Retirees need an income stream that they can count on throughout their golden years. While many choose to get that steady cash flow from bonds or annuities, neither of those options offers the built-in inflation protection and potential income upside of dividend-paying stocks. While those payouts do carry higher risk, the reward can be well worth it.
Take oil pipeline giant Plains All American Pipeline (PAA 1.90%), which currently offers investors a lucrative 8.9% yield. While there is some risk involved with the company, it has worked hard over the past year to mitigate that risk so that it can offer investors a sustainable income stream. Here's why retirees should take a closer look at Plains All American Pipeline.
Image source: Getty images.
Plains All American Pipeline 101
Plains All American Pipeline is a master limited partnership (MLP) focused on operating crude oil pipelines and storage terminals. While being an MLP has certain tax advantages, it does require some extra paperwork come tax time. Because of that, investors might want to consider investing in its general partner Plains GP Holding (PAGP 1.09%) instead because it's a C-Corp that owns units of Plains All American Pipeline. Because of that structure, Plains GP Holding offers a similarly high yield of 8.8% without the additional tax headaches.
That difference aside, retirees might want to consider investing in either option because of the stable business model of Plains All American Pipeline. For the most part, the company makes its money by collecting a fee-for-service as oil producers and shippers use its assets. In fact, about 90% of its underlying earnings in 2017 will come from stable fees. That's by design because the company has been building and buying fee-based assets over the past several years to reduce its direct exposure to commodity prices.
Providing further support to the company's lucrative shareholder distributions is its improving financial profile. Plains All American Pipeline currently has an investment-grade balance sheet that it's in the process of shoring up by reducing its leverage ratio. While its debt-to-adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) ratio was an elevated 4.8 times at the end of last quarter, that's due in part to several recent transactions to bolster its portfolio and growth prospects. After adjusting for that disruption, its leverage ratio would have been 4.4 times, which is getting it closer to its 3.5-4.0 times target level. In addition to that improving balance sheet, Plains All American Pipeline completed a financial repositioning transaction with Plains GP Holdings last year, which resulted in both companies reducing their payouts to a more sustainable level. In fact, Plains All American Pipeline expects to generate just enough cash flow to cover its payout this year. It plans to further improve that coverage in the future.
Growing into a stronger company
Driving Plains All American Pipeline's view that its leverage and coverage metrics can quickly get back to more comfortable ranges are the expansion projects it has underway. The company currently has $900 million of capital projects under construction that should enter service over the next year. These projects, along with recent acquisitions, should fuel a 17% increase in earnings next year. The company has tremendous confidence in that outlook because it secured fee-based contracts to underpin these projects. For example, the company is working with Valero Energy (VLO -2.86%) to construct a pipeline that will supply one of its refineries in Tennessee with oil. Not only is Valero Energy financing half the project's cost, but it signed a 10-year minimum volume contract, which will supply Plains with stable income for a decade.
In addition to its internally developed growth projects, the company has been busy expanding its asset footprint and opportunity set in the fast-growing Permian Basin. For example, in January the company spent $1.2 billion to buy a crude-oil gathering system in the basin, and it followed that up in February by signing a joint venture to acquire another pipeline in the region. Those transactions will increase Plains' current cash flow, as well as provide opportunities to invest capital in expanding those systems. Furthermore, by growing its footprint in the basin, Plains has been able to capture additional organic growth opportunities, including the announcement of two new pipeline projects in the region that would move crude to market centers. If everything goes according to plan, these pipelines could be in service by 2019.
The visible growth from these strategic initiatives has Plains forecasting that it could generate as much as $3 billion in annual earnings a few years from now, which implies more than 30% growth from the company's 2017 projection. That forecast suggests that Plains can sustain its current payout, with an increased likelihood that it could grow it over the coming years while maintaining a conservative financial profile.
Investor takeaway
Plains All American Pipeline has focused on enhancing the long-term sustainability of its payout over the past year. It has done so by significantly improving its financial profile, which should only get better as the company completes its current slate of growth projects. Meanwhile, with new expansion projects in the works, the company could soon start delivering sustainable income growth, which is exactly what retirees are looking for these days.
