There is a certain allure to high-yield stocks. Investors see them as their golden ticket to lock in a lucrative income stream allowing them to just sit back and watch the income pile up in their brokerage account. Unfortunately, it does not always work out that way. In fact, more often than not a double-digit yield is a sign of trouble. That certainly seems to be the case with Midcoast Energy Partners (NYSE:MEP), CSI Compressco (NASDAQ:CCLP), and USA Compression Partners (NYSE:USAC), with their double-digit payouts appearing to be on life support.
Unsustainable without support
With a current yield north of 16%, investors firmly believe that Midcoast Energy Partners will need to cut its payout in the future. That said, it does have some time because the company entered into a distribution support agreement with its parent company Enbridge Energy Partners (NYSE:EEP). That agreement guarantees that Midcoast Energy Partners can maintain its payout through 2017, without having to reimburse its parent for the adjusted distributions.
That said, both companies are exploring their options regarding the future of their jointly owned natural gas business. That strategic evaluation could result in Enbridge Energy Partners reabsorbing Midcoast Energy Partners, or selling it and the rest of its natural gas business to a third party. Either way, Midcoast's currently eye-catching yield is not likely to last much longer.
More important uses for cash
Compression services company CSI Compressco, likewise, hands out an overly generous distribution to its investors. At 13.5%, it is an eye-catching payout that CSI Compressco currently adequately supports via distributable cash flow. In fact, its $15 million in distributable cash flow during the second-quarter covered its distribution by 1.19 times. However, its leverage situation suggests that it would be better off cutting the payout and redirecting that money toward debt reduction. That is evident by the fact that CSI Compressco needed to amend its senior secured credit facility last quarter to increase the maximum leverage ratio. It is a step the company had to take because it borrowed $236 million on its $340 million credit facility as of the end of the second quarter.
To further address its balance sheet woes, the company has issued $80 million of convertible preferred units over the past few months at a gaudy 11% interest rate. It's capital the company might not have needed to raise if it diverted more distributable cash flow toward debt reduction. While that equity issuance will likely reduce the need to cut the payout in the near-term, the distribution is not yet on solid ground and could still get cut in the future, especially if all those preferred units get converted.
Just scraping by
USA Compression Partners is another high-yield compression company with what appears to be an unsustainable yield. During the second quarter, the company just barely covered its lucrative payout -- which currently yields nearly 11% -- with cash flow, squeaking by with a 1.03 times coverage ratio. That said, like Midcoast Energy Partners, USA Compression Partners is getting support from its parent company with USA Compression Holdings, LLC, the owner of approximately 42.5% of its outstanding units, electing to reinvest 50% of its distributions in the company's distribution reinvestment plan (DRIP). Because of that, the actual cash coverage was a more comfortable 1.33 times.
Given the company's outlook, its distribution coverage will only get tighter as the year goes on. According to the company, it expects to generate $110 million to $120 million in distributable cash flow in 2016. After pulling in $62.4 million through the first half of the year, the guidance implies that USA Compression Partners' distributable cash flow will fall to between $47.5 million and $57.5 million in the second half. That would likely not be enough cash flow to maintain the payout if it did not receive the support of its parent. Suffice it to say, this payout could be heading lower if industry conditions do not start improving.
It is possible that all three companies make it through the energy market downturn without any more adjustments to their payouts. However, this risk is one few investors can afford to take. That is why investors are better off steering clear of these three income traps and instead seeking out stocks with safer payouts.
Matt DiLallo has no position in any stocks mentioned. The Motley Fool recommends Enbridge Energy Partners. 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.