Holly Energy Partners (HEP -0.49%) and Andeavor Logistics (ANDX) have delivered impressive dividend growth throughout their histories. Holly Energy Partners recently raised its distribution for the 56th consecutive quarter, while Andeavor Logistics just broke a string of 29 straight quarterly increases.
However, due to continued turbulent market conditions in the midstream sector, investors in both companies could see their income streams decline in the coming year. That's why dividend-seekers might want to hold off on buying these midstream companies until there's more clarity on the long-term sustainability of their high-yielding payouts.
New parent, new rules
Andeavor Logistics' parent company recently merged with refining giant Marathon Petroleum (MPC -1.91%). As a result, Marathon is currently evaluating its plans for Andeavor Logistics. One of the first changes it made was to put an end to Andeavor Logistics' distribution growth streak.
However, that probably won't be the only change because Marathon wants to run the company more like its MLP MPLX (MPLX -0.29%). That would mean having a low leverage ratio and higher distribution coverage level so that the company can internally finance its expansion initiatives. While Andeavor Logistics' leverage ratio was 3.7 times at the end of the third quarter, which was consistent with Marathon's less than 4.0 times debt-to-EBITDA target, distribution coverage was 1.05 times. That's well below the current level of MPLX, which covered its payout by 1.47 times during that same quarter.
Marathon Petroleum has several options to boost Andeavor Logistic's distribution coverage. The quickest way would be to reduce the 11.4%-yielding payout. However, the company could also continue holding the distribution at its current level and let coverage grow alongside cash flow, or merge that entity with MPLX, which would have the same effect as a distribution cut. Since most of its alternatives involve a payout reduction, there's a high risk that this high-yielding payout might not last much longer.
Hanging by a thread
Holly Energy Partners is currently paying out 100% of its cash flow to support its 9.3%-yielding distribution, leaving it with no breathing room. Because of that, the company needs to finance its current slate of growth projects with its credit facility. While the MLP has a solid leverage ratio of 4.2 times, that's below the comfort zone of Marathon.
Making matters worse, the company doesn't have much growth coming down the pipeline since its refining parent, HollyFrontier (HFC), ran out of assets to sell to its MLP. Meanwhile, the company noted on its conference call that it isn't able to issue new units to acquire assets from third parties or pay for expansion projects due to the complete closure of the MLP equity market. In the words of CEO George Damaris, "we're in a tight spot." The company doesn't know how long it will take until market conditions improve, which leaves "no obvious strategic or corporate action to us at the moment," though it will "look at all the options," according to Damaris.
Among those it could consider is slashing its payout so that it can reduce leverage and self-finance expansion, or HollyFrontier could take the company private, which is what fellow refiner Valero Energy did with its MLP. Either option would result in investors collecting less income going forward.
It's not looking good for these income stocks
Andeavor Logistics has already ended its distribution growth streak, while Holly Energy Partners appears poised to join it in the coming months. That's likely just the beginning since it seems possible that both companies will reduce their high-yielding payouts in the future, either through an outright cut or a merger with a lower yielding entity. Because of that, income-seekers are better off steering clear of these high-yielding stocks until there's more clarity on their long-term prospects.