MLP Dividends are Starting to Get Cut
Midstream companies have come under pressure lately, with DCP Midstream cutting its dividend in half. Yet some say that even if every MLP cut its dividend in half, the sector would still yield 9.2%.
Yet companies in the sector may be in better shape than their prices indicate.
When oil and gas prices fall, the companies with the most to lose tend to be producers. That’s because they are directly affected by the price of those commodities.
The recent plunge, however, has clearly spread well beyond those companies. Increasingly, so-called midstream companies are having to cut their budgets and dividends to keep on sound financial footing.
On Monday, DCP Midstream (ticker: DCP), a company that operates natural gas processing facilities and pipelines, announced that it would cut its dividend in half “in response to extraordinary and volatile market conditions.”
“This 50% distribution reduction results in $325 million of cash that will be fully utilized to reduce leverage and strengthen the balance sheet,” the Denver-based company said. Cuts to its capital expenditures will also free up cash, it added.
“Importantly, we announced over $850 million of cash optimization today as a result of capital, distribution, and cost reductions,” a DCP spokesperson wrote in an email to Barron’s when asked about the move.
Asked about whether the company’s move was spurred by its clients going out of business, the spokesperson wrote “We have not had any producers enter bankruptcy and many have announced adjustments to their capital programs as a result of the unprecedented external environment.”
DCP Midstream is organized as a master limited partnership, a corporate structure that passes the corporation’s income through to shareholders, generally resulting in high dividends. It also has a special tax structure that keeps it from having to pay taxes on the corporate level.
Because they tend to sign longer-term contracts, MLPs are relatively safer than companies whose fortunes fluctuate based on the day-to-day price of oil. But MLPs have been criticized in the past for carrying high debt loads, and they have been trading with similar volatility to the broader energy sector. When overall oil and gas activities slow, their customers no longer need their services.
Clearly, their dividends -- the biggest reason to buy them -- are under threat right now. Targa Resources (TRGP), another MLP, also announced a dividend cut last week, to 10 cents a quarter from 91 cents.
The Alerian MLP ETF (AMLP), which tracks the industry, has fallen 62% this year. On March 9 alone the underlying index fell 27.4%, the largest drop in its history.
Stacey Morris, director of research at Alerian, has published reports arguing that the companies are in better shape than these prices indicate. Even if every MLP cut its dividend in half, the sector would still yield 9.2%. And if they cut by 75%, they would yield 4.6%, which would “represent premiums to REITs, utilities, and bonds,” she wrote earlier this month. “Additionally, keep in mind that MLP distributions are typically tax advantaged.”
“The key point is that’s not our base-case scenario. You have the larger names in the index that are well-positioned,” Morris said in a phone interview.
Because she works for an index provider, Morris doesn’t recommend individual stock names, but she did explain that bigger names are more insulated at a time like this.
“We think in general the larger names are probably best-positioned for a downturn just given the diversified nature of their business, the diversified customer base they have and the benefits that come with size,” she said.
In one recent note, she pointed out that Enterprise Products Partners (EPD), one of the largest MLPs, maintained its dividend last week, telling investors that it will have more information on its plans on its next quarterly conference call. Enterprise Products stock yields 13%.
Write to Avi Salzman at email@example.com
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