Why Shares of DCP Midstream Fell 17.5% in August

What happened

Shares of natural gas liquids (NGL) midstream partnership DCP Midstream (NYSE: DCP) fell 17.5% in August, according to data provided by S&P Global Market Intelligence.

That was a much worse performance than most midstream master limited partnerships (MLPs). Enterprise Products Partners (NYSE: EPD), for example, saw its unit price -- MLP-speak for share price -- fall by only 5.3% during the month, while units of Magellan Midstream Partners (NYSE: MMP) actually finished the month up by 0.8%. 

A pair of pipelines in a trench

Energy industry player DCP Midstream focuses on natural gas liquids. Image source: Getty Images.

So what

DCP Midstream has a fairly unique income structure among midstream MLPs...and not in a good way. Most of its rivals like Enterprise and Magellan rely heavily on fixed-fee contracts for the bulk of their cash flow. That's good for those MLPs, because it insulates their cash flow from commodity price fluctuations. Fee-based income makes up about 85% of the margins for both Enterprise and Magellan. By contrast, only about 65% of DCP's cash flow comes from fixed-fee contracts. 

When commodity prices are high, this can work out OK for DCP. In the first quarter of 2019, when natural gas and oil prices were high, DCP pulled in enough cash to cover its distribution 1.45 times over, a very high margin of coverage. Unfortunately, when DCP reported second-quarter earnings on Aug. 6, after a drop in both oil and gas prices, it reported only a scant 1.12 times coverage. That's still not terrible, but what worries investors is where it might go from here. 

Oil prices -- which can affect the prices of NGLs -- have fallen further since Q2, and indeed were declining throughout August. Henry Hub natural gas prices have been on a slow decline for much of the past year. If those falling prices could drop DCP's coverage from 1.45 times to 1.12 times, and things are looking even worse for the third quarter, well, you can do the math. So could investors during August, and they headed for the exits.

Now what

DCP's CEO, Wouter van Kempen, is clearly aware of the problem, saying in a press release, "We are reducing our capital spending, while executing a strategic growth program focused on strong earnings growth and fee-based investments, mitigating commodity price sensitivity." 

It's good to know that the company is ready to take steps to move toward a more fee-based structure, but that transition will take time. In the meantime, there are other midstream partnerships -- and other companies in the energy sector -- that look like safer investments now. 

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John Bromels has no position in any of the stocks mentioned. The Motley Fool recommends Enterprise Products Partners and Magellan Midstream Partners. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


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