If we could all invest in stocks with double-digit dividend yields without the specter of an imminent payout cut, then we would all be filthy rich. In reality, though, a company with a sky-high yield typically means that there is something wrong with it, and that means its payout is seriously compromised.
Three companies in particular -- Midcoast Energy Partners (NYSE: MEP), Sunoco LP (SUN 1.32%), and Suburban Propane Partners (SPH -0.66%) -- each have some serious threats to their current businesses that could lead to a major payout cut. Let's take a quick look at each of these companies and why their high yields could be in trouble.
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Left in limbo
Midcoast Energy Partners has been a bit of a problem child for its parent company Enbridge Energy Partners (EEP) for a while. Gathering and processing volumes for both natural gas and natural gas liquids (NGLs) have declined 22% and 19%, respectively, since the third quarter of 2014. These declines have hit the company's cash flow so hard that Enbridge Energy Partners has needed to give the company cash to support its payout. In 2016, Enbridge Energy Partners has forked over $8.5 million to Midcoast in order to fund its distribution to shareholders.
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To be fair to Midcoast, it has done some significant cost-cutting and divested some of its less-profitable elements such as its trucking segment. As a result, management believes that it can meet its fourth-quarter distribution without support from Enbridge Energy Partners. However, much of that is predicated on improving volumes in its system as drilling activity picks up. It's certainly a possibility, but not necessarily a guarantee.
Enbridge Energy Partners has been saying for months that it was looking at strategic alternatives for Midcoast because, frankly, it hasn't met Enbridge Energy Partner's expectations. Enbridge Energy Partners had originally said it would have a plan together by the end of the year, but a wrench was thrown into those plans when Enbridge Energy Partners' parent company, Enbridge, decided to merge with Spectra Energy. The tie up of these two companies is likely going to result in some major restructuring at the two's subsidiary partnerships. What that means for Midcoast remains to be seen.
While it is entirely possible that Midcoast Energy Partners will be able to pull off its cost-cutting and put itself back on stable financial footing, there are a lot of things up in the air right now that could impact Midcoast. Considering that the company's distribution yield is a whopping 19% today, the market doesn't seem to think that this payout will last much longer.
Another subsidiary left hanging
Like Midcoast, Sunoco LP is in this strange situation where the parent companies above it are in the middle of a major restructuring. The company that holds the general partnership stake in Sunoco, Energy Transfer Partners (ETP), is being bought by Sunoco Logistics Partners. The reason that this is important for Sunoco LP is that, as it stands, the company's financials are looking less than robust, but its parent company is likely looking at other things right now.
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According to the company's most recent earnings release, Sunoco was sitting on a sizable debt load. Its net-debt-to-EBITDA ratio is a rather scary 7.35 over the past 12 months. The company's EBITDA has improved as of late, so that ratio will come down a bit. That being said, it is still high enough to give investors concern.
If the company was solely focused on cutting its debt load, then this may not be a huge issue, but Sunoco wants to keep growing. In the retail filling station market, that most likely means making acquisitions. It's a very mature market with few organic expansion opportunities, but it's a very fragmented industry with tons of small-time players. To make acquisitions, it will need a source of capital, and that typically entails either issuing debt or equity.
Taking on more debt isn't really an option since its debt levels are already high. Furthermore, the high distribution yield of Sunoco's shares -- a 13% yield -- makes it prohibitively expensive to issue new equity. The only other way to grow, then, is to free up some of its internally generated cash flow, and that would entail a distribution cut.
This puts Sunoco in a bind. This may be a little less of an issue if we knew that it could get financial support from its general partner to get deals done. Unfortunately, though, Energy Transfer Partners is facing its own financial troubles, and its using the tie up with Sunoco Logistics Partners to address those issues. With this all in mind, it isn't too much of a stretch to see Sunoco cutting its payout.
Winter is coming, hopefully
Last winter was a tough one for the propane distribution business. Higher-than-average temperatures last year across most of the markets in which Suburban operates resulted in 13.7% and 26.3% declines in propane and fuel oil sales, respectively. Those declines translated into a big cash funding shortfall for the fiscal year. The company's distribution coverage ratio came in at an alarmingly low 0.6.
Suburban's management was able to cover the distribution funding shortfall by tapping into its cash reserves. Unfortunately, this is something the company can only do once. To cover that shortfall, the company burned through $111 million -- or 75% -- of total cash on hand and left it with a paltry $37 million in cash going into the winter season.
This winter is going to be a pivotal point for Suburban. The winter months are the time when propane distributors generate a vast majority of their revenue, and the cash it takes in during this time is used to sustain the business throughout the year. Normal winter temperatures would likely allow the company to keep its payout going at its current rate. However, another winter with higher average temperatures and lower fuel sales would likely mean management would have to revisit its payout.
Investors watching Suburban will need to keep a close eye on the thermometer over the coming months. Anything less than a cold winter could spell disaster.
