U.S. Markets close in 2 mins

These High-Yield Stocks Are Adding Bolt-Ons to Accelerate Growth

Matthew DiLallo, The Motley Fool

Equitrans Midstream (NYSE: ETRN) and its MLP EQM Midstream Partners (NYSE: EQM) were already on track to deliver significant growth over the next few years due to the expansion projects they have underway. Now, they're bolstering their already strong prospects by spending $1.03 billion for two midstream systems focused on the Marcellus and Utica Shale plays. These transactions will enhance the long-term sustainability and growth prospects of their high-yield dividends, which are currently 8.3% for Equitrans and 10.5% for EQM Midstream.

Drilling down into the deal

EQM Midstream will pay $860 million in cash and assume $170 million in debt to acquire 60% of Eureka Midstream and 100% of Hornet Midstream from a private equity fund. The company intends to pay for this deal by issuing $1.1 billion of new convertible preferred units to several other private equity funds. This structure will allow EQM Midstream to finance the transaction without significantly diluting its existing investors in the near term since the company is selling the preferreds at a 20% premium to the current trading price of its common units, and they won't convert into common units for two years.

A person holding out their hand with the word dividends above and an arrow sloping upward.

Image source: Getty Images.

Eureka consists of a 190-mile natural-gas gathering system, while Hornet is a 15-mile pipeline that also gathers natural gas from producing wells. Long-term contracts underpin both systems and should generate about $100 million in EBITDA during the next 12 months. That will provide a noticeable bump for a company that produced $1.2 billion in EBITDA last year.

"This bolt-on acquisition, within our footprint, leverages our existing assets and core operating competencies and is the first step in executing our strategy to grow into a top-tier midstream company," CEO Thomas Karam said, adding that "these assets will complement EQM's basin-leading gathering and transmission system, allowing us to continue being the low-cost provider for gas transportation and, increasingly, for water handling as well."

As Karam noted, this transaction is an excellent strategic fit. Not only can the company connect these assets to its existing footprint, but it can also provide additional services to customers on those systems with its water handling capabilities.

A red natural gas wellhead.

Image source: Getty Images.

Adding fuel to the growth engine

EQM Midstream is paying a relatively high price for the acquired assets at roughly 10 times EBITDA. For perspective, the company is currently investing $3.5 billion to build out other midstream assets in the region, which will generate about $400 million in annualized EBITDA, implying an 8.4 multiple. Because of that higher price, and the cost of the preferred units EQM is issuing to pay for the deal, the transaction will be neutral to the company's distributable cash flow over the first 12 months.

However, the deal should start paying off next year. Driving that view is the expected growth in natural gas volume on those systems as well as the anticipation that EQM Midstream will roll out its water services to producers. In the company's estimation, EBITDA on the acquired assets will expand more than 20% annually over the next several years.

The fast-paced growth of those assets will help compliment EQM Midstream's expansion efforts, which are on track to increase EBITDA 33% as they come on line over the next couple of years. The combined earnings growth from its current expansion projects and the bolt-on acquisitions will provide further support for the dividend growth plans of both companies, which currently have EQM Midstream on track to increase its distribution 6% per year while Equitrans' dividend should rise by 8% annually.

Enhancing its prospects

EQM Midstream is pouncing on the opportunity to buy two fast-growing gathering systems within its footprint that it can bolt onto its existing business. While the company is paying a high price for the deal and did have to get creative to finance the transaction, it has the potential to pay off down the road as earnings growth on the system accelerates and combines with its other expansion efforts. That increases the likelihood that the company and its parent Equitrans can achieve their dividend growth plans.

More From The Motley Fool

 

Matthew DiLallo has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.