When a dividend yield gets over 10%, it's usually a sign that the market believes a cut is coming down the pipeline. Given that Energy Transfer Partners (ETP) and Summit Midstream Partners (SMLP -0.25%) currently yield 11.6% and 14.5%, respectively, the market seems to believe that will be the case for both of those master limited partnerships. That's why investors should steer clear of those two high-yielding stocks and instead consider Crestwood Equity Partners' (CEQP) much safer 7% payout.
The numbers look good, but they're not the issue
On the surface, Energy Transfer Partners' ultra-high-yielding payout looks like it's on solid ground. During the first quarter of 2018, the company covered it with cash flow by a comfortable 1.1 times after adjusting for the support provided by parent company Energy Transfer Equity (ET -0.19%), which has temporarily reduced its management fees to help its MLP fund a large slate of expansion projects. That's a noticeable improvement from the year-ago quarter when Energy Transfer Partners would have paid out all its cash flow, and then some, if it weren't for the assistance of Energy Transfer Equity.
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While the company's expansion projects should boost cash flow in the coming quarters, investors worry that Energy Transfer Partners won't be around long enough to benefit from that uptick. That's because Energy Transfer Equity is exploring ways to simplify its corporate structure, which will almost certainly result in Energy Transfer Equity acquiring Energy Transfer Partners. CEO Kelcy Warren stated as much on the company's most recent quarterly conference call, saying that "we've looked at every scenario possible to us. And we don't see any mathematical scenario that makes any sense other than that one." That transaction will likely result in a distribution cut for Energy Transfer Partners' investors down to Energy Transfer Equity's lower rate.
The numbers went south quickly and could get worse
Last year, Summit Midstream Partners covered its high-yield payout by a comfortable 1.14 times. For 2018, however, the company expects to barely generate enough cash to cover the payout due to some additional costs. As a result of that tight leverage ratio, the company will need to rely on its balance sheet to fund the expansion projects it has underway.
While Summit seems to have enough financial wiggle room to maintain its payout this year even as it also finances expansion projects, it's not clear how long the company can keep this up considering the potential cash outflows it has coming down the pipeline. One of those is the proposed Double E Pipeline, which Summit has under development. The pipeline could cost up to $450 million to build, which would be a significant undertaking for a company of Summit's size considering that it only expects to produce $300 million in earnings this year. While the company is looking for partners to help fund the project, it doesn't have all that much flexibility to finance even a reduced portion of the anticipated capital cost because it also has to pay back its parent for an acquisition made in 2016. As of the end of the first quarter, the company still owed its parent $467.5 million, which is due by the end of 2020. With so much cash potentially heading out the door in the coming years, Summit might have no other choice but to slash its distribution so that it can meet these obligations.
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A much better option
While there are serious concerns about the sustainability of the high-yielding payouts of Summit Midstream and Energy Transfer Partners, that's not the case at Crestwood Equity Partners. The company currently expects to cover its lucrative payout with cash flow by a comfortable 1.2 to 1.3 times this year. That will leave it with some excess cash, which when combined with its solid balance sheet, should provide Crestwood with the money to finance its current slate of growth projects. The company believes that those expansions will boost cash flow at a 15% compound annual rate through 2020, putting it in the position to potentially start increasing its payout later this year.
That near-term upside is one of the many reasons why Crestwood looks like an excellent buy right now. Another factor is its valuation since the company believes it is "undervalued from several different perspectives." Not only does the company think that it's not getting enough credit for all the fees generated by its legacy assets, but that the market isn't properly valuing its growth prospects. Because of that, Crestwood offers investors a compelling blend of income and upside, while both Energy Transfer Partners and Summit Midstream could have more downside ahead if they end up slashing their payouts.
