More often than not, dividend investors focus their attention on a stock's current yield instead of its ability to sustain that income stream over the long term. As a result, they can end up getting burned when those payouts flame out.
That future pain seems likely for investors in Sunoco LP (SUN 2.17%) and Targa Resources (TRGP 2.17%) since their payouts appear to be on shaky ground. That's why investors should stay away from those high-yielders for now and instead consider Crestwood Equity Partners (CEQP), which offers a rock-solid payout with visible growth coming down the pipeline.
Even the targets are too low
Fuel distribution company Sunoco LP currently yields an eye-popping 11.5%. However, that payout looks to be hanging by a thread. For starters, Sunoco LP has barely generated enough cash flow to cover its distribution to investors over the past year, averaging a tight 1.04 times coverage ratio, which was below its 1.1 times target. Worse yet, the company has way too much debt, evidenced by a leverage ratio that was a dangerous 5.59 times last quarter, well below its 4.5 to 4.75 target range.
Sunoco LP is in the process of addressing its financial concerns, having secured a deal earlier in the year to sell the bulk of its retail gas stations to 7-Eleven for $3.3 billion in cash. The company hopes to close the transaction early next year, which will give it the money to pay down debt and repurchase enough equity so that it can better cover cash distributions to investors. That said, even if it hits its targets for leverage and distribution coverage, those levels would still be below most other master limited partnerships, which tend to prefer leverage of less than 4.0 times and coverage of at least 1.2 times. So, Sunoco LP's ability to sustain its lucrative distribution over the long term remains one big question mark.
Razor-thin coverage, especially given the cash flow volatility
Pipeline and processing company Targa Resources pays a generous 7.7%-yielding dividend. However, it's a bit too generous at the moment because the company paid out more than it brought in last quarter and is on pace to do that for the full year since it sees coverage between 0.95 to 1.0 times. That's a concern, considering that Targa only gets about two-thirds of its cash flow from predictable sources like fee-based contracts while most pipeline companies secure more than 90% of their earnings from stable sources. Meanwhile, because of its tight coverage, it must raise outside capital to finance all its expansion projects and any dividend shortfall, which is costlier to do with its weaker financial profile.
That said, Targa does have a bounty of growth projects underway, which should fuel significant cash flow growth in the coming years. In the company's estimation, earnings could rise from $1.13 billion this year to as much as $2 billion by 2021. That growing income stream could provide more breathing room on the payout and might even enable it to start increasing the dividend once again. However, that's if it can find the money to finance those projects. If it can't, then it might need to temporarily cut the payout and use that cash to fund expansion projects, which is why the sustainability of this dividend looks so uncertain.
Great ratios and visible growth coming down the pipe
Crestwood Equity Partners, on the other hand, offers a rock-solid payout with highly visible growth prospects. Currently, the company yields an impressive 9.5%, which it expects to cover with cash flow by about 1.3 times this year. Furthermore, its cash flow is much more predictable than Targa's given that 85% comes from fee-based assets. In addition, it has a comfortable leverage ratio of 4.1 times, which provides plenty of financial flexibility for financing expansion projects.
Speaking of which, Crestwood has several near-term growth projects in progress, which it has prefunded with retained cash and the sale of a noncore asset. Therefore, cash flow should rise from around $220 million this year to about $250 million in 2018. That positions the company to start growing its already lucrative payout in the second half of 2018 while maintaining healthy coverage and leverage ratios. That visible growth, when combined with Crestwood's stronger financial metrics makes it a far better choice for income seekers.
It pays to dig a little
While all three of these energy companies offer exceptionally high yields, only one appears to have the ability to maintain its lucrative payout over the long term. However, investors wouldn't know that unless they did some homework. That's why it pays to look past a company's tempting yield to make sure it has the numbers to back it up.