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This 9.9%-Yielder Could Be an Ideal Option for Fearless Investors

By Matthew DiLallo – Mar 19, 2018 at 2:37PM

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Units of this high-yielding oil and natural gas pipeline MLP have tumbled even though its financial numbers look good.

Last year was both the best of times and the worst of times for Tallgrass Energy Partners (NYSE: TEP). On the one hand, the midstream MLP delivered outstanding financial results in 2017, with earnings, cash flow, and distribution coverage all coming in at the high end of its guidance range. Because of that, the company was able to boost its payout by an impressive 18%, which fueled 32% distribution growth at its parent Tallgrass Energy GP (TGE). However, despite all that progress, Tallgrass Energy Partners' stock has lost a quarter of its value in the past year, which when combined with that big-time distribution increase, has pushed its yield up to 9.9%.

When a dividend yield gets close to the double digits, it's often a sign that the market sees a payout cut coming. While Tallgrass' financial metrics suggest otherwise, there is one area of uncertainty that has the market spooked. That dynamic makes this stock a compelling opportunity for investors who aren't afraid of accepting more risk for a potentially richer reward. 

A man in a suit being carried across a wide gulf by balloons.

Tallgrass' numbers seem to suggest it can navigate the current uncertainty. Image source: Getty Images.

Tallgrass Energy Partners 101

Tallgrass Energy Partners is an oil and natural gas pipeline and processing MLP that operates mainly in the central part of the country. While the company operates a diverse set of assets, its crown jewel is the 1,712-mile Rockies Express Pipeline (REX), which moves natural gas both east and west from the Rockies and Appalachia. The company owns a 50% stake in the system, with the remainder split between its parent Tallgrass Energy GP and refining giant Phillips 66. Another important asset is the Pony Express Pipeline, which moves crude oil from the Powder River Basin to refineries in Kansas and Oklahoma, among them Phillips 66's Ponca City refinery.

Tallgrass Energy has steadily grown its asset footprint over the years by investing in a combination of organic growth projects, third-party acquisitions, and drop-down transactions with a development company now owned by its parent. In fact, earlier this year the company acquired the final 2% interest in the Pony Express pipeline it didn't already own, and signed a joint-venture agreement with a third party to build another pipeline. That said, it's worth noting that Tallgrass has maintained very conservative financials even as it has expanded its portfolio. It ended last year with a low 3.0 times leverage ratio while covering its high-yielding distribution by an ultra-conservative 1.47 times.

A pipeline under construction with a blue sky up ahead.

Image source: Getty Images.

What's coming down the pipeline

Those metrics suggest that Tallgrass Energy should have no problem meeting its goal to increase its payout another 7% to 10% this year, which would power an accelerated 37% to 40% increase in the distribution of parent Tallgrass Energy GP. The company anticipates that organic growth projects and third-party acquisitions announced over the last few months will fuel this growth. For example, last year the company made several purchases in the Powder River Basin to build out an oil and gas gathering business as a first step in becoming a one-stop shop for producers in the region.

That said, this distribution growth plan assumes Tallgrass remains a standalone entity, which might not be the case. Earlier in the year, Tallgrass Energy Partners and Tallgrass Energy GP announced that they were evaluating a reorganization that could either combine them into one entity or at least eliminate the high management fees the MLP pays its parent. The uncertainty about how this will play out has been one factor weighing on Tallgrass' valuation this year. 

That's because several other MLPs have opted to reduce their payouts as part of similar reorganizations. NuStar Energy, for example, slashed its dividend 45% after announcing a deal to acquire its parent this year. Meanwhile, Plains All American Pipeline reduced its payout 21% in 2016 after securing an agreement with its parent to eliminate management fees, and went on to cut it by another 45% last year.

That said, both NuStar Energy and Plains All American Pipeline needed to reduce their distributions -- they had much higher leverage ratios of more than 4.5 times, and concerning distribution coverage ratios of less than 1.0. That's not to say Tallgrass won't choose to cut its payout as part of a transaction simply to remain ultra-conservative, but it doesn't seem likely given its stronger metrics.

An interesting option for those unafraid of the unknown

Tallgrass Energy looks like an enticing opportunity for income-seeking investors given that it offers a high and fast-growing yield backed by conservative financial metrics. That said, the company did throw some uncertainty into the mix by announcing that it might reorganize. While that unknown is weighing on the valuation right now, it's also providing investors who are comfortable with the added risk an discounted opportunity to scoop up what could be a high upside, high-yield stock. 

Matthew DiLallo owns shares of Phillips 66. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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