1 High-Yield Stock to Think About
In today’s low-yield environment, it’s no secret that down-and-out stocks offer the biggest yields. The problem, of course, is that these stocks often plunged for a reason. And if investors are not careful, they might be entering what’s called a yield trap.
Some beaten-down companies, though, are making a turnaround. Their share prices are still in the doldrums—meaning their yields stay elevated. If they can successfully turn their business around, investors might be locking in some capital gains on top of collecting oversized dividends.
Plains All American Pipeline, L.P. (NYSE:PAA) could be one of those turnaround opportunities.
As the name suggests, Plains All American Pipeline is in the pipeline business. Structured as a master limited partnership (MLP), PAA owns and operates an extensive network of pipeline transportation, terminaling, storage, and gathering assets in key crude oil and natural gas liquid (NGL) producing basins and transportation corridors and at major market hubs in the U.S. and Canada.
To give you an idea, in the transportation segment—PAA’s largest segment—the partnership handles, on average, more than six million barrels of crude oil and NGL per day. The transportation business is also well positioned to generate predictable cash flow because it is fee-based and supported by long-term minimum volume commitments and acreage dedications. (Source: “Investor Presentation September 2020,” Plains All American Pipeline, L.P., last accessed October 14, 2020.)
Of course, given the downturn in the energy sector this year, even pipeline operators have been impacted. Looking at Plains All American Pipeline, we see that the partnership reduced its distribution earlier this year, and its stock price also tanked. (Source: “Quarterly Distributions,” Plains All American Pipeline, L.P., last accessed October 14, 2020.)
The neat thing is, because PAA stock tumbled so much, it remains an ultra-high-yielder even after the distribution cut. With a quarterly cash distribution rate of $0.18 per unit and a unit price of $6.97, Plains All American Pipeline stock offers an annual distribution yield of 10.3%.
Obviously, double-digit yielders are not the safest bets in this day and age. So we need to check whether this high-yield stock can afford its payout.
According to its latest earnings report, Plains All American Pipelines, L.P. generated a distributable cash flow of $0.41 per common unit in the second quarter of 2020. Considering that the MLP paid a cash distribution of $0.18 per unit for the quarter, the distributable cash flow covered the payout more than twice over. (Source: “Plains All American Pipeline and Plains GP Holdings Report Second-Quarter 2020 Results; Update 2020 Guidance,” Plains All American Pipeline, L.P., August 4, 2020.)
In other words, even though the MLP has cut its payout before, it managed to achieve very strong distribution coverage in the second quarter, which was a very challenging period, to say the least.
The partnership has also raised its guidance in August. For full-year 2020, management expects Plains All American Pipeline to generate adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) of $2.5 billion, up from their April guidance of $2.43 billion. Implied distributable cash flow is projected to be $2.25 per unit, compared to April’s outlook of $2.16 per unit.
If the partnership meets the new guidance, its distributable cash flow would cover its payout for the year approximately 2.5 times.
At the same time, Plains All American Pipeline is becoming thriftier when it comes to capital spending.
In February, management’s projection for expansion capital was $1.4 billion in 2020 and $900.0 million in 2021.
Now they expect to spend just $1.0 billion in 2020 and around $450.0 million in 2021.
For 2022, capital spending is expected to be lower than $450.0 million. (Source: “Investor Presentation September 2020,” Plains All American Pipeline, L.P., Op. cit.)
Lowering capital expenditures should help PAA improve its free cash flow. And the partnership could use the excess free cash flow to reduce leverage. After that, increasing cash returns to investors could be on the agenda.
Commenting on the MLP’s plan regarding future excess free cash flow, PAA’s chief financial officer and executive vice president, Alan P. Swanson, said, “…we will be focused on using the excess in the near term for debt reduction, leverage reduction. And then, we’ll be looking to allocate to equityholders, whether it’s distribution increases and/or share repurchases.” (Source: “2Q 2020 Earnings Package,” Plains All American Pipeline, L.P., August 4, 2020.)
Bottom Line on Plains All American Pipeline, L.P.
Given the uncertainties facing the economy and the energy sector, it’s hard to say when Plains All American Pipeline will bring its distribution back up. But given the MLP’s 10.3% yield that’s well covered, PAA stock investors are earning oversized cash returns while waiting.