The Market Is Ignoring High-Yield Dividend Growth
A few weeks ago, the largest publicly traded midstream MLP decided the market wasn’t rewarding it for distribution growth. And other MLPs clearly feel the same way.
Indeed, while the sector is still recovering from the energy crash, the more conservative MLPs have continued to grow their payouts between 5% and 7% annually, with some boosting their distributions each and every quarter.
But that along with the jump in crude oil prices hasn’t been enough to stop the benchmark Alerian MLP Index from dropping 20.5% from its trailing-year high.
Despite being one of the highest-quality MLPs, Enterprise Products Partners LP (NYSE: EPD) has seen its unit price tumble more than 16% from this year’s high. The MLP has grown its distribution, which currently yields 6.8% on a forward basis, for 53 consecutive quarters.
However, in mid-October, EPD decided to slow its distribution growth from around 5% annually to 3% annually.
Since the market doesn’t seem to care about distribution growth in this environment, management believes the partnership is ultimately better off retaining extra cash flow and redeploying it toward future growth. The $54 billion MLP has $9 billion of capital projects under construction with more new projects under development.
MLPs typically fund new projects with a 50/50 mix of debt and equity, so reallocating this capital toward future growth would reduce the need for dilutive equity issuances, while affording greater financial flexibility.
In fact, the partnership believes that by 2019 it can fund the equity portion of its annual growth spending via internally generated cash flows.
And management says it may be able to afford buybacks down the road—so greater fiscal discipline comes with a potential sweetener, albeit one that income investors generally don’t find all that compelling.
So is the market’s apathy toward distribution growth just a convenient excuse? Or is this a tacit acknowledgment that with energy prices staying lower for longer even one of the best-run MLPs has to tighten its belt?
It’s probably a little bit of both.
Over the past two years, EPD’s distribution growth has been outpacing growth in cash flows. As a result, while distribution coverage is still ample, at 1.2 times, it’s down considerably from 1.5 times a few years ago. This move will help restore this crucial buffer to former levels.
The same holds true for another mature MLP, albeit one that’s been comfortable with higher leverage and lower distribution coverage than EPD.
With Buckeye Partners LP’s (NYSE: BPL) terminal operations caught in the path of three major hurricanes during the third quarter, we had been bracing ourselves for lower cash flows and even thinner distribution coverage.
Despite these headwinds, the partnership still performed better than expected during the third quarter. At the same time, a mid-September equity issuance to help fund an acquisition technically pushed BPL’s distribution coverage just below 1.0 times.
Since the associated acquisition was only completed on Sept. 18, that means the partnership only saw a week and a half of improved cash flows arising from the transaction, while it’s still on the hook for the full distribution to new unitholders.
As such, I think it’s a bit fairer to consider that distribution coverage excluding that transaction would have been around 1.1 times.
Even so, tight distribution coverage and high leverage means that BPL shouldn’t be growing its payout until cash flows ramp up and debt is pared.
Nevertheless, management borrowed part of EPD’s rationale for this move. As Buckeye CEO Clark Smith put it, “We believe the market is not adequately rewarding companies such as Buckeye for consistent distribution growth, as demonstrated by our high yield and the reduced inflow of new capital into the MLP space.”
“We believe that greater value can be generated by retaining that capital rather than distributing at our current yield,” he concluded.
As such, management decided to temporarily halt distribution growth. Prior to that, Buckeye’s distribution had been growing around 4% annually, with the payout rising on a quarterly basis.
The analysts on Buckeye’s earnings call were clearly relieved by this move. And while I normally look for MLPs that offer both enticing yields and distribution growth, it’s hard to turn down an otherwise solid long-term operator that yields nearly 10%.
Of course, it wasn’t always like this. During the energy boom, distribution growth drove share-price appreciation, which, in turn, spurred further distribution growth. But that relationship fell apart during the crash.
While the market hates any sign of weakness, I like the fact that these MLPs aren’t offering excessive distribution growth at the cost of undermining their financial strength.