DT Midstream

Moat: 2/5

Understandability: 2/5

Balance Sheet Health: 4/5

DT Midstream is an owner, operator, and developer of integrated natural gas midstream assets, with operations mainly in the Appalachian and Haynesville Basins.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

DT Midstream operates primarily in the U.S. Northeast, Midwest, and Southwest regions, with its core business segments including:

  • Pipeline: Transports natural gas through a network of high-pressure pipelines, gathering systems, storage systems, and other related facilities.
  • Gathering: Collects natural gas from production fields via a network of pipelines, including both high and low pressure systems.
  • Transmission: The transmission of gas is done through a large system of pipelines in the Northeast and Gulf states.

This creates a diversified midstream company that can benefit from both growing domestic production and transportation. DT Midstream’s strategy is built around being a full-service natural gas solutions provider, with a commitment to safety, reliability, and responsible operations.

DT Midstream’s primary customers are producers of natural gas, utilities and power companies, and industrial consumers, and their contracts are mostly fee-based. Their core assets consist of regulated pipelines.

Revenue Distribution

  • Revenues are generated primarily from transporting and processing natural gas for customers. The Pipeline segment contributes about 70-75% of overall revenue, which the remaining portion is contributed by Gathering.
  • A key differentiator for them is their integrated gathering and transmission system. This makes them a good middleman in the industry with various sources of revenue.
  • Geographically, the revenue streams are mostly located in the U.S., with concentration in the Appalachian Basin, the Haynesville, and the Midwest.
  • The natural gas industry in the U.S. has shown remarkable resilience since the COVID-19 pandemic, driven by increased domestic and international demand. However, recent events show the demand and price have decreased a little bit.
  • A notable trend in the midstream space is the increased focus on infrastructure optimization and integration with renewable energy sources, driven by sustainability and energy transition goals.
  • Regulatory scrutiny is expected to increase in response to incidents like the recent pipeline leaks, with increased focus on safety protocols and infrastructure upgrades.
  • The demand for natural gas for power generation is expected to grow steadily due to its cleaner nature as compared to coal. This is a plus point for DTM.
  • Although the long-term outlook for natural gas demand is generally positive, short-term price volatility and supply constraints will always remain the biggest challenge for midstream companies to manage.
  • The current conflict in Ukraine is increasing demand for LNG and gas from the US, and this could boost volumes for pipeline companies like DTM.

Competitive Landscape

  • The midstream space has a lot of diverse companies, with both large incumbents and smaller, more specialized players. Competition is expected to be intense as a result.
  • Key differentiators are the ability to provide reliable services with integrated operations as well as having good access to energy markets.
  • The ability to expand operations through acquisitions and new project development is a must to maintain the advantage. There is a strong focus in new acquisitions which could be helpful for DTM.
  • With large players in the industry, DTM faces high competition in obtaining customers and projects.

What Makes DTM Different?

  • DTM primarily focuses on owning and operating pipeline and gathering assets, rather than exploration or production. This reduces risk and increases reliability.
  • The strategic location of DTM’s pipelines within the most active natural gas production areas gives a big advantage as the company can transport gas from multiple supply sources, creating a diverse supply base and also helps it in capturing the demand for the service.
  • Their high contract diversity is also a great safety net for operations during times of crises and when specific projects are down.

Financials

Revenue

DT Midstream has shown strong revenue growth in the last few years, driven by high demand for their services. In the year ended 2022, revenues reached $727 million in a yearly basis, a huge leap of around 20% compared to the year before.

  • For the three months ended September 30, 2023, the operating revenues increased by around 10.7% compared to the prior year period, driven by higher volumes from gathering and transportation services.

  • A more granular view, including revenues by segment, will provide deeper insights.

Profitability and Margins

  • While revenues have been stable and growing, profitability is still fluctuating over the past three years. The operating margins in FY 2021 stood at 33%, with a significant improvement in net profit margins of around 10%, but the operating margins declined to around 24% in the year ending 2022 and also net profit margins decline to 5%.
  • The decline can be seen in the recent report for the quarter ending in September of 2023. Operating margins decreased to around 17% and net profit margins to around 4%.

  • The decline in profitability was primarily due to increase in operating costs, interest expenses, depreciation, and amortization.

  • DTM’s ROIC was around 5-10% in 2021 and this was further reduced to around 2% in 2022, showing a potential weakness in how well capital is being allocated and used. A lot of emphasis should be made to improve this.
  • Although they did have record earnings for the last 2 quarters of 2023, that is to be seen if the improvement remains.

Cash Flow

  • DTM’s operating cash flow has been variable, but remains high, at about $578 million in 2022, from which about $371 million was available for reinvesting in the business. Free cash flow decreased in 2022 compared to 2021.
  • The most recent quarterly numbers indicate a decrease in cash flow from operations, from 2021’s quarterly average of about $175 million to current quarterly cash flows of around $50 million. This highlights that they may have some issues in their operating model and need to control cost and improve profitability.

Balance Sheet Health

  • DTM has a fairly high amount of long-term debt ($3.9 billion) relative to its total assets (around $6.3 billion). Total debt-to-equity was around 2.4X in 2022, indicating high leverage.
  • This high reliance on debt could become a risk during recession and periods of interest rate hike cycles, making them more vulnerable.
  • On the other side, their liquidity looks solid, their current assets roughly balance current liabilities. Their cash reserves are at a good level of around $500 million which could be beneficial for future expansion.
  • DTM’s debt profile has been simplified since the separation with DTE. They have a single debt facility and are committed to reducing leverage in the coming years.

Based on the above analysis, DTM’s balance sheet health is rated 4/5. Although they are highly leveraged, they are showing commitment to lower debt, and also have good enough operating revenue to meet current liabilities.

Debt

  • The company has a revolving credit facility for short-term capital, maturing in 2027, with available liquidity at about $1.08 billion (as of September 2023).
  • They also have senior notes, maturing in 2026 and 2031, and a term loan facility, maturing in 2028.
  • High leverage in a business that’s dependent on large capital assets means that they may need to rely heavily on the capital markets for funding, which may become risky.

Recent Concerns and Controversies

  • There has been some concerns about the company’s lower profitability and margins that have reduced its return on capital.
  • There have also been some concerns on the high debt levels of the company, which needs careful monitoring. Management acknowledges the need to lower this leverage.
  • Management stated that current economic uncertainty and recent interest hikes may have some significant impact on the debt, so they are taking measures to improve liquidity.
  • There are also concerns that many pipelines of DT Midstream are approaching the end of their lifecycle, and there is increased competition in their main markets.
  • During the latest earnings call, management confirmed that they are focusing on operations that create real value and increase margins in existing businesses, and are also carefully pursuing mergers and acquisitions that add value to the operations. They are also trying to improve the balance sheet by reducing debt in the upcoming years.

Moat Analysis

  • Moat Rating: 2/5. DT Midstream has some competitive advantages, but not enough to warrant a high moat rating.
  • Limited Scale Economies: Although their integrated operations in one of the most attractive basins help them in achieving a lower cost per transported unit of gas, it is not enough to get a really wide moat.
  • Niche Market Positioning: Some of DTM’s assets are in less competitive areas in the US, allowing for less pressure on margins and revenue.
  • Sticky Customer Relationships: They have a diverse customer base with primarily fee based contracts that is a positive. But these contracts can always change.
  • Regulatory hurdles: Pipeline companies such as DTM have to go through a complex and expensive process in order to set new pipes and acquire new areas for transportation. This helps reduce competition, but is not enough to provide a big advantage over other pipeline players.

Overall, the company does have some advantages due to its pipeline network, infrastructure, and geographical concentration, but they are not unique enough to create a wide or strong moat.

Risks to the Moat

  • Technological Disruption: The natural gas transportation industry, while established, could see a gradual shift towards newer, cleaner transportation alternatives which will affect DTM negatively.
  • Regulatory Changes: More stringent regulations on the environment, safety and operations may increase costs for pipeline maintenance. Also, new regulations could also restrict expansion for the company.
  • Commodity Pricing: Despite fee-based contracts, price volatility and decreasing natural gas prices can still affect DTM as customers may reduce production due to low prices, which would lower the volumes that DTM handles.
  • Competition: Even though the barriers to entry are quite high, some existing competitors can also expand, putting pressures on the contracts that they can acquire.
  • Geopolitical Risks: The energy sector is quite sensitive to geopolitical and political disruptions, these could affect pricing and demand for oil and gas, affecting DTM’s business.
  • Increased leverage: Since DTM operates with high leverage, they could be severely impacted by sudden financial distress.

Business Resilience

  • DTM’s diversification and long-term contracts will help it in maintaining a stable stream of income even in difficult economic conditions.
  • Their essential nature of services (natural gas distribution) makes them have strong demand.
  • The growing focus on sustainability and energy transition gives a good incentive for more natural gas pipelines, which is also good for DTM.
  • They have enough cash and liquid assets to endure the short-term market downturn.
  • The company has taken a conservative approach in its expansion plans, so they can weather financial downturns without much issue.

Understandability

Rating: 2/5 DT Midstream has a complex business with multiple moving parts. They operate on a multi-level supply chain where natural gas is collected, transported, and distributed to various customers. This makes it complex for investors to grasp how all their operations tie together. Also, there are a lot of accounting regulations and other legal jargon that a normal non-sophisticated investor may not understand. This creates a problem for an average investor to truly grasp the working model of the company and its financial statements. Therefore, the company is given a rating of 2/5.