No one likes to lose money, which is why so many have a deep-seated fear of the stock market. However, while there is a risk of losing money when investing in stocks, some companies have a much lower risk profile than others. These companies drive out risk by maintaining a conservative financial profile, such as keeping debt down and operating businesses that generate stable cash flow, which positions them to withstand any storm.
All shored up and ready to grow
Natural gas pipeline MLP Williams Partners has been on a mission to reduce its risk profile over the past year. The company has worked with parent company Williams Companies (WMB -0.62%) on several strategic initiatives that reduced its exposure to commodity price volatility and eliminated the need to access the capital markets for growth financing. These moves included selling their Canadian assets and Williams Partners' stake in a petrochemicals plant to raise cash and reduce commodity price exposure. Meanwhile, Williams agreed to eliminate the high-cost incentive distribution rights that ate up a significant portion of its MLP's cash flow. Finally, both companies reset their investor payouts to more sustainable levels.
As a result of these moves, Williams Partners is a much less risky company than it was just a year ago. By selling commodity price exposed assets, the company has increased the percentage of cash flow that comes from stable fees all the way up to a 97%. Meanwhile, the proceeds from these sales will push its leverage ratio to a more conservative 4.5 times debt to EBITDA this year. Because of that, one credit rating agency recently said it would likely upgrade the company's credit rating by two notches, to BBB+. Meanwhile, with the capital raised this year, Williams has the financing it needs to complete a slew of high-return, fee-based growth projects. Those expansions put the company in the position to grow its reset distribution by 5% to 7% per year while maintaining at least a 1.1 times coverage ratio, which is healthy growth for a payout that already yields 5.8%.
On rock-solid ground and getting better
Fellow natural gas pipeline MLP Boardwalk Pipeline Partners made the tough decision to cut its distribution several years ago to reduce financial risk. Because of that, the company's current yield is just 2.2%. However, it covers that payout 5.0 times with cash flow, which is among the highest coverage ratios in the sector. Meanwhile, Boardwalk uses its retained cash to finance growth projects and reduce debt, which has helped improve its leverage ratio from 5.4 times at the end of 2014 to 4.5 times at the end of last year. It's a healthy enough ratio to earn the company an investment grade credit rating of BBB-.
In addition to its solid balance sheet and well-covered distribution, Boardwalk Pipeline Partners also generates consistent cash flow since 90% of its revenue comes from fixed-fee and ship-or-pay contracts. Meanwhile, the company is currently in the process of placing $1.3 billion of new fee-based projects into service that should grow its percentage of fee-based cash flow and further improve the security of its financials.
Leading the sector with the lowest leverage
Magellan Midstream Partners does things a bit differently in that it operates refined product and crude pipelines instead of gas-focused assets. That said, these assets still generate rather consistent cash flow since Magellan only gets 13% of its operating margin from commodity-related activities. While that means its percentage of fee-based revenue is lower than Williams Partners and Boardwalk, the company more than makes up for that with the strength of its balance sheet.
Driving that strength is the fact that Magellan has consistently kept its leverage ratio below 4.0 times debt to EBITDA. In fact, its ratio has recently been below 3.5 times, which is among the best in the sector. Meanwhile, the company retains a significant portion of its cash flow for growth projects, typically targeting a distribution coverage ratio of around 1.2 times. Like its peers, Magellan reinvests what it doesn't send back to investors into growth projects. This year, for example, the company plans to reinvest $180 million of cash flow, giving it a good head start on financing its $550 million capex budget. Further, thanks to its low leverage ratio, the company has one of the best credit ratings among MLPs at BBB+, which gives it open access to cheap capital to finance the balance of its capital needs. As a result, the company's distribution, which currently yields 4.4%, isn't at risk of being reduced. Instead, the company plans to boost it by 8% this year and next.
Pipeline stocks are often a great option for risk-adverse investors because the bulk of their earnings typically come from steady fees. That said, some companies ratchet up the safety factor by employing a conservative financial profile, including low leverage and high distribution coverage. By going the conservative route, Williams Partners, Boardwalk Pipeline Partners, and Magellan Midstream Partners shouldn't have any problem maintaining their distributions and growing their businesses, which makes it less likely that they'll run into financial problems when times get tough.