Thanks to some stock sales at the end of last year, my portfolio was flush with cash at the beginning of 2018. I decided to put some of that money to work by investing in several high-yielding energy companies that I thought were good bargains.
While two of those stock picks haven't done much more than supply my portfolio with income, the third, midstream MLP Crestwood Equity Partners (CEQP), has taken off. Overall, my first purchase is up more than 40% and the total return is closer to 50% after adding in its high-yielding distribution.
While there's some temptation to cash in my chips and reinvest the winnings into another opportunity, I think holding is the better option because I believe Crestwood Equity still has ample upside ahead. Three factors drive that view.
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Locked in an excellent income stream
One of the characteristics that initially drew me to Crestwood was an irresistible high yield, which was 9.5% at the time of my initial purchase. While yields approaching double digits are often a sign of trouble, I didn't believe this was the case for Crestwood because it spent the past few years addressing its financial issues by cutting costs and selling assets.
As a result of those moves, the company expected to cover its lucrative payout with cash flow by a comfortable 1.2 to 1.4 times in 2018, which was a vast improvement from a few years ago when it barely generated enough money to pay its distribution. Further, Crestwood anticipated that its leverage ratio would be between 4.0 to 4.5 times this year, which is not only a solid level for an MLP but an improvement from 4.8 times last year.
Meanwhile, thanks to its strong showing through the first half of this year, Crestwood's financial metrics are coming in slightly better than expected, increasing the sustainability of its payout. Because of that, it would make sense to keep holding for the distribution alone since Crestwood should be able to keep paying out this current rate for years to come -- meaning I'd still earn a near double-digit yield. Further, that payout has the potential to increase in the future given the company's growth prospects.
Even more growth coming down the pipeline
While Crestwood Equity Partners' financial results have improved this year, the company is just about to hit its stride. That's apparent from comments made by CEO Bob Phillips on the company's first-quarter conference call where he said, "when combined with the new projects that we have coming online in 2018, we expect Crestwood will reach an inflection point near midyear 2018 to begin to see meaningful cash flow growth as we exit the year and move into 2019." In the company's view, cash flow will increase at a more than 15% compound annual growth rate on a per-unit basis through 2020, given the expansion projects it currently has in the backlog.
The company's growth prospects have improved even further since that time due to some recent transaction activity. In July, the company acquired a stake in a section of the EPIC NGL pipeline, which will enable it to move natural gas liquids produced from its recently completed Orla gas processing plant to a customer on the Gulf Coast.
Meanwhile, that same month, the company and its joint venture partner Williams Companies (WMB 1.21%) said that they'd secured a contract with a large customer to support the further build-out of their Jackalope gas gathering system in the Powder River Basin. As part of the expansion, Williams Companies and Crestwood will construct additional gathering pipelines to connect newly drilled wells to their Bucking Horse natural gas processing plant, which they will expand by year-end, as well as add a second facility by the end of next year. These expansions should enable Crestwood to grow its cash flow at an even faster pace in the coming years while providing a boost to Williams' growth prospects, as well.
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It's still cheap despite the rally
One reason Crestwood's yield was nearly in the double digits earlier this year was that the company sold at a deeply discounted valuation. At the time I invested in the company, it was trading at around eight times cash flow, which was ridiculously cheap compared to other MLPs that were selling for about 15 times cash flow, on average. While that discount has narrowed somewhat thanks to Crestwood's rally, shares still are cheap compared to rivals, especially when looking ahead to 2019.
Currently, Crestwood trades at around 10 times next year's earnings, which should be meaningfully higher than 2018's results. Contrast that with its peers, which, on average, sell for 12.2 times projected 2019 earnings. That discount doesn't make sense considering that Crestwood is growing faster than most rivals these days and therefore should trade at a premium valuation compared to its peers.
It all adds up to a compelling case to continue holding
While Crestwood isn't the steal it was at the beginning of the year, it's still a compelling buy right now. That's because there's plenty of upside left since the company's cash flow growth engine is just about to hit the accelerator -- which could fuel distribution growth in the future -- and it's trading at a relatively cheap price. Add in its high-yielding payout, and this midstream company could continue generating high-octane total returns in the coming years, which is why I plan to keep holding.
