Review of Williams Companies (WMB)

Williams Companies (WMB) has doubled since I bought it in mid-2020.  Should I sell it?

Business Segments

What do they do again?  And how are they affected by energy prices and inflation?

Based on 1Q24 EBIDTA (slide 8):

• 39%: Interstate Gas Pipelines.  Mostly Transco (30%) running through the east coast, bringing gas from the Appalachians and GoM to consumers and LNG export terminals.  Smaller pipelines in the Northwest.

Regulated long-term contracts: "The rates are established primarily through the FERC’s ratemaking process, but we also may negotiate rates with our customers pursuant to the terms of our tariffs and FERC policy."   In general, FERC gas-transmission rates are often adjusted for cost-of-service (bottom p1), so its like a "delayed" inflation adjustment.

• 38% Gathering and Processing from gas fields.  Collecting and treating gas (eg: removing NGLs) from producing fields so it can be transported in pipelines.  Mostly volume based.  So indirectly affected by price (eg: revenue drops during warm winters).  Management mentioned these contracts are often inflation protected (bottom p19).  A few of them have exposure to gas prices (bottom p18).

• 13% Gathering and Processing from oil fields: onshore (7%) and GoM (5%)

• 4% Marketing.  Deliver gas to customers, bear the risk of price movements in-between the time of order and delivery.  Very volatile.  Was 10% of EBIDTA in 2023, -ve in 2022, and negligible in 2021.

A 2022 Fitch Report estimated that 50% of revenue was from regulated or take-or-pay contracts.  so rough guess: maybe a quarter of their G&P revenue is covered by take-or-pay. 

Cashflows

CFO covers dividends.  But not always CFI and dividends together.  ie: They are investing for expansion:

They rarely sell assets, last made substantial disposals in 2018: 

Maintenance capex was 820m in 2023, and is guided at 800m and 1.2b for 2024 and 2025 (p11).

Growth

Growth capex was 1.9bn in 2023, and is expected to be 1.6bn in 2024 and 1.8bn in 2025 (p11).

The above "growth capex" excludes acquisitions of new businesses.  Following this, I'll take the words "capex" or "growth capex" in this post to exclude acquisitions, which is pretty strange.

Lets put it in a table.  AFFO below is CFO (excluding some working capital changes and minus a few things) - think of it as "Smoothed CFO" ¹:

AFFO easily covers maintenance capex plus growth capex, and almost covers dividends after that too.  It doesn't cover acquisitions in 2024, so debt will go up.

They say they've gotten 19.5% ROIC on their 2019-2022 investments (p12).  Seems ridiculously high, but these are usually small "bolt on" projects.  e.g.: small pipelines adding off their main lines, adding new takeaway or feeds to new customers.  Or adding incremental G&P capacity to their existing network.

And thats probably only for growth capex, as recent acquisitions were bought at 7-10X EBITDA (1), (2).

Overall they aim to grow EBIDTA and dividends by 5-7% in the next 2 years.

The background is growth opportunities from the expected US LNG export boom (slide 16):

Management comments on the urgency of this (p17): "Our issue is that our customers, which are some of our best and biggest customers on Transco are –their demands are very urgent. And for us to sit around and wait to finalize any more of the demand that was pending out there, really, it doesn't serve those customers very well." 

To summarise, they are still growing, and taking on debt to afford to both pay dividends and make acquisitions.  At some stage of the cycle - years later - that may become a bad thing, but its good today.

Valuation

Taking FCF to be "AFFO minus maintenance capex" ², it is projected to average 4.2bn over 2023 to 2025. At a share price of $42.5, thats a price to FCF of 12.x.  Fairly priced for a long term growth rate of 5-7%.

The yield is 4.5% before tax (or 3.1% after tax for me).   AFFO payout ratio is just under half.

Conclusion

Its not cheap anymore - growth is priced in.  I wouldn't buy now, but its not clearly overvalued so I'll hold.  We're probably still at the beginning of the US natural gas export boom.

1 AFFO is defined by them as "cash flow from operations excluding the effect of changes in working capital and certain other changes in noncurrent assets and liabilities, reduced by preferred dividends and net distributions to noncontrolling interests. AFFO may be adjusted to exclude certain items that we characterize as unrepresentative of our ongoing operations".^↩

2 Their definition is different - slide 34^↩

Investing for the next Decade of inflation

These interviews from Lyn Alden and Luke Gromen explain why we'll get high inflation this decade.  US Federal debt is too high and must be reduced by inflation - financial repression - where interest rates are lower than inflation for a long time.  Cash holders will suffer and bondholders will get screwed.  But not in a straight line, it bounces around.   Its a more rigorous and nuanced description of Kuppy's Project Zimbabwe diatribe.

Key Points:

• (6:19) US has entered Fiscal Dominance, meaning govt spending affects the economy more than interest rates.  Because:
• High Federal Debt means that they are paying interest to someone (bondholders or savers) which becomes income.
• Low Private Sector debt means there is not much bank debt to reduce.

So high rates might actually stimulate the economy, of the income from high rates is more than the reduction in debt.

• (10:00) Fiscal and Monetary dominance is a continuum.  If true interest expense (minus entitlement paygo) goes to 100% of receipts, you are heading into Fiscal Dominance.  (12:06) We flip back and forth between them in a cycle:
• As you near fiscal dominance, the global dollar market gets crowded out,
• USD goes up, EMs get pressured to sell treasury bonds to defend their currencies...
• leading to an increase in treasury supplies, treasury market gets dysfunctional...
• so the Fed supplies liquidity, market calms down...weaker dollar.
• Bond and stock markets go up, assets up, higher tax receipts, no longer in fiscal dominance.

• Its a stop-start process.  (13:53) Its a function of the dollar - strong USD leads to crisis that must be fixed by Fed.  The Fed intervened several times before:
• 3Q23 (raising front end rates while keeping the long end stable)
• 3Q22 (Yellen running down TGA)
• So its a stop start process of: whenever a problem in the bond market occurs, Fed will buy US treasuries to lower the US dollar to stave off the crisis.  Cannot afford to let the price of US Treasuries be set by market forces alone.
• In another podcast he mentions DXY of above 1.05 (today's price) there'll be a treasury supply problem, "or if it goes to 1.04 to 1/03 it'll probably be OK", if it goes to 1.00 it'll be fine but with higher inflation.
• So in the long run, the price of US treasuries is held artificially low.  This is financial repression, LT bond holders get fucked.
• (19:40) Maybe the government tries to obfuscate it. eg: change SLR rules: fund banks to hold more treasuries.  When they have to choose between a financial crisis or inflation, they will choose the latter (eg: covered depositors in Silicon Valley Bank instead of letting them be wiped out).
• (24:30) When does the deficit start to matter?  Answer: We've already seen it in the markets, eg:
• Gold no longer correlating to real rates (Chart at 2:46).  
• 3Q2020 Treasury market crashed along with stock market - for the first time in 40 years.
• The process has started, and is accelerating.
• (29:07) The big deficit (rising debts) in the 80's were offset by falling interest rates and globalisation (cheap energy from Russia and cheap goods from China).  These 2 things have now reversed, so government debt starts to matter.
• (38:53) Do we see any way it can reverse?  Generally no:
• Deglobalisation speeds up the process, as increasing inflation leads to increasing bond yields.
• New oilfield discoveries could help reverse it by increasing productivity and lowering inflation.
• Economies that have recovered from this before have been non-financialized.  US has a financialized economy - too much tax income is tied to asset prices.  Austerity would cause asset prices to fall, and lower tax receipts.
• A 'productivity miracle'.  But there's some nuance:
• It can't be too fast.  eg: If AI takes too many people's jobs, it will reduce tax receipts further. 
• AI is different from previous tech revolutions like the internet and cloud computing, as its energy intensive.  It could decrease service costs but increase energy costs.
• (1:25) Think we're in a Secular inflation environment: the debt of the reserve currency issuer is not sustainable without inflation being higher than interest rates for a sustained period.   The test is: what happens to inflation the in the next expansion?  
• (5:43) Views on oil?  Follow conventional view: range bound between USD 70-90.  70 is when US shale starts to be unprofitable.  90 is where it starts to affect inflation.
• Views on different assets in the next 12 months:
• (11:45) USD: lower in an orderly manner, or sideways,
• (14:17) Gold and Bitcoin: Both a lot higher.  Probably halfway through the bitcoin upswing. (18:10) Luke things gold is becoming an oil currency, replacing the USD.  (23:08) "You need to stay un-levered, because the cycle is so volatile".
• Views on interest rates: No view, rising rates no longer effective due to Fiscal Dominance.  The fiscal situation, and oil supply/demand affect the economy more. (28:05) From 3Q23, if the ten year goes to 5%, this creates problems which make the Fed step in, so 5% is a ceiling.  
• (31:28) Lyn: the 60:40 portfolio doesn't work in Fiscal dominance, suggest replace bonds with energy/gold/bitcoin.  To guard against inflation instead of recession.
• (34:20) Recessions.  Recessions are now probably sector specific (eg: CRE) because fiscal dominance stimulates parts of the economy.  Not gonna see a 2008 crisis recession, maybe get a 2001 (shallow) or 1970's (stagflation) recession.  (37:55) In a recession, we can still expect CPI prices and the stock market to rise, like an EM.

The above is just a framework to understand whats going on.

As always, the market can do whatever it wants.  I can be right and still lose money if my timing's off.

How do I use this in investing?  

Historically commodities worked best in past inflationary periods.  Buy anything that can't be printed.

When do I buy?  Hedgeye models the next several quarters as having increasing US yoy inflation (see graph at 16:33).  So now.

More color:

• 86% of my portfolio is "inflation resistant":
• commodity producers
• Gas pipelines - irreplaceable assets producing inflation adjusted cashflows
• Companies that have low material/labour costs harmed by inflation (eg: stock exchanges),
• or commodities themselves.
• My core positions make up 100% of my portfolio.  This is stuff I'm comfortable holding throughout the cycle:
• stocks that generate cashflows and dividends even at the low point of the cycle.  If they're commodity producers, they're low cost ones.
• Or sometimes they're just too illiquid to trade.
• Uranium, which doesn't generate cashflows, but which I hold cause it doesn't correlate with the markets and supply/demand is out of whack for the next few years.
• My non-core positions make up another 6% of my portfolio, bought with borrowed money.  I trade in and out of based on Hedgeye trend signals.  When they work well, these signals last for months or quarters.  When they don't, I get whipsawed.  This is for stuff I don't want to hold during downturns:
• Higher cost commodity producers in risky countries, like FCX
• Bitcoin: I'm a believer, but I don't wanna hold something that can drop 70% peak to trough.
• Industrial commodities: like nickel, silver, platinum.  They're volatile since they also depend on demand.  In theory I should put tin in here, but Malaysian Smelting Corp is too illiquid to trade.
• I may short long term bonds.  Following to the Hedgeye trend signals.
• 1/3rd of my portfolio is US Energy pipelines, susceptible to a decade-long 10-30% fall in the USD.   Its a risk, but the US is the cleanest shirt in the dirty laundry pile.