This Double-Digit Yielder Looks Interesting
If your goal is to own soaring tickers, you can cross DCP Midstream LP (NYSE:DCP) off your watch list. DCP Midstream stock started the year trading at $26.68 apiece. As of this writing, it’s at $24.89, so there’s nothing impressive in terms of its stock-price performance.
If you want to earn a high yield, though, few names look more exciting than DCP Midstream.
Allow me to explain.
DCP Midstream LP is a master limited partnership (MLP) that owns and operates a diversified portfolio of gathering, processing, logistics, and marketing assets. Headquartered in Denver, Colorado, the partnership is one of the largest natural gas liquids (NGL) producers and marketers, and one of the largest natural gas processors in the United States.
Today, the No. 1 reason to check out DCP stock is its massive payout to investors. Right now, the partnership has a quarterly cash distribution rate of $0.78 per unit, which translates to an annual yield of 12.5%.
Of course, in the current low-yield environment, an ultra-high yield—especially one coming from the energy sector—can look a bit risky.
The good news is, like most MLPs, DCP Midstream reports something called distributable cash flow. To check whether the partnership’s payout is safe in a given reporting period, all we need to do is compare its distributable cash flow to its cash payout for that period.
Is the Distribution Safe at DCP Midstream LP?
DCP Midstream last reported earnings on November 6. The report showed that, in the third quarter of this year, the partnership generated $190.0 million in distributable cash flow. (Source: “DCP Midstream Reports Strong Third Quarter Results and Announces Elimination of Incentive Distribution Rights,” DCP Midstream LP, November 6, 2019.)
Considering that DCP declared $155.0 million of cash distributions to unitholders during the quarter, it achieved a distribution coverage ratio of 1.2 times, leaving a margin of safety.
In the first nine months of 2019, DCP Midstream earned $587.0 million of distributable cash flow. Its declared cash distributions, on the other hand, totaled $464.0 million during this period. As a result, the partnership’s distribution coverage ratio in the nine-month period was about 1.3 times. So again, the payout remained safe.
Now, if you look at the other double-digit yielders in the energy sector, you’ll see that many of them have less-than-stellar dividend histories. For instance, when oil and gas prices crashed in the summer of 2014, a lot of energy companies slashed their dividends.
And that’s another reason why DCP Midstream stock stands out. The partnership completed its initial public offering in December 2005. Since then, its per-unit payout has only been going up. (Source: “Distribution Payments,” DCP Midstream LP, last accessed December 20, 2019.)
How was that possible?
Well, the neat thing about DCP stock is that, despite coming from the energy industry, the partnership’s business is predominately fee-based.
For full-year 2019, DCP Midstream expects its fee-based operations to account for 65% of its adjusted gross margin. (Source: “Investor Presentation December 2019,” DCP Midstream LP, last accessed December 20, 2019.)
At the same time, the partnership also has a hedging program that provides downside protection on commodity-exposed margin. Combined, around 78% of DCP’s 2019 adjusted gross margin is projected to be either fee-based or hedged. As a result, the MLP can run a relatively stable business despite volatility in crude oil, natural gas, and NGL prices.
As a matter of fact, DCP Midstream’s business has grown over the past several years. In 2017, the partnership’s adjusted earnings before interest, tax, depreciation and amortization (EBITDA) was $1.0 billion. This year, it is on track to generate adjusted EBITDA of $1.2 billion, translating to a total increase of 19.5%.
It’s a similar story with distributable cash flow. In 2017, DCP Midstream generated $643.0 million in distributable cash flow. This year, management expects the amount to be between $700.0 million and $800.0 million. At the midpoint of the guidance range, this MLP would achieve a distribution coverage ratio of around 1.2 times in 2019.
Of course, at the end of the day, it’s up to management to decide how much cash to return to investors. And as we have seen plenty of times, past performance is no guarantee of future results, especially when it comes to stocks with yields north of 10%.
Fortunately, DCP Midstream LP’s management team is pretty determined to keep paying that oversized cash distribution.
In the MLP’s latest earnings conference call, chief executive officer Wouter van Kempen said, “The distribution is absolutely not at risk. Not now, not tomorrow, not for a long time to come.” (Source: “DCP Midstream’s (DCP) CEO Wouter van Kempen on Q3 2019 Results – Earnings Call Transcript,” Seeking Alpha, November 7, 2019.)
As it stands, DCP Midstream stock could be an opportunity for yield-seeking investors.