Don’t Bail on This 17% Yielder Just Yet
1 Ultra-High Dividend Stock
Can a company really afford to have a 17% dividend yield?
If you believe that markets are efficient, the answer would be “no.”
After all, when most dividend stocks struggle to pay six percent, a 17% yield—if it is safe—would make income investors jump on the opportunity.
And before long, all that buying of the company’s stock would cause its price to rise and, therefore, its yield to drop.
In other words, if a stock’s yield stays at an ultra-high level, chances are that investors don’t have much faith in the payout.
So when I came across Summit Midstream Partners LP (NYSE:SMLP), which yields 17%, I was highly skeptical.
Like many ultra-high yielders, one of the reasons for SMLP stock’s jaw-dropping yield was a downturn in its stock price.
Summit Midstream Partners is a master limited partnership (MLP) that owns, operates, and develops midstream energy infrastructure assets. The partnership’s stock price took a huge hit when oil prices crashed in the summer of 2014, and it has yet to make a meaningful recovery.
Over the past five years, SMLP stock has plunged more than 60%. Ouch!
There is, however, one thing that we should commend this partnership for: despite the downturn in the energy industry, Summit Midstream Partners did not cut its cash payout to investors.
Maintaining a Generous Payout
You see, Summit Midstream Partners LP completed its initial public offering in 2012. It started with a quarterly distribution rate of $0.41 per unit.
Then management decided to raise that payout every quarter. And by September 2015, the amount had increased to $0.575 per unit. (Source: “Historical Distributions,” Summit Midstream Partners LP, last accessed February 1, 2019.)
Today, the payout is still at $0.575 per unit. This means that, while SMLP stock’s distribution hike streak had come to an end, the partnership did not reduce the payout.
To put this in perspective, quite a few high-yield MLPs slashed their distributions during the industry-wide downturn.
By maintaining its distributions, Summit Midstream shows that it’s determined to return cash to investors on a regular basis.
How About the Distribution?
Of course, that doesn’t mean the stock is perfect. In order for an MLP to be worth considering for income investors, it needs to earn enough cash to cover its distributions.
In the third quarter of 2018, Summit Midstream Partners generated $43.6 million in distributable cash flow while declaring $45.2 million in actual cash distributions. That translated to a payout ratio of 0.96 times, meaning the partnership did not generate enough cash to cover its payout. (Source: “Summit Midstream Partners, LP Reports Third Quarter 2018 Financial Results and Provides Update for Double E Pipeline,” Summit Midstream Partners LP, November 8, 2018.)
In the first nine months of 2018, the company generated $134.9 million in distributable cash flow. Its declared distributions, on the other hand, totaled $135.6 million. That gave it a distribution coverage ratio of 0.99 times. So, while the partnership fell short of covering the payout, it came awfully close.
For full-year 2018, management expects the partnership’s distribution coverage ratio to be around one time.
As a risk-averse investor, I like to see an MLP with a distribution coverage ratio of above one, because that would imply a margin of safety in its payout.
Still, that doesn’t necessarily mean you should ditch the stock completely. The partnership’s expected producer activity levels in its service area, along with its ongoing projects, could lead to steady improvements.
In particular, management has issued a preliminary guidance for 2019; they are targeting a growth rate in adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) of at least 10% over 2018.
Most importantly, management expects the MLP’s distribution coverage ratio to expand “generally in line with adjusted EBITDA growth” this year and that, by the fourth quarter, the ratio will rise to above 1.15 times. (Source: Ibid.)
Summit Midstream Partners is scheduled to report its 2018 fourth-quarter results on February 21 after the closing bell. Investors should watch for its distribution coverage ratio for the reporting quarter, and for management’s update on their initial 2019 guidance.
If the MLP can deliver on that target and easily out-earn its payout by the end of this year, its jaw-dropping yield would be worth considering.
As it stands, I suggest keeping the 17%-yielding SMLP stock on a watchlist.
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