DCP Midstream LP: Can a 9.5% Yield Possibly Be Safe? Income Investors 2019-04-04 11:56:41 DCP Midstream LP DCP stock NYSE:DCP DCP Midstream DCP Midstream LP (NYSE:DCP) stock offers investors a generous distribution yield of 9.5%. But can you count on this ultra-high yielder? Here's a look. DCP Midstream Stock https://www.incomeinvestors.com/wp-content/uploads/2019/03/DCP-Midstream-LP-Can-a-9.5-Yield-Possibly-Be-Safe-150x150.jpg

DCP Midstream LP: Can a 9.5% Yield Possibly Be Safe?

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Should Investors Consider This High-Yield Stock?

Today’s article highlights one of the most generous dividend-payers in the current stock market, DCP Midstream LP (NYSE:DCP).

Unless you follow the energy industry very closely, the name “DCP Midstream” won’t sound familiar. The partnership doesn’t sell a product or service to the mass market. Instead, as its name suggests, it focuses on the midstream energy business.

The partnership owns and operates 60 natural gas processing plants and 64,000 miles of natural gas and natural gas liquids (NGL) pipeline. Headquartered in Denver, Colorado, DCP has a presence in 17 states and is one of the largest NGL producers and marketers. It’s also one of the largest natural gas processors in the country.

Right now, the No. 1 reason to check out this midstream energy stock is for the sheer size of its distribution checks. The partnership pays quarterly cash distributions of $0.78 per unit, giving DCP stock an annual yield of 9.5%.

Given that this is a stock that comes from the energy sector, and that it offers a jaw-dropping yield, it’s only natural to ask, “Are the payouts reliable?”

Is the Distribution Safe at DCP Midstream LP?

Well, the first thing you should note is that, despite being an ultra-high yielder—which doesn’t really scream the word “safety”—DCP Midstream LP actually has a pretty solid track record of returning cash to investors.

The partnership was founded back in 2005. Throughout its 13-year history, DCP Midstream has paid quarterly distributions that are either steady or increasing. In other words, there was no distribution cut. (Source: “Distribution Payments,” DCP Midstream LP, last accessed March 27, 2019.)

That’s quite an accomplishment. During this period, commodity prices have been volatile, to say the least. And dividend cuts were not uncommon in the energy sector. Besides, we also had the Great Recession, which many believe to be the biggest economic downturn since the Great Depression. The fact that DCP paid steady or increasing distributions during these tough times indicates that the partnership could be something special.

Indeed, that specialness comes from DCP’s fee-based business.

You see, one of the main risks with investing in energy companies is their exposure to commodity price movements. For instance, if a company earns most of its revenue from commodity margins, then its business will fluctuate due to the movement in commodity prices. And as we saw not that long ago, those margin-based businesses didn’t do that well when oil and gas prices crashed in the summer of 2014.

DCP Midstream LP, on the other hand, makes most of its money from fees earned through providing midstream services. For 2019, management expects that 65% of the partnership’s adjusted gross margin will come from fee-based operations. (Source: “2018 Update and 2019 Outlook,” DCP Midstream LP, last accessed March 27, 2019.)

Of course, that means 35% of the company’s adjusted gross margin would be generated from its commodity margin-based operations. But the neat thing is, 32% of those operations are hedged.

Put it together and you’ll see that, for the current year, 76% of DCP Midstream LP’s gross margin is projected to be either fee-based or hedged. That adds stability to the partnership’s business and distributions.

Still, as is the case with most master limited partnerships (MLPs), the key performance metric to check when it comes to distribution safety is distributable cash flow. Basically, you want to see a partnership with a distributable cash flow that is greater than its actual cash payouts.

In 2018, DCP Midstream LP generated $684.0 million in distributable cash flow while declaring $618.0 million in cash distributions. That translated to a distribution coverage ratio of 1.1 times. (Source: “DCP Midstream Reports Fourth Quarter and Full Year Results and Announces 2019 Guidance,” DCP Midstream LP, February 11, 2019.)

Therefore, the partnership generated 11% more cash than what was needed to meet its distribution obligations for the year. That created a margin of safety.

And the best could be yet to come. For 2019, management is forecasting $700.0 to $800.0 million in distributable cash flow. Note that even the lower end of the guidance range is greater than what the partnership earned last year.

At the midpoint of the 2019 guidance range, DCP’s distributable cash flow would represent an increase of 9.6% from 2018. Most importantly, the projected figure would allow the partnership to achieve a distribution coverage ratio of around 1.2 times.

The good news doesn’t stop there. Because of DCP Midstream LP’s ability to earn more cash than its payout, it can use the excess cash to fund its growth. That is to say, the partnership doesn’t need to issue more units to get financing.

“In 2019 we expect to continue to self fund the portion of our growth via excess coverage and divestitures resulting in no planned common equity issuances and we are hitting the ground running with the recently announced sale of our non-core wholesale propane business for an attractive multiple that is immediately accretive,” said DCP’s Chief Financial Officer Sean O’Brien earlier this year. (Source: “DCP Midstream Partners LP (DCP) CEO Wouter van Kempen on Q4 2018 Results – Earnings Call Transcript,” Seeking Alpha, February 12, 2019.)

In this day and age, it’s not uncommon for publicly listed companies to issue more shares (which causes dilution) to raise money. By using internally generated cash flow, DCP shields its investors from the dilution effect.

The Bottom Line on DCP Midstream LP

If DCP Midstream LP can deliver on its growth targets, it would make its already-covered distributions even safer. For investors searching for yield in this market, DCP stock’s 9.5% payout surely deserves a look.

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