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  1. Home
  2. / Investing
  3. / Energy

Your Energy Dividend IS at Risk

Here are eight MLPs primed for a dividend cut (and two that look solid).
By DAVID PELTIER Dec 21, 2015 | 09:00 AM EST
Stocks quotes in this article: CEQP, DPM, NGL, NS, ENBL

(The following is a collection of alerts send directly to subscribers of TheStreet's Dividend Stock Advisor over the past two weeks.)

The price of WTI crude oil sits below $35 a barrel and while some may laud the injection of extra cash into consumers' wallets during the holiday shopping season, there are just as many alarm bells ringing for the fate of income investors in the energy sector.

Quite simply, the master limited partnerships (MLPs) that deliver the oil are scrambling to preserve cash. They rely on expansion for their distribution to investors as existing infrastructure ages and older oil fields dry up. That not only requires cash, but credit -- and here we are in the first rising-rate environment in nine years.

If you want ground zero for income investing -- this is it. Kinder Morgan (KMI) slashed its dividend and that was just a shot across the bow.

Here are the most vulnerable stocks that could face Kinder's fate.

On Dec. 9, Dividend Stock Advisor highlighted Targa Resources Partners (NGLS) and Vanguard Natural Resources (VNR) as stocks whose double-digit dividend yields are at high risk of being cut.

On Friday, Vanguard slashed its monthly distribution by 74%.

In fact, since Kinder's news, Seadrill Partners (SDLP) and Teekay Offshore Partners (TOO) have also cut their distributions. Even exchange-traded fund, Kayne Anderson MLP (KYN), reduced its dividend.  

We believe these recent cuts could prove to just be the tip of the iceberg, with funding drying up in the energy patch and underlying commodity prices expected to be lower for longer.

Identifying these names ahead of time is important, because investors are not quick to forget a dividend cut. In addition to the loss of income, according to Bank of America/Merrill Lynch, the average stock that lowers its payout lags the S&P 500 index by 8% in the next six months.

Crestwood Equity Partners (CEQP) is a midstream name that has natural gas storage and oil services operations. The shares have dropped 80% in 2015 and recently changed hands around $16.50. The company has maintained a quarterly distribution of $1.375 a share (around a 33% yield) for the past eight quarters.

Management has attempted to bolster finances by merging with brethren Crestwood Midstream Partners, earlier this year.

Even so, the combined company still sports a lofty 4.8x debt/EBITDA (earnings before interest, taxes, distribution and amortization) ratio. This figure does not include $500 million of preferred stock, which will also be entitled to cash flow.

In the meantime, we believe that Crestwood will struggle to generate enough cash flow to cover its quarterly dividend for the next several quarters, as will likely be the case for 2015. With a credit rating that is already two levels into junk status,  the company will see little sympathy from creditors if management tries to raise more funds to cover the payout.

DCP Midstream Partners (DPM) is a midstream play that processes, transfers and stores natural gas and natural gas liquids (NGL). The stock is down 54% year to date and recently changed hands around $21. The company has offered a quarterly distribution of $0.78 a share (15.1% yield) for the past four quarters.

Management will likely be able to cover the dividend for the fourth quarter, but that is largely because of drawing down hundreds of millions of dollar on its credit line and through aggressive commodity hedging.

The hedging is important, as about 35% of DCP's business is leveraged to commodity prices. Those hedges will dwindle in 2016 and/or will become considerably more expensive. In the meantime, the company's credit rating is already two levels below investment grade.

NGL Energy Partners (NGL) is a midstream play that focuses on logistics and water-treatment purchases. The stock has lost 69% year to date and recent changed hands around $8. The company has consistently boosted its quarterly distribution since going public in 2011, with the latest increase coming in October, to $0.64 a share (30.1% yield).

Just last week, management said that it will likely freeze future dividend increases in 2016. That said, NGL already cut its capital expenditure guidance last quarter and will have to try to raise hundreds of millions of new debt and tap its credit facility in the next two years just to meet its current payout. In the meantime, the company's debt rating in three levels below investment grade, which means that future borrowing capacity could quickly dry up if energy prices remain depressed.

Nustar Energy (NS) is a midstream name that has oil pipelines, terminals and storage. The shares have dropped 43% in 2015 and recently changed hands around $34. The company has maintained a quarterly distribution of $1.095 a share (13.4% yield) since 2011.

While Nustar's dividend has been consistent over the past four years, we believe that readers should not expect that trend to continue in 2016. The company is seeing lower EBITDA from its pipeline and marketing business lines. As a result, management can only cover the payout this year by tapping its credit revolver by a couple of hundred million dollars.

The same will be true for 2016, including some expected equity dilution. In the meantime, Nustar's credit rating is already in junk status.

Archrock Partners (APLP) is an energy services provider that focuses on natural gas compression and processing. The shares have lost more than 44% in 2015 and closed Friday at $11.15. The company has raised its quarterly distribution for 19-straight quarters and currently pays out $0.5725 a share (18.9% yield).

Management is on track to generate enough cash flow to cover the dividend in the fourth quarter, but admitted that visibility has declined regarding future customer activity levels. Given that Archrock needed both an equity raise and its credit facility to help fund the payout this year, it's likely that management would look to more external financing in 2016.

The company has a relatively high 4.4x debt/EBITDA ratio. That, and a debt rating that is a full five levels into junk status, will likely make lenders wary of lending management more money in order to fund the dividend. 

Enable Midstream Partners (ENBL) is a midstream play that focuses on gathering and processing oil and natural gas. The stock dropped more than 60% year to date and closed Friday at $6.60. The company just went public last year and raised its quarterly distribution in October to $0.318 a share (17.5% yield).

After the books are closed on the fourth quarter, Enable should generate enough cash flow in 2015 to cover its dividend. But a look at the internal figures shows that a steady, steep drawdown on its credit revolver was necessary in order to do so.

It's also worth noting that management cut guidance in October, citing both lower energy commodity prices and customer volume. As a result, the company could struggle to maintain its current payout, even with more external funding likely needed.

In the meantime, Enable's credit rating is teetering on the edge of investment grade status. As a result, we believe that new Chief Executive Rodney Sailor may face a Kinder-like moment, where the current dividend may need to be sacrificed to maintain an investment grade credit rating.

Rose Rock Midstream (RRMS) is a midstream name that focuses on gathering and transportation of crude oil. The shares are down about 65% in 2015. It closed Friday at $16.25.

The company is another recent IPO, from 2011. Management last raised the quarterly distribution in October to $0.66 a share (16.1% yield).

Last month, Red Rock cut its guidance because of lower customer oil production and increased pipeline competition. The company also postponed offering a long-term guidance outlook until next February, during which time we believe that management will be forced to question the validity of the current dividend.

The distribution has been regularly supported with asset drop-downs from the parent company SemGroup (SEMG). That said, Red Rock will likely struggle to finance future acquisitions given a relatively high 4.4x debt/EBITDA ratio and a credit rating that is five levels below investment grade.

USA Compression Partners (USAC) is a midstream energy name that offers compression services for customers that gather, process and transport natural gas. USAC went public in 2011 and pays a quarterly distribution of $0.525 a share (19.1% yield).

The stock closed Friday at $11.03 and has lost more than 30% year to date. But USA Compression has further downside potential in the coming quarters, as the current dividend does not appear sustainable.

Despite some recent insider buying in USA Compression, we would not chase the double-digit dividend yield at current levels. As with a lot of negative recommendations in this space, USAC has a relatively high debt yield and will struggle to earn enough to cover its dividend in the coming quarters.

USAC posted better-than-expected quarterly results last month, but USA Compression will only be able to cover the 2015 payout by issuing new stock and by drawing down on its credit facility.

Looking ahead to 2016, when the consensus calls for a double-digit cash flow decline even with slashed capital spending, USAC will likely fall short of covering the dividend, even if it can access the secondary markets. If lenders do lend more to USA Compression, it will likely be a distressed rates, as USAC has an above-average 4.7% debt/EBITDA ratio.  

Out of the Danger Zone?

Not to end on too dismal a note, Dividend Stock Advisor also identified two other energy MLPs with double-digit yields that we believe can fund their dividends through 2016, which appear considerably more attractive than they were a month ago.

Up first is Oneok Partners (OKS), which close at $22.83 Friday, indicating a yield of 13.8%. The company currently pays out a quarterly distribution of $0.79 a share, with the next dividend likely to come in February 2016.

Management has spent 2015 renegotiating a lot of its contract to fee-based arrangements, in anticipation of lower natural gas and natural gas liquids (NGL) volume and pricing. Oneok Partners is targeting fee-based revenue of more than 70% in its gathering and processing business in 2016, up from 50% this year. 

This was evident when Oneok Partners posted in-line quarterly results back in October, reaffirming its cash flow guidance, including the expectation to earn at least as much as its expected distribution in 2016. Many MLPs are expected to fall short on this front in the coming quarters, which will cause them to try and raise more funds in the secondary market, in order to maintain their dividend and credit ratings.

In the meantime, the company has a BBB credit rating, which is two levels above junk status and management does not expect a need for new equity issuance through at least the first half of 2016. Investors looking to sift through the carnage in the energy MLP space should consider Oneok Partners in the mid-$20s.

Another name that caught our eye is Williams Partners (WPZ), which closed Monday at $22.00, indicating a yield of 15.45%. The company currently pays a quarterly distribution of $0.85 a share, with the next dividend likely to come in February 2016.

Williams Partners delivered better-than-expected quarterly EBITDA in the third quarter, aided by higher realized NGL margins. About 88% of the company's business is fee-based and management is consistently generating enough cash flow to cover the quarterly distribution. Looking ahead to 2016, William Partners should also see higher income flowing in from Williams (WMB), which will cut costs, following its pending merger with Energy Transfer Equity (ETE).

Like Oneok Partners, Williams Partners also has a stable BBB rating on its debt, with no major maturities coming due until 2020. This coupled with a healthy backlog of fee-based projects slated to come on line in the coming quarters, should allow the company to not only maintain its current distribution, but potentially increase it in 2016.

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At the time of publicaton, Dividend Stock Advisor had no positions in any of the securities mentioned.

TAGS: Investing | U.S. Equity | Energy | Stocks

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