Wireline telecom Frontier Communications Corporation (OTC:FTR) is struggling as customers continue to switch to alternative communication options like cellphones. That's already led to a dividend cut this year -- so if you're looking at the company's huge yield, stop. Instead, consider the impressive yields offered by limited partnerships Alliance Resource Partners, L.P. (NASDAQ:ARLP) and Buckeye Partners, L.P. (NYSE:BPL), both of which just raised their distributions.
Not worth the risk
Frontier's yield was recently hovering around 18%. That's a huge yield, but it comes with equally large risks. For starters, the company has already cut its dividend this year. Then there's the not-so-minor issue of a weak balance sheet. Long-term debt stands at 83% of the capital structure; Frontier loaded up on debt to buy more of the wireline assets that underpin its struggling business. Its current ratio, meanwhile, is a relatively weak 0.7. And in the second quarter it announced a write-off that pushed earnings deep into the red. It's been bleeding red ink for two years, with 2017 likely to bring that number to three.
In the end, that nearly 20% yield appears to be pricing in a lot of risk and, likely, more dividend cuts.
Slow and steady
Instead you should consider Buckeye Partners, a midstream partnership with a 22-year history of annual dividend increases and a yield of around 9%. This is notably higher than some of the larger players in the midstream space, partly because Buckeye hasn't been able to cover its distribution lately -- for example, in the second quarter, distribution coverage was just 0.95. But there's a reason for this, and, equally important, there's a reason why it raised the distribution in the quarter despite the shortfall.
Buckeye takes a long-term view of its business. At times that means its investments for the future will push distribution coverage below 1. That happened in 2013 and 2014, before coverage rose above 1 in the following two years. Roughly 30% of the $8 billion in investments the partnership has made since 2010 occurred in in those two years, largely driven by acquisitions. It didn't pull back on its distribution increases because management expected those investments to eventually pay off... which they did.
The current shortfall was partly driven by a recently completed $1.15 billion acquisition that materially increases Buckeye's global presence. It appears that the partnership is letting its coverage ratio drift below 1 while it waits for that investment to bare fruit. It also has a number of growth projects it's working on, like a pipeline to connect the prolific Permian Basin to facilities it has on the Gulf Coast in Texas.
In the end, as long as the world continues to use oil and natural gas, Buckeye's largely fee-based business should continue to grow and support further distribution increases. The short-term dips in coverage, like the one it's seeing today, appear to be buying opportunities, not cause for alarm.
Not dead yet
Another option worth digging into is 10%-yielding coal miner Alliance Resource Partners. On the surface coal seems like a dying industry, and it is. But that death is going to be slow and drawn out, and Alliance is easily one of the best-run coal partnerships around.
For example, despite a deep industry downturn that's pushed some of the largest companies in the coal sector into bankruptcy court, Alliance managed to remain profitable in each of the last 10 years. A big part of that is the location of its main operations, which reside in the Interior Region.
The U.S. Energy Information Administration expects the Interior Region to increase its share of U.S. coal production from 20% to 26% between now and 2040. Equally important, it also expects coal to remain a key part of the U.S. power grid until at least that point -- if not longer. Basically, coal is in slow decline, but it's far from dead. And Alliance happens to be very well positioned to deal with the situation.
You also need to take into consideration the company's recent 14% distribution hike. The coal miner expects to cover its distribution by a massive 1.7 times in 2017. That means there's not only a margin of safety, but there might even be some room for more increases. The high yield offered today appears to paint Alliance with the same brush as weaker coal miners, when it really is in much better shape.
Risks worth taking
There are clearly risks involved in buying Buckeye or Alliance. For example, Buckeye's investments might not pay off, and coal's position in the power grid could decline faster than expected, curtailing Alliance's prospects. But both have just increased distributions, which is a sign of confidence in the future. Contrast that with Frontier, which just cut its dividend and had to write down the value of its assets. Sure the 18% yield is enticing, but I don't think Frontier is worth the risk. Consider high yielding Buckeye and Alliance instead.