Kinetik Holdings Inc.

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 4/5

Kinetik Holdings Inc. is an energy company in the Permian Basin, primarily engaged in gathering, compressing, treating, and processing natural gas, crude oil, and produced water, with assets including pipelines and processing facilities.

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

Kinetik Holdings Inc. operates primarily in the Permian Basin, a region known for its hydrocarbon production. Their business model revolves around gathering, compressing, treating, and processing natural gas, crude oil, and produced water. They have a network of approximately 1,600 miles of pipelines, as well as gas and liquid processing facilities.

  • Midstream Logistics: This segment focuses on gathering and processing services, with a network spanning across the Delaware Basin.
  • Pipeline Transportation: This segment involves moving gas and liquids through pipelines that run across the area. The company’s operations are underpinned by strong relationships with producers, and their infrastructure plays a key role in getting product to market.

Moat Analysis

Kinetik’s moat is considered narrow, scoring a 2 out of 5. The justification for this rating is multi-faceted:

  • Limited Economies of Scale: While Kinetik operates a vast network of pipelines, this scale doesn’t translate into a significant cost advantage over its competitors. The capital intensity of pipeline construction and operation means that it has to maintain similar operational structures as everyone else in this business. Any new competitor could replicate this infrastructure over time. They do not have proprietary knowledge that cannot be replicated.
  • Geographic Niche: The company’s presence in the Permian Basin acts as a somewhat local network effect, the idea that there are a finite number of areas where one can place a pipeline economically. It is not clear how much this provides a true moat to this company. This is mainly where their competitive advantage resides but this is more of a localized mini moat, not a durable wide moat.
  • Switching Costs are Low: While producers are dependent on their midstream provider they don’t have any incentives to stay with a given company. There is no contractual aspect and costs for a producer to move to a new midstream provider aren’t huge.
  • No Intangible Assets: The company relies heavily on physical assets rather than brands, intellectual property, or government regulation. This limits its ability to command premium prices or achieve monopolistic position.

Legitimate Risks to the Moat and Business Resilience

  • Commodity Price Fluctuations: Because Kinetik handles natural gas and crude oil, their revenue is highly susceptible to commodity prices. Since they are not a price-maker, a decline in commodity prices would lead to losses in business.
  • Regulation and Political Risk: Changes in regulations or environmental policies could negatively impact their operations by increasing costs or limiting business expansions. For example in June 2023, the Company entered into the Permian Highway Pipeline System Agreement with certain regulators where the prices are set to reflect cost plus a determined rate of return. This does give a margin of safety but also shows that they have regulations that will control how much they can earn, and limit their future pricing power.
  • Economic Downturn: A significant downturn in the overall economy could curtail business expansions and, therefore, limit new investment in infrastructure. If there is less production from oil and gas companies, there is less volume for Kinetik to collect fees upon.
  • Disruptive Technology: New sources of energy might diminish the importance of natural gas or oil, reducing the need for Kinetik’s services. Also, new pipeline technology could make some existing infrastructure outdated.
  • Competition: The midstream industry is competitive, and Kinetik faces other firms with similar or overlapping services. Competitors can copy their strategies or technology, and compete with prices.

Financial Analysis

Kinetik’s financials show a steady increase in revenues, but there are some points of caution that need to be made. In FY 2023, they generated total revenues of $746.3 million. Net income was $47.4 million and Adjusted EBITDA was $431 million which is a pretty good number and shows a very profitable enterprise.

  • Revenues: The company’s revenue comes from fees charged for gathering, compressing, and processing of natural gas, crude oil, and water. This is a volume-based pricing model, thus the company generates more revenue when there is higher production levels.
    • The revenue structure also contains price elements where they are able to get some of the prevailing prices and can generate higher revenues when prices of the products that are being produced rises.
  • Profitability: EBITDA margin in 2023 is around 58%, showing decent profitability. However, the company has struggled to sustain these margins and they have declined slightly YoY, driven in part due to decreasing prices and rising operation expenses. There is a clear need for the company to maintain its margins or grow them in the next few years.
  • Capital Structure: The company is leveraged with long-term debt of $1.9 billion. A significant part of their invested capital is financed by the debt, but this seems to be manageable based on the positive operational results.
  • Cash Flow: The company has positive operating cash flow of $397 million, that helps in paying down debt and making investments.
  • Recent Challenges and Concerns:
    • The Company’s Q3 2024 earnings call, released October 2024 showed a dip in revenue and also concerns of inflation impacting their operations. There were also concerns about high natural gas price volatility, implying uncertain cash flow situations. Management is looking to cut down on expenses and is trying to ensure they meet their targets on time.
    • They are working on increasing pipeline capacities in the Permian basin.
  • The company has a good ability to service its debt, but could face trouble during periods of low commodity prices.

Understandability Rating: 3 / 5

The business is somewhat complex to understand, receiving a rating of 3 out of 5. This is due to:

  • Specialized Operations: While the basic idea of gathering and transporting energy resources is clear, the technical aspects of their operations, such as specific pipeline management and processing techniques, is more technical than a regular business.
  • Interconnectedness: The relationship between commodity prices, production levels, and various contracts is complex. For an amateur investor, understanding how their revenues react to underlying situations might be hard.
  • Industry Jargon: Investors may not be aware of acronyms such as NGLs, NOPLAT, P/E, or EBITDA.

Balance Sheet Health: 4 / 5 

Kinetik has a balance sheet that is relatively healthy. It is a mixture of both positive and negative signs that balance out. It gets a rating of 4 out of 5   *   **Leverage:** Debt makes up a substantial part of their capital structure. The company also continues to rely on debt to make new acquisitions and expansions. This poses a risk to the company if something were to happen to their growth in profits. They have good amount of flexibility, but might be constrained in the future if debt levels increase further.   *  **Liquidity:** The company has sufficient cash reserves to meet short-term needs.   *   **Asset Quality:** A large portion of their assets come from fixed assets and goodwill. But they don't rely only on them as they have multiple different parts of the business that generate revenue. *   **Overall**: The company's overall finances seem solid, though their dependence on debt and fluctuating commodity prices does provide a concern.