Aris Water Solutions is a fast-growing, dividend-paying company that appears significantly undervalued, with its environmental credentials overlooked due to its operations within the oil and gas industry.
Aris’s Expanding Revue and Margins
Aris has been expanding its revenue and margins by investing in its footprint and enhancing research and development to optimize the yield from recycled produced water for the oil industry. With a robust pipeline infrastructure in the Permian basin, Aris has established a competitive moat and secures long-term contracts with large, investment-grade oil companies.
These contracts typically include six-month termination clauses, ten-year terms, and CPI adjustment clauses. Aris profits by reducing the environmental impact of oil and gas drilling, offering valuable services to the industry.
Market Overview
By 2030, the U.S. petrochemical industry is forecast to produce 60 million barrels per day (mbpd) of water containing high concentrations of dissolved solids, hydrocarbons, and other contaminants. Traditionally, this produced water has been disposed of in deep wells, but environmental regulations are tightening, necessitating better water management, treatment, and recycling.
Aris plays a crucial role in the Department of Energy’s plans to improve produced water management, working closely with ConocoPhillips, a key customer and investor.
Aris went public in 2021 and operates two main divisions: one for collecting, transporting, and handling produced water, and another for treating, storing, and recycling it. The company has secured numerous long-term contracts with investment-grade companies, ensuring a stable revenue stream.
Infrastructure and Operations
Aris operates 745 miles of produced water pipelines, 66 handling facilities, and 23 recycling facilities in the Permian basin. With permits in place to double its current footprint, Aris is well-positioned for future growth. In Q1 2024, the company guided for 1.03 mbpd of produced water and 415,000 bpd of water solutions sales, representing less than 3% of the potential market in the Permian basin.
Aris is also engaged in research into produced water treatment, including reverse osmosis systems, and has received a Department of Energy grant for research on using treated produced water for irrigation.
The company is building desalination pilot plants in collaboration with major oil companies to extract high-value minerals and expand water reuse opportunities.
Financial Performance
Aris has shown impressive financial growth, with revenue up nearly 300% over five years. In 2023, the company generated positive free cash flow and achieved record operating margins. Long-term contracts provide 80% of revenue from ongoing oil production, offering strong revenue visibility.
Despite a high debt-to-equity ratio of 59%, Aris has strong operating cash flow, allowing it to service its debt comfortably. The company’s balance sheet is heavily weighted towards long-term infrastructure, providing a competitive advantage but limiting liquidity.
Valuation
A discounted cash flow (DCF) model suggests that Aris is significantly undervalued, with a fair value estimate of $24.7, indicating more than 50% upside. The model assumes reduced CAPEX in 2024, reflecting the end of the initial pipeline buildout, and a gradual increase in CAPEX thereafter to continue expanding infrastructure.
Dividends and Shareholder Returns
Aris has been paying dividends since Q2 2022, with a recent increase to $0.105 per share, yielding 2.7%. The company’s strong cash flow and reduced CAPEX needs suggest that dividends will continue to grow, potentially reaching a yield of 4% by the end of the decade.
Risks and Conclusion
Despite its environmental benefits, Aris operates within the oil and gas industry, exposing it to regulatory, market, and environmental risks. Regulations such as the Clean Water Act and Superfund law could impose liabilities and operational restrictions.
Additionally, the company’s reliance on the Permian basin, where production could peak soon, presents a risk. However, consolidation among operators and increased recycling requirements could mitigate this threat.
Aris Water Solutions presents a compelling investment opportunity with its extensive infrastructure, long-term contracts, and focus on environmental sustainability. The company’s strong balance sheet, positive cash flow, and dividend growth potential make it an attractive medium-term investment.
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Faith is an enthusiastic freelancer and regular contributor to numerous finance blogs, creating valuable pieces to educate individuals on finance and fintech options. As a skilled writer, Faith has created content for diverse industries—if it exists, she’s likely written about it!
