be available after dividends at the guidance midpoint. Out of the $140 million, it is estimated that around $110 million would be needed to lower debt to the 3X EBITDA target, which AM plans to achieve by year-end. The milestone would make room for dividend hikes and share buybacks as management maintains its stance on returning capital to shareholders. However, reaching AM’s pre-pandemic annual yield of $1.23 per share from the current $0.90 per share would need almost $160 million. AM has an 8-year debt of $3.2 billion with a 6.625% coupon rate.

Meanwhile, AR’s gathering and compression contracts with AM and water contracts have well over a decade left in their agreement tenure. AM gets paid according to the volumes produced by AR. For instance, water volumes depend on the wells drilled by AR and the length of the laterals in each well. AR has been improving operational efficiency and profitability by increasing the lateral length of wells and drilling several wells from a single pad to reduce maintenance overheads. However, potential headwinds remain in the natural gas market, which is oversupplied as current pricing could lead to a repeat of the 2019 crisis. Furthermore, issues within the Antero companies might also emerge as concerns remain that management will favor AR over AM during a crisis, as the chairperson of both entities, Paul Rady, has a massively larger stake in AR.

AM is not on our list of the 31 Most Popular Stocks Among Hedge Funds. As per our database, 28 hedge fund portfolios held AM at the end of the first quarter, which was 24 in the previous quarter. While we acknowledge the potential of AM as an investment, our conviction lies in the belief that AI stocks hold greater promise for delivering higher returns, and doing so within a shorter timeframe. If you are looking for an AI stock that is as promising as AM but that trades at less than 5 times its earnings, check out our report about the cheapest AI stock.

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Disclosure: None. This article is originally published at Insider Monkey.