Western Midstream: The Unbearable Tightness Of Oxy's Embrace - Yet Still Appealing

seekingalpha11-21

Western Midstream offers a high, tax-deferred yield and strong fundamentals, with potential for increased distributions and enhanced payouts in 2025.WES's affiliation with Occidental Petroleum (OXY) ...

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Denis Shevchuk This is a follow-up to my previous posts about Western Midstream Partners, LP  - \"10% Forward Yield Plus Capital Appreciation From Investment-Grade Company\" and \"Occidental Sale Is Bullish For Long-Term Investors\". Please check them for the company description and background. In this post, I want to address primarily risks related to WES's affiliation with Occidental Petroleum Corporation . Why is WES att","collect":0,"end_time":0,"defaultTopTitle":"seekingalpha.com","property":[],"viewcount":null,"language":"en","relate_stocks":{"BK4144":"石油与天然气的储存和运输","WES":"Western Midstream Operating, LP.","BK4590":"PTP"},"translate_title":"西部中游：Oxy拥抱的难以忍受的紧绷——但仍然很有吸引力","themeId":null,"isJumpTheme":false,"ttsUrl":null,"symbols_score_info":{"WES":0.9},"content_text":"Western Midstream offers a high, tax-deferred yield and strong fundamentals, with potential for increased distributions and enhanced payouts in 2025.WES's affiliation with Occidental Petroleum (OXY) poses risks due to potential conflicts of interest and uncertainty about OXY's intentions to divest its WES stake.Recent developments, including OXY's partial sale of WES units and CEO transitions, have created market uncertainty but also potential investment opportunities.OXY may sell its stake or arrange a sale of WES for the price per unit exceeding the current market price.   Denis Shevchuk This is a follow-up to my previous posts about Western Midstream Partners, LP (NYSE:WES) - \"10% Forward Yield Plus Capital Appreciation From Investment-Grade Company\" and \"Occidental Sale Is Bullish For Long-Term Investors\". Please check them for the company description and background. In this post, I want to address primarily risks related to WES's affiliation with Occidental Petroleum Corporation (OXY). Why is WES attractive? The list below is well-known to WES investors and I will not comment on it:  High yield of ~9.2% today counting base distributions only. This yield is tax-deferred as WES is an MLP. WES is likely to raise its distributions starting from Q1 2025 payable in Q2. Since WES has generated free cash flow above its distributions year-to-date, it may pay enhanced distributions for 2024 on top of its base distributions. WES is investment-grade with a current leverage of ~3.0 in terms of Net Debt/EBITDA which is better than required for its rating. WES is far more exposed to natural gas than oil which is favorable from an environmental standpoint. Since most WES contracts are fee-based with limited sensitivity to commodity prices. WES's core assets which gather, process, and transport energy are located in some of the most active basins in the United States, including the Delaware and DJ Basins. Operational and financial KPIs are strong and growing.  Aside from the tricky Occidental relationship, WES's main risk is the dependence on E&P activities in its points of presence. Lower demand for oil and natural gas could reduce WES throughput, negatively impacting cash flows despite the protections offered by minimum-volume commitments and cost-of-service provisions in customer contracts. However, recent positive developments seem to more than offset this risk:  The war in Ukraine has increased demand for US oil and gas. Energy-thirsty AI infrastructure increases energy demand across sources. The new US administration appears friendly to the oil and gas industry and higher demand for the midstream infrastructure is expected.  Occidental relationship This is the latest diagram of WES holding by Occidental:   WESBesides being the controlling holder, Occidental is the main WES customer responsible for more than 50% of the revenues. It is not coincidental that the Risk section of WES's 10-K starts with three points related to Occidental. Here is the most relevant point for our discussion: Occidental owns our general partner. Occidental’s ownership of our general partner may result in conflicts of interest. The directors and officers of our general partner and its affiliates have duties to manage our general partner in a manner that is beneficial to Occidental. At the same time, our general partner has duties to manage us in a manner that is beneficial to our unitholders. Therefore, our general partner’s duties to us may conflict with the duties of its officers and directors to Occidental. As a result of these conflicts of interest, our general partner may favor the interests of Occidental or its owners or affiliates over the interests of our unitholders. Timeline Since early 2024, disclosures and rumors have made investors uncertain about Occidental's intentions for its WES stake due to the former's preparations to issue debt to acquire CrownRock (closed in late summer 2024). Speculation was growing about the role, if any, WES would play in the announced plans to reduce debt following the acquisition. On Feb 20, Reuters reported that OXY is exploring a sale of WES to slash its debt. Enterprise Products Partners L.P. (EPD), The Williams Companies, Inc. (WMB), Kinder Morgan, Inc. (KMI), and private equity were reportedly interested.  Later on the same day, WES issued a press release stating that while aware of recent news coverage, WES has not launched a sales process nor has it engaged bankers or other advisors intending to do so. And further: \"We are aware, as has been publicly stated, that Occidental Petroleum Corporation (\"Oxy\") has expressed interest in divesting assets. We cannot speak to the composition of the assets Oxy may seek to divest…\" On Feb 21, WES reported its Q4 2023 and full-year results. In its release, WES stated that its quarterly per-share distribution would be increased from $0.575 for Q4 2023 (payable in Q1 2024) to $0.875 for Q1 2024 (payable in Q2 2024). On Feb 22, the units jumped to $33.60 vs. $30.18 the previous day. When WES increased its distribution by 52%, units did not follow in sync and added only ~15% initially. Some investors ascribed the hike to OXY's intention to pump up WES units before initiating the sale. On its earnings call on Aug. 8, Oxy's CEO Vicky Hollub, stated: \"Beyond oil and gas, we expect our OXYChem and midstream businesses to continue to provide material cash flow durability in the years ahead.\" On the surface, it implied that OXY did not plan to dispose of WES. However, on Aug. 12, Oxy announced a partial sale of its WES stake. Through the secondary public offering, OXY sold ~ 20M limited units of the approximately 194M total it owned for ~$36 per unit. WES neither issued any additional units nor received any proceeds from the sale. On Oct 28, WES issued a press release with the subtitle \"Michael Ure Steps Down Following Successful Transformation of Western Midstream into Leading Midstream Operator\" with the following text: \"Today Western Midstream Partners, LP (WES) (“WES” or the “Partnership”) announced Oscar K. Brown, an independent director of Western Midstream Holdings, LLC, WES’s general partner (the “General Partner”), has been appointed President and Chief Executive Officer of the General Partner, effective immediately. The Board of Directors of the General Partner (the “Board”) and Michael Ure agreed that he will step down from his position, including as Director. To ensure a smooth transition, Mr. Ure will continue as an advisor to the CEO until the end of the year. Mr. Brown will remain a director on the Board.\" And further in the same release about Michael Ure: \"We wish him the best as he shifts his focus to his greatest passions: his faith, his family, and giving back to the community\". This explanation did not seem convincing to me. On the same day, WES issued an 8-K disclosing the terms of Mr. Ure's Transition and Separation agreement which stated that \"Mr. Ure’s departure is not the result of any disagreement with the General Partner or the Partnership\". On the earnings call on Nov. 7, investors witnessed the following dialogue between an analyst and the new CEO (per SA transcript):   Jeremy Tonet Hi, good afternoon. Really just one question for me. I want to touch base on, Oscar that, CEO transition here from -- the market side, Mike had been with the company for some time, and was really the face of the company to many of us. And the transition just seemed pretty abrupt. And so I was just wondering if you could walk us through a bit more the process here. I guess, just -- it seemed a bit abrupt in timing. So, if anything you could share with us would be helpful. Oscar Brown Sure. Well, from our perspective, it's been pretty smooth. It's been a pretty smooth couple of weeks. I mean, recall I've worked with Michael since 2016, actually in a number of capacities, and considered him a friend and so we've debated and thought about financial policy and operating policy and things like that all through the years. So, importantly, you'll find my views on most of those things are the same. And to the extent, as we've said a couple of times, anyone's concerned, we are -- everything is the same as it's been in terms of our capital allocation policy and our goals for the Partnership. So, in the last -- from the perspective of kind of the abruptness, number one, just for me, I think it's been great. Michael is going to focus on his faith as you guys know, he's a religious guy and his family and his community. And finally, on the OXY's earnings call on Nov 13, Ms. Hollub never even mentioned WES by name. Oxy's deleveraging plans were at the center of discussion and Ms. Hollub stated the following: \"We think we've already had some significant success over the $4 billion, but we do believe that even in a lower price environment, we're going to have some cash flow. We're still going to have some divestitures. We'll still make progress in 2025 regardless of where prices will be. And that's our target. Our target is to continue our debt reduction through the year, regardless of what it takes to do that.\"  What should investors think about all this? The timeline was long and boring but necessary to explain the uncertainty about WES units. They responded negatively to Mr. Ure's \"agreement,\" then recovered but have not reached their highs of ~$43 at the end of July shortly before Oxy's partial sale. Investors feel that something is brewing, and Mr. Brown's profile supports it. He is a former banker experienced in mergers and acquisitions in the oil and gas. On the earnings call and during the interview after it, he talked about M&As a lot. But what kind of M&As does OXY have in mind for WES? Surely, tuck-in acquisitions, similar to the recent Meritage acquisition, are possible. But Mr. Ure seemed quite capable of handling them. Can WES venture a transformational acquisition? This seems unlikely, as OXY relies on cash flow from WES to help with deleveraging. The divestiture of WES units appears to be the only remaining avenue for M&A activity that would productively employ Mr. Brown's talents. When OXY initiated the partial sale of WES units, I saw it as a confirmation of the intention to retain most of its stake. However, another interpretation is possible. What if OXY intended to divest its entire stake but couldn't reach a timely agreement on price? It could lead them to initiate a partial sale to show quick progress in deleveraging and continue negotiations regarding the entire stake. There are three types of possible acquirers for WES: Berkshire Hathaway Inc. (BRK.B) (BRK.A), other midstream companies, and private equity. Regardless, the price for OXY's entire stake should noticeably exceed the $36 per unit achieved in the partial sale. Moreover, a potential acquirer may bid for all units, including those held by public LPs, adding further complexity to the deal. In such a scenario, Mr. Brown's expertise would be relevant, and the acquisition price would likely be even higher. I do not see much risk in any of these scenarios for investors except for long-term WES holders facing massive taxes on depreciation recapture. Meanwhile, WES fundamentals remain strong. Q2 was excellent while Q3 was mediocre but acceptable. On average, WES seems to perform well. That was my logic when I added units to my position around $36. While I prefer a no-divestiture scenario, unless I am missing something, either outcome should deliver both yield and capital appreciation. The latter will be short-term in case of divestiture and long-term otherwise.  OXY's awkward maneuvering may have welcomed market inefficiencies, presenting potential opportunities for investors. 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