It's easy to get drawn in by a stock's current yield and think you've hit the income jackpot. Unfortunately, more often than not, a high yield is a sign of trouble instead of a lucrative future income stream. That certainly appears to be the case when looking at Enbridge Energy Partners (EEP), Sunoco LP (SUN 0.57%), and Energy Transfer Equity (ET 0.12%) -- all companies with dangerously high yields.
Don't expect a rescue
Enbridge Energy Partners is one of the market's oldest master limited partnerships. Over the course of its more than two decades in operation, the company has delivered consistent distribution growth, boosting its payout by 95% since 1991. However, it has fallen on hard times recently due to the significant slump in oil and gas prices, which has had a major impact on its liquids assets in North Dakota and its gas gathering and processing assets.
Because of that, Enbridge Energy Partners is in the midst of a strategic review to determine the best way forward amid declining distributable cash flow. Investors fear that the company will have no choice but to cut the payout, which has skyrocketed to 13.3% to reflect these concerns. Those worries appear to be justified because while the company, and its parent Enbridge (ENB -1.21%), are evaluating several options to address the situation, the Canadian energy infrastructure giant made it clear that it's not planning to rescue its MLP via a buyout.
Instead, it is exploring several other options to shore up the MLP's financial situation, including buying back the gas gathering and processing assets and restructuring the incentive distribution rights, which would likely result in a significant payout reduction for Enbridge Energy Partners.
Image source: Getty Images.
Getting squeezed
Sunoco LP's distribution rate has also surged to more than 13% in recent months because of fears that it will need to reduce the payout in the future. Fueling the concern are the company's declining earnings and cash flow. Last quarter, for example, adjusted EBITDA slumped to $153.6 million, which was down from $188.7 million in the year-ago period due to lower fuel margins in both its retail and wholesale segments as well as lower profits on merchandise sales. Distributable cash flow, likewise, fell sharply, falling from $91.1 million in 2015's fourth quarter to $62.6 million in the most recent fourth quarter on lower earnings, higher interest, tax, and maintenance capital expenses.
Because of that slump, the company's distribution coverage ratio fell to a very concerning 0.61 times for the quarter and 0.98 times for the year, meaning the company paid out more than it earned. The sharp decrease in earnings caused its leverage to grow out of control, with its net debt to adjusted EBITDA ballooning to 6.5 times at the end of last quarter. Unless the company's earnings significantly improve, it will have no choice but to reduce its payout so that its leverage doesn't grow any further.
Trickle-down economics
Sunoco LP's parent, Energy Transfer Equity, is also at risk of cutting its payout. While a payout reduction at Sunoco LP would have a minor impact on Energy Transfer because it doesn't supply its parent with much income, the company has other issues that might lead to the payout's demise.
Topping the list are problems at its namesake MLP, Energy Transfer Partners (ETP), which will be supplying less income in the future. That's partly because Energy Transfer Partners is merging with another Energy Transfer affiliate, Sunoco Logistics Partners (NYSE: SXL), in a deal designed to shore up its financial situation. However, one of the drivers of that improvement is a backdoor distribution cut -- the combined entity will pay a distribution at Sunoco Logistics' lower rate. That cut means less income for its parent.
In addition, Energy Transfer Equity has agreed to help out both companies by agreeing to relinquish a growing portion of its incentive distribution rights. Because of that, its cash flow declined last year and could continue to fall in 2017. Furthermore, while its distribution coverage ratio improved last year, that was solely due to the impact of a controversial preferred share offering that allowed certain investors to forgo a portion of future cash distributions for up to nine quarters in exchange for convertible units. When this deferral ends and the preferred units convert, it could cause a significant coverage reduction that might leave no choice but to cut the payout.
Investor takeaway
While it's quite possible that all three companies will find a way to maintain their overly generous distributions, that's not something investors should bank on. Both Enbridge Energy Partners and Sunoco LP are currently living well above their means. Meanwhile, Energy Transfer Equity put on a Band-Aid to preserve its payout. As a result, the only solution these companies might find to fix their problems is to make deep cuts to their distributions.
