If a fat dividend is what you're after, the energy master limited partnership industry is a great place to go hunting. MLPs are required to pay out most of their net income as distributions to their unitholders, so they tend to have better-than-average yields.
But even I was floored a few weeks ago when I saw that energy MLP Buckeye Partners (NYSE:BPL) was sporting a 15.2% yield. Even in the world of high-yielding partnerships, that's absolutely bananas: easily one of the highest in the sector, if not in the whole stock market.
Since then, the yield has bounced around a bit, and is currently at 13.3% as of this writing, but still: Wow! And what's even more amazing is that (at first glance, anyway) the company doesn't seem to have any major issues that would explain why the yield has become so big.
So, is this really just a case of the market completely overlooking an incredible value? Or is there danger lurking just below the surface? Let's take a closer look at Buckeye Partners to see if it's worth the investment.
What Buckeye does
As an energy MLP, Buckeye Partners owns and operates a network of petroleum product pipelines, storage tanks, and terminals. Buckeye owns 6,000 miles of pipelines, and in recent years has significantly raised its terminal capacity, including through the purchase of VTTI Energy Partners this year.
While 6,000 miles sounds like a lot, it's not that much in the grand scheme of things. Fellow MLP Magellan Midstream Partners (NYSE:MMP), for example, operates 10,800 miles of pipelines and 80 terminals. Buckeye's pipelines are exclusively located in the Northeast and upper Midwest, primarily between St. Louis and New York City, with a large footprint around Chicago. Its terminals and storage facilities, though, sprawl across the country and the globe, with marine terminals on the Gulf Coast and in Western Europe, the Caribbean, and even Singapore.
That makes for a diversified business portfolio within the sector.
History is on its side
Despite its diversification, Buckeye isn't invincible. The company's Q2 2018 earnings were down, thanks to weakness in its segregated storage division. That could spell trouble for its yield.
The company isn't currently generating enough cash flow to cover its distribution, with Q2's coverage ratio an unappealing 0.87 times. And Buckeye expects overall 2018 coverage to be only 0.9 times to 0.95 times. In other words, even the company's rosiest scenario shows it falling short.
That hasn't been an issue for Buckeye in the past, however. As the company pointed out in a June presentation, it has never cut its distribution in its more than 30-year history, and has maintained its distribution during past periods in which its coverage ratios slipped below 1.0 times. Management even went so far as to proclaim, "Given our current outlook, we have no intentions of cutting Buckeye's distribution, and we continue to view a distribution cut as an option of last resort."
That sounds pretty comforting. But a lot can change in a month.
Below the surface
Despite Buckeye's history and management's promises, though, the company's current situation may be unsustainable. When an MLP can't cover its distribution, it has three choices:
- Increase cash flow (usually by bringing new projects on line) to cover the current distribution.
- Cut the distribution -- which doesn't make investors happy, but is sometimes a necessary step.
- Fund the difference through debt.
Unfortunately, Buckeye may not have that much room to keep funding its distribution through debt. CEO Clark Smith has stated in no uncertain terms that maintaining an investment-grade credit rating is of paramount importance. But the company's debt is already five times its EBITDA, which is generally considered the upper limit to warrant an investment-grade rating for this industry. The company touts the figure of 4.3 times adjusted EBITDA, but it's still very high.
In other words, funding the distribution through more debt isn't sustainable, and may not even be possible while keeping an investment-grade credit rating. Buckeye's debt is already rated Baa3/BBB-, just one level above junk status.
The company may find it tough to increase cash flow significantly, as well. Its total projected capital expenditures (capex) for 2018 are just $610 million to $680 million. That's not much: Fellow energy MLPs Magellan Midstream Partners and Spectra Energy Partners, despite being much smaller than Buckeye in terms of revenue, are spending $950 million and $1.6 billion, respectively, on capex in 2018.
That leaves a distribution cut as the only remaining option. And despite previous statements to the contrary, in the most recent earnings call, Smith hinted that one might be on the way. First, he announced a pending strategic review of Buckeye's asset portfolio and financial strategy, in which "no option will be off the table." Then he followed up with, "Given the challenges we face in our business and our ability to maintain our investment-grade rating, our distribution policy will be part of the strategic review that I just spoke about."
That makes the current yield look tenuous at best.
Winter is coming
While Buckeye has a long history of distribution increases even in the face of insufficient cash flow coverage, that might be coming to an end. The company has now held its payout steady for five consecutive quarters and is publicly contemplating changes to its distribution policy. Other options seem to be off the table, as management clearly wants to maintain its already bruised investment-grade credit rating.
It's worth noting that even a 50% distribution cut would still result in a roughly 6.7% yield, which is pretty high. And if the unit price dropped in response, that yield would go up.
But as part of its strategic review, Buckeye could decide to drop its MLP structure. Many MLPs have been vanishing lately, and with them have gone their mouthwatering yields.
Buckeye's yield might look tempting, but one way or another, it might not be around much longer. If the high yield of an MLP is what you're after, there are surer bets for your money.