The Advisor’s Guide to Variable Dividends in Midstream
Midstream dividend trends remained positive for the first quarter of 2022 with no cuts across Alerian’s midstream indexes for the third straight quarter.
The favorable momentum continued through the first quarter, with more companies growing dividends, a handful of names announcing double-digit percentage increases, and no cuts. A few midstream names have added a variable component to their distributions or deployed a special dividend in recent quarters, Stacey Morris, CFA, director of research at Alerian, wrote in an insight.
“Several oil and gas producers, including Devon Energy (DVN), Pioneer Natural Resources (PXD), and Diamondback Energy (FANG), have deployed variable or special dividends to enhance cash returns to investors,” Morris said.
Morris said a few midstream companies have followed suit, including Western Midstream (WES), Cheniere Energy Partners (CQP), and MLPX (MPLX).
“More midstream companies could look to deploy variable dividends, but special payouts are likely to be less popular for midstream names compared to their upstream counterparts,” Morris added.
A primary reason is midstream businesses typically have limited commodity price exposure, which means less upside for cash flows in strong pricing environments like today and less downside in more challenging periods. Relative to oil and gas producers, midstream companies can pay attractive dividends consistently from stable cash flows, which should be rewarded with higher equity prices.
A key attraction of variable or special dividends is the inherent flexibility, but there is debate around whether special payouts are appropriately rewarded in equity prices, Morris said.
Some companies may favor buybacks over special dividends because there is a more direct impact on the equity price, but buybacks may be less attractive if a company has a limited float (i.e. shares available to be traded by public investors), according to Morris.
For upstream, special dividends can help restore investor confidence, which was damaged by years of outspending cash flows and a lack of capital discipline. Within midstream, adoption of variable payouts may be less common, but businesses with more commodity price exposure would arguably be better suited for special payouts, namely gathering, and processing, Morris stated.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.