Get Ready for a Distribution Hike From a Stock That Already Yields 11%
A Rare Find in the Stock Market
In today’s stock market, what could be better than a safe yield of over 10%?
The answer: a double-digit yielder that keeps growing its payout.
I know, in an era where most companies pay less than four percent, this sounds too good to be true.
But such a high yielder does exist, and it goes by the name of Delek Logistics Partners LP (NYSE:DKL).
As a master limited partnership headquartered in Brentwood, Tennessee, Delek Logistics Partners does not make headlines very often. It was formed by Delek US Holdings Inc (NYSE:DK) back in 2012 and completed its initial public offering in the same year. Today, DKL owns, operates, acquires, and builds crude oil and refined products logistics and marketing assets.
Like I said, this is a double-digit yielder. With a quarterly distribution rate of $0.79 per common limited partner unit, DKL stock offers investors a jaw-dropping yield of 11.1%.
How This Double-Digit Yielder Came About
Of course, as is the case with many ultra-high yielders, one of the reasons behind this elevated yield is the partnership’s lackluster stock price performance. Over the past 12 months, DKL stock slipped more than 10%.
Still, a more important reason why Delek Logistics Partners can offer such a generous yield is the fact that the partnership has actually been growing its payout. When DKL stock first went public, it had a minimum quarterly cash distribution rate of $0.375 per unit. Its initial distribution of $0.224 per unit was a prorated payment corresponding to the minimum distribution rate. (Source: “Delek Logistics Partners, LP Declares Initial Quarterly Cash Distribution,” Delek Logistics Partners LP, January 24, 2013.)
Since then, the partnership has raised its payout every quarter, by a total of 110.7% from its minimum quarterly cash distribution. That’s 23 consecutive quarterly distribution hikes.
The latest payout increase, which was announced in October 2018, represented a 2.6% increase sequentially and a 10.5% increase year-over-year. (Source: “Delek Logistics Partners, LP Increases Quarterly Cash Distribution to $0.79 per Common Limited Partner Unit,” Delek Logistics Partners LP, October 23, 2018.)
Now, keep in mind that the past several years have been a rough period for many companies in the oil business. After oil prices crashed in the summer of 2014, the industry saw a whole bunch of production cuts and layoffs. Dividend cuts weren’t uncommon.
And that’s where DKL stock truly stands out. Despite this massive downturn in the oil business, this partnership was still giving shareholders a pay raise every three months.
Of course, continuous distribution increases from an oil stock in a hostile commodity price environment could be risky.
Does the partnership have enough resources to cover its payout? Let’s take a look.
Delek Logistics Partners LP: A Safe Yield of 11%
Delek Logistics Partners last reported earnings in November. In the third quarter of 2018, the partnership generated $32.4 million in distributable cash flow, representing a 50% increase year-over-year. Since the company paid total distributions of $26.0 million for the quarter, it achieved a distribution coverage ratio of 1.25 times. (Source: “Delek Logistics Partners, LP Reports Third Quarter 2018 Results,” Delek Logistics Partners LP, November 6, 2018.)
In other words, Delek Logistics Partners generated 25% more cash than what was needed to meet its distribution obligations. That has left quite a sizable margin of safety.
Looking a bit further back, we see that in the first nine months of 2018, Delek Logistics Partners generated $94.1 million in distributable cash flow. Its actual distributions, on the other hand, totaled $74.9 million for the period. That translated to a coverage ratio of 1.26 times, so again, the payout remained safe.
The reason why Delek Logistics Partners can offer oversized yet safe distributions lies in the nature of its business. Despite being in the beaten-down oil industry, the company operates through a relatively stable business model.
You see, the company’s asset portfolio consists of hundreds of miles of crude and product transportation pipelines, a crude oil gathering system, storage facilities, a rail offloading facility, and a wholesale and marketing business, among others.
Through these assets, the partnership provides gathering, transportation, and storage services for crude oil and marketing, distribution, transportation, and storage services for refined products. Delek Logistics Partners’s client base includes its sponsor Delek U.S. Holdings, as well as third-party customers.
The neat thing about the business is that it is largely backed by long-term, fee-based contracts that also come with minimum volume commitments. In the third quarter of 2018, 73% of the partnership’s gross margin came from minimum volume commitments. (Source: “Investor Presentation,” Delek Logistics Partners LP, last accessed December 21, 2018.)
By running a fee-based business with multi-year contracts, Delek Logistics Partners can limit its exposure to movements in oil prices and generate more stable cash flows.
Prepare for Another Distribution Increase
In the latest investor presentation, management reaffirmed their distribution-per-unit growth target of at least 10% through 2019. If they continue to follow the quarterly distribution increase schedule, the next payout hike will likely arrive later this month.
That is, DKL stock’s 11.1% yield is about to get even higher.
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