Targa Resources Corp's (NYSE:TRGP) 8%-yielding dividend might look attractive, but at the moment it's hanging by a thread. The natural gas pipeline and processing company just managed to generate enough cash flow to cover it last year and expects razor-thin coverage again this year. That's well below the levels of its pipeline peers, which like a margin of safety of 20% to 50% (and above) of cash flow because it gives them a head start on financing expansion projects.
Because Targa Resources doesn't have the luxury of generating excess cash, it has had to be creative in financing expansion projects; it also can't issue more stock to raise money, as this would make its already-tight dividend coverage even worse. While that same scenario led rival Kinder Morgan (NYSE:KMI) to slash its dividend and divert that cash to fund capital spending a few years ago, Targa is using a variety of alternative funding sources to finance its growing slate of projects. If this plan works, those expansions could potentially support significant dividend growth in the coming years.
Targa Resources has lined up $3.215 billion of capital projects, which should enter service through 2020, including $850 million of new ones announced this week. That's a large funding requirement for a company that pays out all its spare cash in dividends. However, it has steadily chipped away at that number by partnering on projects with other pipeline companies and private equity funds.
In January, Targa secured a 50-50 joint venture with Hess Midstream Partners (NYSE:HESM) to build the Little Missouri 4 natural gas processing plant in North Dakota. The partners will construct the $150 million project at Targa's existing Little Missouri facility. The joint venture, which should enter service by year-end, offloaded half of the capital costs to Hess Midstream, but also provided the MLP with more fuel for its fast-growing high-yield distribution.
The company also expanded its natural gas processing joint venture with MPLX (NYSE:MPLX) in Oklahoma. This existing 60-40 partnership will build a new gas-processing plant that should also start up by year-end. However, instead of funding 60% of the cost, Targa contributed a decommissioned plant that will eventually become the new one after upgrades. In addition, Targa contributed another plant to the joint venture and will receive a cash distribution from MPLX so the partners can maintain their current 60-40 split.
Finally, last month Targa secured a $1.1 billion development joint venture with a private equity fund. The funding venture will own Targa's 25% stake in Kinder Morgan's Gulf Coast Express Pipeline, a 20% interest in Targa's Grand Prix Pipeline, and 100% of the company's next NGL fractionation train, which will separate NGLs into the various streams like propane and ethane. Much like Kinder Morgan's private equity funding deals over the past few years, this transaction offloads future capital costs. One major difference: Targa has the option to reacquire these stakes after all assets enter service in 2020.
Exploring alternatives for the next round
These various partnerships initially eliminated much of Targa's equity-funding needs for 2018 and 2019. However, the company recently announced that it would invest $350 million to extend its Grand Prix Pipeline and spend $500 million in building two new natural gas processing plants and associated pipelines. As a result, the company now needs to secure more financing.
Targa Resources is currently evaluating a range of financing opportunities, including additional joint ventures as well as potentially selling its petroleum logistics and marine barge businesses. These sales could offset a significant portion of the capital required for its latest round of expansion projects.
Building a better future
This growing slate of projects has Targa Resources on pace to increase earnings from $1.14 billion last year to well over $2 billion in 2021, after all these expansions enter service. That potential to nearly double earnings in the next few years could spark a substantial improvement in the dividend-coverage ratio, since the company might not have to issue much, if any, equity to finance this growth in the near term. So it looks increasingly likely that Targa Resources will avoid the fate of Kinder Morgan and maintain its lucrative 8%-yielding dividend while it builds these projects, and potentially increase the payout significantly as the projects start sending cash flow higher.