Equitrans Midstream Corp. (ETRN, Financial) is a natural gas midstream company that provides gathering, transmission and water services to primarily Appalachian basin producers in Pennsylvania, West Virginia and Ohio. It was spun off from EQT Corp. (EQT) in November 2018, with EQT still retaining a 20% stake.
With gas prices increasing, this appears to be a good time to get back into the sector. Natural gas has rallied this year, with summer heat and tight U.S. supply of the fuel in storage lifting prices to their highest levels in two and a half years—and setting the market up for a potential shortage for the winter. Futures prices on July 12 settled at $3.749 per million British thermal units, the highest since Dec. 21, 2018. They trade more than 45% higher this year. Both Spot and future contract prices at the Henry Hub are up more than 100% from a year ago. As the economy reopens, demand has come roaring back.
Equitrans caught my eye because of the high free cash flow yield (price-to-free cash flow of 3.62 or a free cash flow yield of 27.6%). It has a dividend yield of 7.36%.
The bubble chart above shows the price-to-free cash flow on the Y axis and the market cap on the X axis. The other green dots are also midstream companies. Equitrans' profit margins have exploded in the last year.
Free cash flow of $750 million easily covers the dividend of around $300 million. Capital expenditures continue to decline as development projects are completed and cash flow increases as producers are encouraged by the rising prices, thereby increasing production.
Below is a snapshot of the company's balance sheet. Long-term debt is about $7 billion, but given the copious operating cash flow, the company has plans to delever.
Given the short operating history, it is hard to value the company. However, Equitrans is trading below its Graham number. (The Graham number measures a stock's fundamental value by taking into account the company's earnings per share and book value per share. The Graham number is the upper boundary of the price range that a defensive investor should pay for the stock. According to Benjamin Graham's theory, any price below the Graham number is considered undervalued, and thus worth investing in).
In conclusion, considering the valuation, increasing demand for natural gas and good dividend, Equitrans is well positioned to thrive over the next several years. However, it is a cyclical stock, so investors should monitor the market and economy and sell well before it peaks, which may be a few years away.
