EnLink Midstream: Mixed Q1 Given Mixed Asset Base (NYSE:ENLC)

Units of EnLink Midstream (NYSE:ENLC) have been a solid performer over the past year as it has been buying back stock, pivoting to the Permian, and seeing growth in Louisiana thanks to the growth in the LNG export business. With an over 7% capital return yield, I view ENLC as attractive after its recent pullback, even with a mixed Q1.

In the company’s first quarter, EnLink earned $0.03, missing estimates by $0.11 as revenue fell by 7% from last year to $1.6 billion. This revenue decline was largely due to lower pass-through of natural gas prices. Adjusted EBITDA of $338 million was up by 4%. Poor winter weather reduced volumes through its system, which drove much of this miss, and management did reaffirm guidance. Ultimately, ENLC has two growth markets and two weaker legacy markets, which combine to leave the company with relatively slow growth, though it continues to pivot into the faster growth Permian, away from Oklahoma and North Texas.

EnLink’s two most important segments are the Permian and Louisiana regions. The Permian, of course, has been a critical center of rising US production, and it continues to be a leading focus of E&P companies’ drilling programs. The Permian is now ENLC’s biggest market; at 27% of the company’s profits in 2023 and an anticipated 30% this year. It is relocating a 3rd processing plant from Oklahoma to the Permian, reducing construction costs by half. The Permian is getting 42% of EnLink’s capex budget as it shifts resources into this area.

Permian segment profits fell from $96 million last year to $89 million in Q1, due to poor weather reducing output sequentially. Gathering volumes rose by 13% YoY, but this was offset by thinner margins, given the commodity price environment. As you can see below, volumes were higher a year ago across each category in the Permian; however, there were sequential declines from Q4 levels, given the difficult January weather. With companies investing more in Permian production, I view this as a transitory seasonal challenge, rather than a sign of weakness to come.

As you can see above, Louisiana gas transportation volumes were about 2% higher than last year, with NGL fractionation flat. Louisiana segment profit rose over 14% to 110 million (23% excluding derivative losses) thanks to strength in natural gas volumes. The Haynesville shale in LA was once a dying region as the Marcellus boomed, but EnLink’s Louisiana infrastructure has found new life, thanks to the surge in demand for LNG exports as Europe has pivoted away from Russian gas.

The US Gulf Coast is critical to the LNG export market, and ENLC can use its pipeline infrastructure to feed these export terminals. With more LNG export facilities being built, there is ample room to move more gas through its pipelines. In fact, the majority of 2024 Louisiana contract maturities have been re-upped at higher rates, speaking to the demand for space on these pipelines. While there are likely to be ups and downs, given rising natural gas demand and a fractured global environment, I expect US LNG exports to grow over time, which will be a positive for EnLink’s business.

While these are the two positive regions, ENLC has legacy OK and North Texas units that are struggling. As you can see below, throughput across EnLink’s system in these two regions has been falling. Poor winter weather played a role in these declines, but there has also been “shut-in” activity whereby producers close wells that are no longer economic, reducing production. Management believes the majority of this activity in Oklahoma is in the “rearview mirror,” but some further shut-in activity may occur. On top of this, unlike in LA where it has re-upped contracts at a higher rate, last quarter, it re-upped contracts at lower rates, given weaker production. That will be a cash flow drag.

These headwinds were evident in financial results. Oklahoma profits fell by $9 million to $85.7 million due to that lower contract reset and weaker volumes, partly exacerbated by winter weather. This contract reset also reduced North Texas profits by over 20% down to $60 million. This decline was despite its Bridgeport carbon capture project coming online last quarter. ENLC has seen transporting CO2 for carbon capture facilities as a way to drive growth and benefit from the green energy transition. Unfortunately, carbon capture has been “slower to develop than we initially anticipated,” though it continues discussions with Exxon Mobil (XOM), a leader in the sector. While it is engaged with XOM, given slower growth in this nascent industry, it may not spend the entire $50 million in capex projects associated with carbon capture.

Additionally, I would note that some pipeline companies are protected from falling volumes by minimum volume commitments (MVCs), which require producers to pay for a certain amount of volume, even if they use none. While ENLC has MVCs, they are very small, providing coverage of ~10% of EBITDA. They are unlikely to meaningfully protect results from ongoing volume declines in OK and North Texas.

Now, importantly, ENLC has a strong balance with just 3.3x debt to EBITDA leverage and $4.6 billion of debt. This is below its long-term target, and the company is now investment grade. Its debt load is also well-laddered, which reduces its near-term refinancing risk and interest rate sensitivity. As such, it can focus free cash flow returns toward shareholders. It pays a 4.1% dividend yield, and it is using retained cash flow after this payout to repurchase stock.

It retained $74 million in cash after distributions in Q1 and repurchased $50 million in units. Due to these buybacks, there has been a 3.8% unit count reduction over the past year. ENLC targets $200 million in repurchases this year, which will reduce the unit count by about 3.4%. Despite mixed results in Q1, ENLC is tracking towards the EBITDA midpoint of prior guidance.

Given strong contract resets in Louisiana and the strength of activity in the Permian, I view overall guidance as achievable. I see an upside risk to free cash flow as ENLC may undershoot its capex target given slower growth in carbon capture. While beneficial now, this does reduce the pace of its longer-term growth prospects. ENLC is a challenging stock given this set-up. It has two excellent assets in the Permian and Louisiana and two weak ones in OK and North Texas while carbon capture’s future is uncertain.

The Permian and LA can grow 0-5% while I see OK and North TX flat to down 3% over time, given production trends. This points to an overall business that has 0-2% growth. Over time, by focusing on growth capex in the Permian, ENLC may be able to shift its company-wide growth potential higher, but this will be a slow process.

Still, ENLC pays a safe dividend with ample cash left over, and it has a solid balance sheet. Overall, it returns about 7.5% to shareholders via distributions and buybacks. With 0-2% longer-term growth, ENLC should deliver a medium-term return of 7.5-9.5%. Historically, the market has returned about 8%, and as such, I have used 10% as my threshold to “buy” a stock. ENLC is poised to deliver market-like to slightly above-market returns. This makes it securely a hold, but not quite a buy. I view ENLC as a hold because, within the pipeline sector, I see other companies like Hess Midstream (HESM) with equally strong capital returns but cleaner growth stories.

Ultimately, ENLC delivered mixed results, given its mixed asset base. It is paying enough capital out to shareholders that there is no need to sell shares, but at their current level, the valuation looks fair. I see greater upside in other stocks, like HESM, which is where I would allocate new funds. However, ENLC is a suitable hold for income-oriented investors.