Williams Companies (NYSE:WMB) issued a stark warning to its investors. Its generous 8.3% dividend could be cut if it doesn't close its merger with Energy Transfer Equity (NYSE:ET). Worse yet, that cut "could be material," according to the company.
Adding insult to injury
Williams Companies and Energy Transfer Equity have been embroiled in a bitter battle over their pending merger for months. However, Williams Companies is reportedly more open to renegotiating the deal in order to settle its legal battle and move forward. One reason for this openness is the fact that Williams Companies would be on the hook to pay Energy Transfer Equity a $1.48 billion termination fee if the deal doesn't close. That's a hefty sum for the company that's the target of the merger to pay.
The possibility that Williams Companies will be on the hook to pay this termination fee is one of the reasons it's warning that its dividend could be cut. The company's financials are already under pressure after having to pay its affiliated MLP Williams Partners (NYSE:WPZ) a $428 million termination fee after breaking up that merger in favor of the merger with Energy Transfer Equity.
In addition to that potential cash payout eating deeper into Williams Companies' coffers, the company's underlying business is clearly being impacted by the downturn in the oil market. That actually stems from the fact that it derives the bulk of its cash flow from its ownership interest in Williams Partners, which is feeling the impact from weak commodity prices on its earnings. Last quarter, for example, Williams Partners' distribution coverage ratio was just 1.02 times, meaning it just barely covered its distribution. That said, the coverage ratio would have been even weaker if it wasn't for the fact that it benefited from a reduction in incentive distribution rights paid out to Williams Companies as part of the aforementioned merger termination fee. This is on top of the fact that Williams Partners' cash flow was weaker than it could have been thanks to volume shut-ins by producers amid weak commodity prices.
These issues weighed on Williams Companies' own coverage ratio, which was a very weak 0.89 times last quarter, meaning it paid out all of its cash flow and then some. While that was partially because of the lower IDRs received as a result of the termination fee payout, the bottom line is that Williams Partners and Williams Companies aren't generating enough cash flow to sustain both payouts in the currently weak operating environment.
Further, because of the credit concerns in the sector, Williams Partners can't raise capital as easily as it had in the past to fund its growth projects. That was made clear earlier this year when Williams Partners had to cut its 2016 growth capex budget by nearly a third. Further, in order to fund its reduced spending plan, Williams Partners announced that it would sell roughly $1 billion in assets this year so it didn't need to issue public debt or equity. While that was expected to cover the balance of its capital needs for the current year, it doesn't solve its capital needs going forward. As such, Williams Partners might need to significantly reduce its distribution in order to fund growth capex, which would therefore cut deeply into Williams Companies cash flow, necessitating a deep dividend cut.
Williams Companies' dividend looks like it could be toast. The company's current operations are just barely sustaining its payout, meaning it certainly couldn't afford to keep it up if Williams needed to pay a big termination fee to Energy Transfer Equity. That said, given the weakness of Williams Partners' underlying operations and the underlying problems causing concerns with the Energy Transfer Equity merger, its dividend doesn't look sustainable even if that merger closes under a framework that has been dramatically reworked.
Matt DiLallo has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.