For the past 18 months or so, Wall Street has been telling Buckeye Partners (NYSE:BPL) that it is concerned with the financial status of the business and its incredibly lucrative payout to investors. In that short period of time, the master limited partnership's stock has declined 45%, and its distribution yield, which has historically been in the 6%-7% range, jumped all the way to 15%.
For several quarters, Buckeye's management was saying that everything was fine and that it would be able to maintain its payout for the foreseeable future. When the company released its second-quarter results, though, management's tone was notably different. Let's take a look at Buckeye's most recent results and why management appears to be listening to what Wall Street has been saying about its payout for some time.
By the numbers
|Metric||Q2 2018||Q1 2018||Q2 2017|
|Revenue||$940.8 million||$1.18 billion||$810.2 million|
|Adjusted EBITDA||$254.8 million||$261.7 million||$269.2 million|
|Net income||$91.9 million||$112.3 million||$112.7 million|
|Distributable cash flow||$161.9 million||$169.7 million||$170.3 million|
The good news: Buckeye's revenue increased significantly compared to this time last year, and its direct and indirect operating expenses (sales, general, and administrative) were down compared to this time last year. The trouble for Buckeye, though, is that the company's cost of product sales is outpacing sales growth as its marine terminal capacity utilization rate declines as global crude inventory levels get drawn down. At the end of the quarter, its capacity utilization rate was down to 85%.
These higher costs have put a damper on Buckeye's cash-generating abilities, and now the company's distribution coverage ratio (total cash available for distribution over distributions paid) is at a dangerously low level of 0.87. Management noted on its investor day presentation in June that it expected its distribution coverage ratio for the year to be between 0.90 and 0.95, but the continued weakness in the company's global terminals is making that goal harder to achieve.
The lack of cash coming in the door couldn't come at a worse time for Buckeye: The company is trying to put the finishing touches on $600 million in capital projects this year and has recently announced a slew of new major capital projects, such as a crude oil and condensate export terminal in Corpus Christi, Texas.
What management had to say
For some time, Buckeye's management has touted the company's long-standing distribution, its investment-grade credit rating, and its ability to work through short-term cash shortages. This past quarter, though, CEO Clark Smith's prepared remarks suggested a reversal in strategy as the company looks into ways of funding its growth plans:
[O]ur ability to execute on these opportunities could be limited by the lack of available sources of capital at a reasonable cost. In addition, although we expect to see improvement in our segregated storage business in the next 12 to 18 months, in particular, with the anticipated benefits of the [International Maritime Organization's] 2020 marine fuel regulatory changes, both our distribution coverage and leverage have been negatively impacted by continued challenging market conditions for segregated storage, combined with the anticipated increased levels of capital expenditure. In light of these factors, our board of directors and management have initiated a comprehensive review of our asset portfolio and financial strategy as we look to guide the company through this current business cycle.
On top of the news that Buckeye Partners is looking to sell assets, there was also this:
[I]n addition, we are assessing our capital structure and the potential benefits of transitioning to a self-funding model for the equity portion of our growth capital requirements, limiting our dependency on public equity markets.
To self-fund the equity portion of its capital spending, the company would need to generate cash from operations in excess of its distribution to shareholders. To free up cash for this strategy, though, a distribution cut would likely be needed. Clark said that management will announce the results of this strategic review during the third-quarter earnings release in November.
You can read a full transcript of Buckeye's conference call here.
Taking drastic steps
For the past year and a half, the market has been pricing in the possibility that Buckeye was going to have to make some changes to its distribution policy if it wanted to maintain its capital spending and its investment-grade credit rating. Paying for its growth without internally generating cash just didn't seem doable. Of course, the mention of a strategic review gave shares a considerable bump since the earnings report came out, as it shows management is taking its cash issues seriously.
Chances are, this strategic review will result in some sort of distribution cut. The size of that cut is yet unclear, though. Ideally, management would target a payout that results in a distribution coverage of around 1.2 as that would provide a good amount of excess cash to fund projects. Until we see the results of this review, though, it's probably best to stay away from Buckeye's stock.